Why do early/middle accumulators need to purchase TIPs?

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AZK
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Why do early/middle accumulators need to purchase TIPs?

Post by AZK »

From all my reading, I see that it's recommended to have some bond portfolio in TIPs. I see the rationale for those that are near the end of their accumulation phase or in their retirement phase (or who have a heavy weighting towards fixed income). I don't see the logic for those just starting out or in the middle of their accumulation phase.

Doesn't your salary and subsequent contributions to your retirement account act as a hedge against inflation?

Moreover, for someone with a heavier weight towards equity, somewhere in the 60-80% range of total assets...won't your equity also act as a hedge?

Thanks.
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Taylor Larimore
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Re: Why do early/middle accumulators need to purchase TIPs?

Post by Taylor Larimore »

AZK:

The primary reasons for young investors to hold TIPS:

* Inflation is a concern to everyone regardless of age.

* Inflation affects young investors longer.

* Just like stocks, bond diversification is important. TIPS add diversification.
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Scott S
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Re: Why do early/middle accumulators need to purchase TIPs?

Post by Scott S »

AZK wrote:Doesn't your salary and subsequent contributions to your retirement account act as a hedge against inflation?
As long as your salary and stocks can be counted on to keep going up, sure. :wink:

- Scott
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bob90245
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Re: Why do early/middle accumulators need to purchase TIPs?

Post by bob90245 »

Scott S wrote:
AZK wrote:Doesn't your salary and subsequent contributions to your retirement account act as a hedge against inflation?
As long as your salary and stocks can be counted on to keep going up, sure. :wink:

- Scott
This is the overlooked point that I made in recent thread. Financial planners assume there will be more savings from your peak earning years, the decade or so before retirement. However, many unexpectedly find themselves out of work in their 50's unable to find work with a salary at a level they previously held.

The takeaway: save as much as you can for as long as you can. Also, you can't always rely on stocks earning higher returns doing the heavy lifting for growing your retirement portfolio.
Ignore the market noise. Keep to your rebalancing schedule whether that is semi-annual, annual or trigger bands.
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Re: Why do early/middle accumulators need to purchase TIPs?

Post by dbr »

AZK wrote:
Moreover, for someone with a heavier weight towards equity, somewhere in the 60-80% range of total assets...won't your equity also act as a hedge?

Thanks.
With a high equity allocation there isn't going to be much of an effect either way on what fraction of one's bonds are TIPS. There may be a small benefit from longer bonds to diversify high equity allocations.

One misconception that seems to come up over and over is that TIPS hedge against inflation. More correctly TIPS themselves are compensated for inflation but they do not somehow protect the remainder or totality of the portfolio from inflation. To do that the investment would have to increase return at some multiple of the rate of inflation. TIPS certainly have essentially nil effect on the inflation risk to a high equity portfolio.
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Re: Why do early/middle accumulators need to purchase TIPs?

Post by biasion »

bob90245 wrote: This is the overlooked point that I made in recent thread. Financial planners assume there will be more savings from your peak earning years, the decade or so before retirement. However, many unexpectedly find themselves out of work in their 50's unable to find work with a salary at a level they previously held.

The takeaway: save as much as you can for as long as you can. Also, you can't always rely on stocks earning higher returns doing the heavy lifting for growing your retirement portfolio.
One issue with assuming your salary will increase, regardless of whether it does or not, is that a dollar invested earlier in life is worth much, much more due to the power of compounding.

When I first signed up for Vanguard years ago, I got the example of Jack and Bob, or whatever. Jack invested 2,000 dollars per year from age 25-35 and then stopped investing. Bob started to invest 2,000 dollars at age 35 until 65. Assuming the same rate of return, who had more money at age 65? Jack who only saved from 25-35 had more money due to the power of compounding returns.

Therefore, not saving, delaying saving more, or saving less than you could in your 20's and 30's is a huge lost opportunity. You want that BMW when you're 35? Well, if you live below your means and save like crazy until you're in your late 40's or 50's, you can afford to pretty much *stop* saving at that point and then keep working to "enjoy" life more.

Back to the topic I agree with Taylor. Inflation affects everybody differently, but it negatively affects all.

In this weak economy, you cannot assume your wages will keep up with inflation!

I will evidence Germany. It still has healthy manufacturing, but, the average German has not seen an absolute (not just real, but any) pay raise in over a decade, which means inflation has ravaged many Germans' standards of living, some perhaps more than others.

Given the huge run up in salaries over the last many decades, the lack of unions, the exportation of "cheap" labor abroad, it would be imprudent to assume that Americans can count on more, or even the same earnings in the future.
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Post by billjohnson »

In my opinion, TIPS are not a necessity....at any investing stage.
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Re: Why do early/middle accumulators need to purchase TIPs?

