Zvi Bodie & TIPS

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snowman9000
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Zvi Bodie & TIPS

Post by snowman9000 »

There is a thread from earlier this year about the book Worry-Free Investing. The thread focuses mostly on how one might or might not benefit from using options to invest in equities.

I just read the book and I don't think that aspect is what Bodie would stress. He stressed buying TIPS during the investment lifetime, to cover a person's retirement needs. The options idea seemed to be a concession to those who felt they had to be in equities in some way.

So what about his idea of building a nest egg completely out of TIPS (and I-Bonds)? Did it fail to gain traction because real rates on the bonds decreased in the years after the book came out?
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Post by nisiprius »

I think it failed to gain traction mostly because there is almost nobody who benefits from it, except the retiree. Who's going to write books about it? There's only one book that needs to get written and Bodie and Clowes wrote it. There's just no money to be made by third parties in selling TIPS to retirement savers.
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SmallHi
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Post by SmallHi »

First of all, very few investors have accumulated (or inhereted) enough money to live on about 2% or so real withdrawals (3% today), especially on an after tax basis. Even if you could make it work, circumstances change, and any increase in spending needs runs the risk of seriously impairing the strategy.

Also, even for individual TIPS owners, many may have a tough time tuning out the short term volatility in prices. The 11% decline on the Vanguard TIPS fund in the last 3 months is more than double the worst 3 month period for nominal Treasuries in 35 years.

For the investor that actually looks at the value of their accounts monthly (and therefore notices changes in account value), they will probably find some combination of short term nominal bonds (say 70%), with a size/value tilted equity portfolio (other 30%), actually offers a higher expected real return for a unit of volatility. Yes, TIPS are guaranteed. But in competitive capital markets, careful risk budgeting should produce a handsome return premium.*

Finally, this is one area where you would find: the higher the demand for TIPS, the worse they get (driving up prices and lowering yields).

Bill Bernstein talks about the book in this article: http://efficientfrontier.com/ef/903/bodie.htm

sh

*if we assume TIPS underperformed nominal treasuries since 1963 by 0.5%, we find $1 invested in a 30/70 portfolio grew to $7.40 after inflation, vs. only $3.55 in TIPS after inflation. Volatility was the same, only minor differences in tax efficiency. The gov't guarantee of inflation was the only difference, and it potentially cost you 50% of your wealth.
Last edited by SmallHi on Tue Oct 28, 2008 9:58 pm, edited 2 times in total.
heyyou
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Post by heyyou »

Has anyone done the math to see just how much nestegg is needed for an all TIPS retirement? What about reinvestment risk?

With the inflation of health care costs and perhaps energy costs both outrunning the CPI-U, will the TIPS only retiree portfolio survive? Looks to me like you are accepting significant risk there. Someone with retiree healthcare from a former employer might do fine with TIPS. That is a thin slice of the retiree population.

I-bonds could help too, but the rules changed so you can't purchase a significant amount now. Is there risk of TIPS being changed?

I'm just skeptical of anything touted as "worry-free" for 30-40 year periods. My Dad bought 4.5% bonds for his retirement. To get that return, he had to get 40 year bonds! As a 1966 retiree, he would have been starving after 30 years.
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Post by stratton »

FYI there is a current thread on a bonds only portfolio here: http://www.bogleheads.org/forum/viewtopic.php?t=26521

Another thread on the Richeldson's book and an interview with them: http://www.bogleheads.org/forum/viewtop ... highlight=

Paul
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Post by RustyShackleford »

SmallHi wrote:First of all, very few investors have accumulated (or inhereted) enough money to live on about 2% or so real withdrawals (3% today)
With portfolio depletion, a 3% real return will support an initial 4% SWR
with inflation adjutsments for 40+ years. That's pretty good for a dead
safe portfolio.
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snowman9000
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Post by snowman9000 »

Bodie also advocated that after accumulating the money via TIPS, upon retirement one should (or might) convert the money to a single purchase immediate annuity. Then the risk of outliving the money is gone. Would that change any of the above opinions?

I'm still thinking it takes real returns of 3% or more in the TIPS.

NOTE: I am in a rush right now and have not read the linked articles yet.
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Post by rmd »

I study and model capital markets as part of my professional work, and have put a special focus on TIPS.

On volatility, the last few weeks have been really extra-ordinary -- and we really don't know why yet. The longer term history of TIPS, and other inflation-linked bonds in other countries, shows a regular pattern of price volatility that is between 50% and 75% for that of a nominal bond of comparable maturity. I personally believe (... and have placed my TIPS bets accordingly) that the credit crisis has temporarily distorted prices through forced selling, along with the short-term prospect of some deflation. I think yields will revert towards the 2% level relatively soon. Am I 100% confident of this? Hell, no -- these days who can be confident of anything!

