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Bogleheads
Investing Advice Inspired by Jack Bogle
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DaleMaley
Joined: 01 Mar 2007
Posts: 999
Location: Fairbury, Illinois
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 Posted: Sun Sep 21, 2008 7:43 am Post subject: Article: Benefits and Management of TIPS |
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In the September issue of the Journal of Financial Planning by Peter Lingane:
Benefits and Management of Inflation-Protected Treasury Bonds
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Executive Summary:
* Treasury bond funds vaulted to the top of the fixed-income category in 2007 and smartly outperformed the U.S. equity markets. Inflation-protected Treasury bond funds (TIPS) did even better, returning almost 12 percent for the year. These returns reflect a decline in interest rates and, for TIPS, underforecasted inflation.
* TIPS outperformed conventional Treasury bonds over the past decade due to underforecasted inflation and shrinkage of the anomalous yield premium, but that superior performance may not be sustained. Conventional Treasury bonds are likely to outperform TIPS in a declining inflation environment.
* TIPS had been expected to be less volatile than conventional Treasury bonds, but the record does not support this.
* Because the returns and volatilities of TIPS are likely to be comparable with those of conventional Treasury bonds over long periods, portfolios should generally contain substantial proportions of each.
* Individual TIPS are ideal for funding a future obligation in real terms and can play an important role in retirement funding.
* Trustees should appreciate that buying TIPS rather than conventional Treasury bonds will generally reduce income distributions.
* Individual TIPS provide a variable cash flow because the inflation adjustment is not paid until maturity or sale. A ladder manages this variation. Buying at the original auction eliminates tax amortization issues.
* Individuals should generally locate TIPS inside a pension or IRA for tax efficiency. This location also eliminates tax complications caused by amortization and inflation adjustments. |
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Dale
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Most investors, both institutional and individual, will find that the best way to own common stocks is through an index fund that charges minimal fees. – Warren Buffett |
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larryswedroe
Joined: 22 Feb 2007
Posts: 5423
Location: St Louis MO
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| Posted: Sun Sep 21, 2008 12:05 pm Post subject: |
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the point on volatility is simply wrongheaded thinking because one cannot compare the volatility of a nominal bond with one of real bond,
a real bond you should only be concerned about it REAL volatility. The nominal volatility is basically meaningless. Consider how silly it is to take a real bond say at 2% and say inflation is 20% on year and inflation 0 the next. If real rate is unchanged the price will still be par but the nominal return will show high volatility--meaningless since the real price is unchanged
Another reason is that this again makes mistake of thinking of asset in isolation. While nominal bonds have positive correlation to equities TIPS have negative correlation---and when you have negative correlation volatility is not a bad thing as it is when you have positive correlation. That is why the high volatility of CCF is not bad because CCF also has negative correlation with stocks |
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