Post by jidina80 »

AZK wrote:From all my reading, I see that it's recommended to have some bond portfolio in TIPs. I see the rationale for those that are near the end of their accumulation phase or in their retirement phase (or who have a heavy weighting towards fixed income). I don't see the logic for those just starting out or in the middle of their accumulation phase.

Doesn't your salary and subsequent contributions to your retirement account act as a hedge against inflation?

Moreover, for someone with a heavier weight towards equity, somewhere in the 60-80% range of total assets...won't your equity also act as a hedge?
I agree with you completely. Most people in the accumulation phase of investing do not need TIPS. Historically, corporate earnings have beat inflation in the long term. You can withstand short term volatility when you have a long term investing horizon.

And apprently Vanguard also tends to agree with you. Their Target Retirement Funds do not add TIPS to the portfolio until nearing retirement age (TR 2015 is currently 2% TIPS and 40% Total Bond Market). Their personal financial planners also do not recommend TIPS in a typical plan until approaching retirement age.

Just.
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Post by GammaPoint »

I'm under 30 and don't have any TIPS, and don't plan on getting any for quite some time. I don't view them being important for me, especially since I have few bonds (~10%) anyway. I would guess that adding TIPS would make my portfolio less risky with lower expected return, and in my particular situation of need, willingness, and ability to take risk that's not something I want to do right now.
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Post by Beagler »

Why don't VG Target Retirement funds add TIPS until fairly late into the glide path? As a % of bonds, TIPS are a fairly small fraction even as the funds approach their target date.

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Post by Noobvestor »

I'm a youngish/earlyish accumulator who holds TIPS. I don't expect them to 'hedge' inflation but prefer to have some component of a portfolio I can count on in the *short* term during periods of higher/unexpected inflation that are likely to *in the short term* hurt nominal bonds and equities. Do I 'need' them? Maybe not, but I feel more comfortable holding them.
I agree with you completely. Most people in the accumulation phase of investing do not need TIPS. Historically, corporate earnings have beat inflation in the long term. You can withstand short term volatility when you have a long term investing horizon.
Seems like the same argument could be applies to cash and various forms of bonds, too. TIPS are not to increase long-term returns but to decrease real-dollar risks, IMHO.
With a high equity allocation there isn't going to be much of an effect either way on what fraction of one's bonds are TIPS. There may be a small benefit from longer bonds to diversify high equity allocations.
Maybe not in our next 2008-like crash, but if inflation and rates go up, equities and long nominals could well tank together. Taylor sums it up well:
The primary reasons for young investors to hold TIPS:
* Inflation is a concern to everyone regardless of age.
* Inflation affects young investors longer.
* Just like stocks, bond diversification is important. TIPS add diversification.
That said, the OP has a point - inflation threatens different people in different ways and to varying degrees, but future income isn't a pure inflation-hedged source of (human) capital either ;)
"In the absence of clarity, diversification is the only logical strategy" -= Larry Swedroe
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AZK
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Post by AZK »

Good points on both sides.

Im buying 20k worth of i-bonds this year and probably yearly for the forseable future. Will likely hold off on a tips fund and revisit in a couple of years.
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Post by Noobvestor »

AZK wrote:Good points on both sides.

Im buying 20k worth of i-bonds this year and probably yearly for the forseable future. Will likely hold off on a tips fund and revisit in a couple of years.
I prefer TIPS simply because I lean toward the simplicity of funds and ability to easily rebalance within accounts, but will be adding some IBonds as well to get more mileage out of my limited tax-advantaged space - both good options.
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Post by jidina80 »

Although I think TIPS are not particularly useful to most investors in the accumulation phase, I don't think an investor is leaving much on the table by having some TIPS. Additionally, Taylor mentioned a good point about it adding diversification in bonds (V's Total Bond Market Fund is not really 'total'. It does not include TIPS).

The 'TIPS or not' question is pretty far down on the list of important investing questions. More importantly, focus on:
1) How much can I invest each month?
2) Should my portfolio be 20% stocks, 50% stocks or 80% stocks?
3) Am I doing a good job of minimizing taxes on my investments?
4) How low can I keep my investing expenses?

Just.
Last edited by jidina80 on Sun May 01, 2011 9:42 pm, edited 1 time in total.
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Taylor Larimore
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Focusing on what's important.

Post by Taylor Larimore »

Hi Just:
The 'TIPS or not' question is pretty far down on the list of important investing questions. More importantly, focus on:

1) How much can I invest each month?
2) Should my portfolio be 30% stocks or 70% stocks?
3) Am I doing a good job of minimizing taxes on my investments?
4) How low can I keep my investing expenses?
Thank you for reminding us of the difference between a forest and a tree.
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LH
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Re: Why do early/middle accumulators need to purchase TIPs?