On the 100% TIPS investment strategy -- that's where I am, and have been for the last 10 years. I am partially retired, and have developed a detailed spreadsheet projecting my spending needs in various categories, such as housing, healthcare, etc. For each category I can set an assumed rate of inflation. Then I project my non-real estate assets (all TIPS) at an assumed 2% real return. Then I open my eyes and see if I am going to be broke before age 95. So far, so good. Having built up enough assets to make this work, I love the idea of sleeping well each and every night when market turmoil erupts...
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Post by daryll40 »

Someone review this math please:

Scenario: Someone accumulates $5Million and invests ALL in tips (taxable account). Say we are in a lowish inflation situation with maybe 3% inflation and 3% tips coupon.

Annually that person would have to pay tax on 6% of $5M or $300,000. Assuming no other income, I am guessing that would cost about $100,000 (maybe more) in taxes. Leaves $200,000. But the coupon was only 3% or $150,000. The other "income" was phantom due to the TIPS inflation adjustment. So there would only be $50,000 of actual free money to spend.

I FULLY understand that my scenario was COMPLETELY approximate. But I sometimes fantasize about a totally stress free portfolio and wonder if TIPS is it. But in the real world for a large accumulator, it doesn't appear that it works because of the tax situation. And that assumes low inflation. If we get 1970s or worse inflation the scenario totally fails.

Or is there something I am missing?
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Post by Robert T »

.
Some selected views on TIPS (my underlines):

CHARACTERISTICS

John Campbell: from Strategic Asset Allocation: Portfolio Choice for Long-Term Investors
  • "In my view, however, the important feature of TIPS is that they are the true riskless asset for long-term investors. Treasury bills are not riskless over the long term, because they must be rolled over at uncertain future real interest rates; but TIPS can support a riskless stream of consumption and should play a central role in conservative long-term portfolios."
William Bernstein – from Zvi Bodie and the Keynes’ Paradox of Thrift
  • "TIPS are a wonderful asset class, with reasonable expected real returns and near total safety. In fact, when The Intelligent Asset Allocator was published in 2000, TIPS were yielding 4%. While I briefly toyed with—and rejected—the idea of an all-TIPS portfolio, I did recommend a healthy allocation to them."
David Swensen – from Unconventional Success: A Fundamental Approach to Personal Investment
  • "TIPS produce the perfect hedge against inflation, because the bond-payment mechanism dictates direct correspondence with changes in inflation rates. The combination of the default-free character of full-faith-and-credit obligations of the US Government and the mathematically certain protection against inflation provides investors with a powerful portfolio tool."
CAUTIONS – the form of TIPS holdings seems to matter

Zvi Bodie – from PIMCO DC Dialogue
  • “It’s important to note that I suggest investing in individual TIPS bonds, rather than an inflation-protected bond fund. Bond funds are marked to market on a daily basis, which takes away the participant’s ability to know specifically the duration and future value of his or her investment. So while the funds are correlated with inflation, the funds have no specific duration and maturity date and, therefore, cannot be used to match a future target.
Brett Hammond – from Using Inflation-Indexed Securities for Retirement Savings and Income: The TIAA-CREF Experience. (from Handbook of Inflation Indexed Bonds)
  • …caution has to do with the effects of daily prices changes on a marked-to-market account as opposed to an individual bond held to maturity. Recall the CREF Inflation-Linked Bond Account, like any variable annuity or mutual fund, is market-to-market each business day. An inflation-indexed bond bought and held to maturity will provide a book value that rises in step with inflation, but a similar bond that is marked-to-market will be priced each day. Also recall that although inflation-indexed bond yields and total returns are likely to be more stable than their nominal bond counterparts, experience form other countries indicates that inflation-indexed bond prices are likely to vary considerably…..Therefore, no marked-to-market fund can guarantee to outpace inflation.
Not sure if these are helpful to others - there were to me.

Robert
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Post by rmd »

A bit more on my own experience with a 100% TIPS investment portfolio. First, and perhaps most importantly, I am doing this with tax-deferred retirement accounts -- so I don't have to deal with the taxation issues, I just pay taxes when I withdraw from the funds. Secondly, for a long time my basic approach was to just be in the Vanguard TIPS fund, and if yields got really low I would move to a regular MM fund until yields returned to what I felt were more normal levels. However, I did buy the an individual 30-yr bond, back in the day, when the yield was at about 4.1% and held onto that while yields moved down, and then harvested the capital gain. Two weeks ago I decided that I better go back to individual bonds, so I am now paying closer attention to all the available issues. More work, but I think there are once again some short-term buying opportunities. Hope I am right...
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Post by ZZ »

daryll40 wrote:Someone review this math please:

Scenario: Someone accumulates $5Million and invests ALL in tips (taxable account). Say we are in a lowish inflation situation with maybe 3% inflation and 3% tips coupon.