Post by LH »

AZK wrote:From all my reading, I see that it's recommended to have some bond portfolio in TIPs. I see the rationale for those that are near the end of their accumulation phase or in their retirement phase (or who have a heavy weighting towards fixed income). I don't see the logic for those just starting out or in the middle of their accumulation phase.

Doesn't your salary and subsequent contributions to your retirement account act as a hedge against inflation?

Moreover, for someone with a heavier weight towards equity, somewhere in the 60-80% range of total assets...won't your equity also act as a hedge?

Thanks.
http://www.amazon.com/Great-Depression- ... 158648799X

Read that book. Consider some inflation thrown in that scenerio as well. That is why you should consider TIPS.

Your job may not exist.
Future income planned on may not happen.

Which is more uncertain, me having 100K in TIPS, or me planning to earn 100K 5 years from now working? I would state the TIPS is more certain.
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Re: Why do early/middle accumulators need to purchase TIPs?

Post by Noobvestor »

LH wrote:
AZK wrote:From all my reading, I see that it's recommended to have some bond portfolio in TIPs. I see the rationale for those that are near the end of their accumulation phase or in their retirement phase (or who have a heavy weighting towards fixed income). I don't see the logic for those just starting out or in the middle of their accumulation phase.

Doesn't your salary and subsequent contributions to your retirement account act as a hedge against inflation?

Moreover, for someone with a heavier weight towards equity, somewhere in the 60-80% range of total assets...won't your equity also act as a hedge?

Thanks.
http://www.amazon.com/Great-Depression- ... 158648799X

Read that book. Consider some inflation thrown in that scenerio as well. That is why you should consider TIPS.

Your job may not exist.
Future income planned on may not happen.

Which is more uncertain, me having 100K in TIPS, or me planning to earn 100K 5 years from now working? I would state the TIPS is more certain.
That's what I like about them, too :) I may pay a little back compared to nominals for my inflation protection, but I get paid a little too for their lack of liquidity, and I know I have one piece that will move with inflation even if everything else doesn't. Would I feel lost without them? Naw. Am I glad I have them, even now? Yup.
"In the absence of clarity, diversification is the only logical strategy" -= Larry Swedroe
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Post by vlad »

Bonds of similar maturity will probably return better over the long term, yet carry a lot more risk than TIPS. TIPS allocation should be directly correlated with your personal exposure to inflation and inversely with number of years to retirement, so they are typically not critical to those in accumulation but very attractive to retirees. Ibonds are also useful as a source of tax-deferred state tax-exempt cash - one could consider them as sort of a backup emergency fund, as well as a method of reducing portfolio volatility. As maturities are less critical than with nominal bonds, I do not much like TIPS funds except if you are forced to hold them in taxable space or cannot buy them at auction in tax-deferred; hence, it's best to build a TIPS ladder of longer maturities in your tax-deferred accounts, while staying much shorter on bonds.

Here's an idea to consider: For a young investor desiring an inflation hedge, first buy some longer-term TIPS at auction, and then gradually add new maturities as you age (for example, starting at age 30 or 35, add 30 year TIPS every 5 or 10 years). This should enable you to (1) get the higher rates usually available with longer term TIPS while (2) gradually building a laddered inflation hedge as the need for inflation protection becomes greater.
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Re: Why do early/middle accumulators need to purchase TIPs?

Post by MarginalCost »

Here's my thinking. Please let me know if I'm missing something.
  • At the time of purchase, there is a market-expected inflation rate that is priced into both the cost of nominal bonds and TIPS.
  • If, over a given period, inflation exceeds expectations, TIPS will end up being a good deal, and nominal bonds will end up loosing.
  • If inflation comes in below expectations, I overpaid for TIPS, and nominal bonds end up having been the better bet.
  • (While I can expect stocks to match inflation, in theory they don't particularly benefit or lose from inflation; they are inflation-agnostic.)

So if I exclude TIPS, as many here are advocating, it seems all of my potential downside risk is concentrated in an increase in inflation. If we really want to diversify risk (and suspect inflation is just as likely to come in above as below market expectations) shouldn't I select a protfolio where half of my assets benefit from inflation, and the other half lose?
Last edited by MarginalCost on Sat Mar 07, 2015 12:04 pm, edited 1 time in total.
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Post by abuss368 »

billjohnson wrote:In my opinion, TIPS are not a necessity....at any investing stage.
Indeed.
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Re: Why do early/middle accumulators need to purchase TIPs?

Post by stevewolfe »

I agree with the posters regarding I-Bonds and having a portion of the portfolio that is both protected from unexpected inflation as well as providing stability to the portfolio.
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Re: Why do early/middle accumulators need to purchase TIPs?

Post by thx1138 »

MarginalCost wrote:While I can expect stocks to match inflation, in theory they don't particularly benefit or lose from inflation; they are inflation-agnostic.
I believe from what I've read that on the time scales of rebalancing TIPS are more negatively correlated with equities than nominals are when it comes to unexpected inflation. Part of the reason is that while in the long term stocks make up for inflation in the shorter term they do poorly as do nominal bonds. Total return of your portfolio is not just how each part gives return but how they interact. TIPS are useful during unexpected inflation because they can rebalance into equities while nominal bonds can't.

Before knocking TIPS too much one should also be careful of recency bias - a liquidity oddity during the crash caused TIPS to do unusually poorly compared to nominals. Will the next downturn be the same? Is ignoring TIPS akin to fighting the last battle?

Lastly short term nominals are also a reasonable inflation hedge but have a lower rate risk premium so long term return is lower than intermediate TIPS. But important to realize there is more than one way to deal with inflation.
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Re: Why do early/middle accumulators need to purchase TIPs?

Post by YDNAL »

MarginalCost wrote:Here's my thinking. I'm a novice investor, so please let me know if I'm missing something.
Welcome, Marginal Cost (after 5 posts) !!

This is a 2011 thread, but it makes sense for a new member to be reviewing old discussions. Below, made today, is a good suggestion/observation (excluding word "oddity").
thx1138 wrote:Before knocking TIPS too much one should also be careful of recency bias - a liquidity oddity during the crash caused TIPS to do unusually poorly compared to nominals. Will the next downturn be the same? Is ignoring TIPS akin to fighting the last battle?
TIPS are relatively new as compared to [say] nominal treasuries and lack the history. Vanguard Inflation-Protected Securities Fund Investor Shares (VIPSX), for instance, has been around only since June 29, 2000. As of August 31, 2013, it has also average annual total return of 6.4% since inception.
link: https://personal.vanguard.com/us/funds/ ... =INT#tab=1

All that said, you are correct in that they protect against UNexpected inflation. Inflation is also individual in nature. If you are highly exposed to unexpected inflation, buy TIPS and you win when/if it rears its ugly head. Otherwise, TIPS are what they are - not something beyond which can be made out to be.
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Re: Why do early/middle accumulators need to purchase TIPs?

Post by cflannagan »

YDNAL wrote: All that said, you are correct in that they protect against UNexpected inflation. Inflation is also individual in nature. If you are highly exposed to unexpected inflation, buy TIPS and you win when/if it rears its ugly head. Otherwise, TIPS are what they are - not something beyond which can be made out to be.
And who aren't exposed to UNexpected inflation? I think a lot of people don't realize they have that risk in their portfolio. I have 20% of my bonds in tips to soften things in event unexpected inflation strikes.
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Re: Why do early/middle accumulators need to purchase TIPs?

Post by YDNAL »

cflannagan wrote:
YDNAL wrote: All that said, you are correct in that they protect against UNexpected inflation. Inflation is also individual in nature. If you are highly exposed to unexpected inflation, buy TIPS and you win when/if it rears its ugly head. Otherwise, TIPS are what they are - not something beyond which can be made out to be.
And who aren't exposed to UNexpected inflation? I think a lot of people don't realize they have that risk in their portfolio. I have 20% of my bonds in tips to soften things in event unexpected inflation strikes.
Who isn't "highly" exposed, you asked ?
  • Anyone with tenured work who is largely unaffected by the economy, or consistently upgrades their ability to increase income, or is young(er) with high(er) allocation to Stocks, or....
The worse possible scenario would be UNexpected increased prices of basic commodities while you lose your job, or unable to increase pay, or...
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Re: Why do early/middle accumulators need to purchase TIPs?

Post by thx1138 »

And a fixed rate mortgage is another protection against unexpected inflation many people have.

As to oddity I meant unanticipated and unlikely to be repeated. Prior to that event I think the general wisdom was TIPS and nominals would behave similarly in a flight to safety situation. International central bank policies combined with TIPS use in commercial credit contracts created what has been called the largest arbitrage ever. The next crash likely will not be the same nor will such a huge arbitrage likely appear given it is now well documented.
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Re: Why do early/middle accumulators need to purchase TIPs?

Post by kingpoppy »

thx1138 wrote:And a fixed rate mortgage is another protection against unexpected inflation many people have.
I use my fixed-rate mortgage as inflation protection in lieu of purchasing TIPs
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