Annually that person would have to pay tax on 6% of $5M or $300,000. Assuming no other income, I am guessing that would cost about $100,000 (maybe more) in taxes. Leaves $200,000. But the coupon was only 3% or $150,000. The other "income" was phantom due to the TIPS inflation adjustment. So there would only be $50,000 of actual free money to spend.
A single person w/ no other income, would pay $82,182 in taxes.
Married filing jointly would pay $73,362.
The percentages are much better using a lower investment like 1, 2 or 3 million. Using a coupon of 1%, you are cooked.

http://www.dinkytown.net/java/Tax1040.html

ZZ
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Re: Zvi Bodie & TIPS

Post by jeffyscott »

snowman9000 wrote:He stressed buying TIPS during the investment lifetime, to cover a person's retirement needs.

So what about his idea of building a nest egg completely out of TIPS (and I-Bonds)? Did it fail to gain traction because real rates on the bonds decreased in the years after the book came out?
I think there are two issues, one is TIPS fell from 4% to about 1.5%. At 1.5% or even 2.5%, I think this idea becomes far less attractive. Additionally with much of our retirement investing controlled by our employers, we can not do anything we would like with non-taxable money.

How does one do this if one's 401k/457/403b does not even have a TIPS fund and does not allow purchase of individual bonds? I could buy a TIPS fund in my 457, but I'd have to use an option it has for going through Schwab. This would add additional costs of a small annual maintenance fee, then I'd have to pay transaction fees to buy VIPSX or buy a fund with a higher ER (maybe about 0.5%). My wife's 403b would let her buy a fund with ER of 0.5%. So suddenly even 3% TIPS become 2.5%.

If we get 4-4.5% real rates then I might want to go to all TIPS and TIPS funds, but even then I'd trade back out and take the gains if they were to fall back to 1.5%.
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Post by richard »

http://www.rotman.utoronto.ca/userfiles ... pages).pdf

Worth reading, even if it does play into the current mindset.

Thanks, Robert
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Post by Robert T »

.
Richard,

This may also be useful - for those who prefer to listen (webcast) than read. Here's one of Zvi Bodie's presentations which touches on some of the issues raised in the article.

http://www.cfawebcasts.org/cpe/what.cfm?test_id=698

Robert
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Post by dumbmoney »

The real yield curve is inverted (lower yield for longer term), which is consistent with the market anticipating near term deflation.

The swing in prices has been pretty amazing. From 0% real yield on the 5-year TIPS a few months ago to 3.7% today.
I am pleased to report that the invisible forces of destruction have been unmasked, marking a turning point chapter when the fraudulent and speculative winds are cast into the inferno of extinction.
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Post by nisiprius »

SmallHi wrote:First of all, very few investors have accumulated (or inhereted) enough money to live on about 2% or so real withdrawals
I'm not personally 100% TIPS; I have a mix of TIPS, Total Bond Market, and equities. But I would submit that if you haven't accumulated enough money to live on withdrawals from a portfolio earning 2% real, you haven't accumulated enough, period.

About a year ago I was spending a lot of quality time with Fidelity's Retirement Income Planner, meaning that I was accepting the default values and Monte Carlo simulations that Fidelity apparently thinks are reliable. By default, they base their projections on the 10%-percentile-worst-case market performance. You select a "plan to" age (what a euphemism), and I accepted their default, which was the 25% percentile--the age 75% of men my age live to, which was 92 for me, 94 for my wife. Depending on the numbers you plug in for asset allocation, projected earnings, expenses, etc. it calculates either the age when your money will run out, or the amount of money remaining at your "plan to" age.

Two things about the experience struck me forcibly. First, they assume 7% health care inflation. That just dominates the simulation. It means that medium-sized changes in assumptions make surprisingly small differences in outcome. You just plain have to earn quite a bit more or spend a bit less to drive the results just a little bit up that steep 7% wall.

Second, asset allocation made amazingly little difference in the outcome. Even though the tool specifically suggested increasing equities allocation, when I did, it actually made the outcome slightly worse (under their 10th-percentile projection). It did, of course, project more money remaining if you picked the median performance, and projected lots more money remaining if you picked a good-performance assumption. If stocks do well you'd be better off having a high equity allocation, no surprise there.

Stocks help the retirees heirs, not the retiree.
Annual income twenty pounds, annual expenditure nineteen nineteen and six, result happiness; Annual income twenty pounds, annual expenditure twenty pounds ought and six, result misery.
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Post by nisiprius »

richard wrote:http://www.rotman.utoronto.ca/userfiles ... pages).pdf

Worth reading, even if it does play into the current mindset.

Thanks, Robert
For some reason, the forum mangles that URL. Try

http://tinyurl.com/bodiehueler
Annual income twenty pounds, annual expenditure nineteen nineteen and six, result happiness; Annual income twenty pounds, annual expenditure twenty pounds ought and six, result misery.
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