Muni vs TIPS vs TBM

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Bubbagump
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Muni vs TIPS vs TBM

Post by Bubbagump » Sun Aug 24, 2014 12:55 pm

I have maxed out my tax free accounts and in order to keep my AA I need to start to put bonds into my taxable account. My current AA is 80/20 as I am 35 and ok being a bit aggressive.

Up until now I have used a basic 3 fund portfolio -- 60% VTSAX, 20% VTIAX, 20% VBTLX. I am also in a high tax bracket and munis show a better yield after tax adjustment for me. Lastly, I have been considering TIPS.

Starting with TIPS (VIPSX more specifically)... I have read from Swedroe that the majority of a bond allocation should be in TIPS. The Vanguard target Retirement accounts show TIPS only being introduced at retirement and then only to ~20% of the fixed income class. This guy http://www.mypersonalfinancejourney.com ... ation.html does some reasonable math and shows that same ~20% allocation but before retirement. This all seems very conflicting

Then, in my taxable account I am considering VWITX with a possible tilt towards VOHIX being an Ohio resident. However, does a tilt make any sense here? I assume fixed income behaves like equities and this is truly a tilt as i am sure VWITX already has Ohio in it.

So all this said, what seems reasonable? It appears to me of my fixed income perhaps 25% in TIPs in tax-advantaged, 60% in VWITX and 15% in VOHIX is reasonable. I am fooling myself? Making this overly complicated? Forget TIPS until retirement and keep things in VBTLX in the non-tax account? It seems there is a lot of talk about equity splits, but I am not finding much in the way of splits in the fixed income side of things.

Bubbagump
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Re: Muni vs TIPS vs TBM

Post by Bubbagump » Sun Aug 24, 2014 1:33 pm

I found this http://www.bogleheads.org/forum/viewtopic.php?t=60475 and it seems the VOHIX seems like a waste of time. Then I also found this http://www.forbes.com/sites/rickferri/2 ... s-on-tips/ which seems pretty convincing and jives with Vanguard more or less, that other link and Malkiel. I think what I may do to keep things simple is 20% of my fixed income in TIPs in a tax-advantaged account. Then, whatever is left to fill out my bond allocation is TBM in tax advantaged and whatever addition in VWITX.

So why does Swedroe suggest TIPS "dominating" the fixed income portion of tax advantaged accounts where as the rest of the world seems to suggest ~20-25%?

dbr
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Re: Muni vs TIPS vs TBM

Post by dbr » Sun Aug 24, 2014 1:37 pm

Fixed income does not behave like equities; the concept of tilting, if it exists, would mean something very different.

You seem to have two questions. One is a tax question and the other is a question about TIPS.

I would not allocate to TIPS because you read that Larry said so. An investor buys TIPS because they are insured, in effect, against inflation, expected or unexpected. Bonds in general reflect expectations for inflation, so TIPs add that they are adjusted for unexpected inflation as well. TIPS are not a hedge against inflation for a whole portfolio of which they are only a part. It makes a lot of sense for older investors concerned with inflation risk to hold TIPS, maybe all their bonds in TIPS (which Larry might suggest). Young investors have the personal capital of lifetime earnings and career success to rely on and also the long run likelihood that equities will outrun inflation.

Taxation is complicated. You need to compute actual tax returns to see if you benefit more from tax exempt bonds than taxable bonds, trying to keep duration and credit quality somewhat similar. You can do a quick and dirty calculation of tax equivalent muni interest (divide the yield by '1-tax rate'). Ohio munis would be state tax exempt but are more risky, which is why one might not go whole hog with the state bonds. TIPS are more tax efficient than other non-exempt bonds because Treasuries are not state taxable. In general TIPS are probably better off in tax deferred accounts, especially if inflation rises a lot.

dbr
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Re: Muni vs TIPS vs TBM

Post by dbr » Sun Aug 24, 2014 1:40 pm

Bubbagump wrote:I found this http://www.bogleheads.org/forum/viewtopic.php?t=60475 and it seems the VOHIX seems like a waste of time. Then I also found this http://www.forbes.com/sites/rickferri/2 ... s-on-tips/ which seems pretty convincing and jives with Vanguard more or less, that other link and Malkiel. I think what I may do to keep things simple is 20% of my fixed income in TIPs in a tax-advantaged account. Then, whatever is left to fill out my bond allocation is TBM in tax advantaged and whatever addition in VWITX.

So why does Swedroe suggest TIPS "dominating" the fixed income portion of tax advantaged accounts where as the rest of the world seems to suggest ~20-25%?
I think because a primary risk to nominal bonds is inflation. This is a risk that can be insured against and so one should do so to cut investing risks. The cost is historically so little that it is worth while. Also, absent inflation risk, it is worth the risk to extend to longer durations for better return. For younger investors that don't hold much in bonds and can evade inflation risk other ways, it doesn't matter. For older investors, all or mostly TIPS might be a good idea.

Bubbagump
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Re: Muni vs TIPS vs TBM

Post by Bubbagump » Sun Aug 24, 2014 1:45 pm

This helps a lot. It seems every time I get into these mental gymnastics, the simple answer generally prevails. So it seems VOHIX is not worth it considering the actual tax calculation in Ohio versus its yield and added risk (aka, I'll take my risk on the equity side). It seems TIPS may be worth looking at again once I am in a true income phase in 30 years.

So that leaves the tax questions which seems to pencil out. VBTLX comes out to 2.06% SEC yield where as VWITX (1.68/72) is 2.33%. I think my conclusion is forget TIPS for another ~30 years, keep going on VBTLX in tax advantaged and any spill over goes to VWITX.

Thanks for the reality check!

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villars
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Re: Muni vs TIPS vs TBM

Post by villars » Sun Aug 24, 2014 5:09 pm

Bubbagump wrote:
....
So that leaves the tax questions which seems to pencil out. VBTLX comes out to 2.06% SEC yield where as VWITX (1.68/72) is 2.33%. I think my conclusion is forget TIPS for another ~30 years, keep going on VBTLX in tax advantaged and any spill over goes to VWITX.

Thanks for the reality check!
thanks for this thread. I have wondered the same question(s).

What you suggest is kind of what I am doing: PIMCO's PTTRX in tax-advantaged as VBTLX is not available, with a portion in VWITX in taxable.

But I am also buying my yearly allocation of I-bonds to expand tax-deferred space and hedge directly against inflation.

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siamond
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Re: Muni vs TIPS vs TBM

Post by siamond » Sun Aug 24, 2014 7:44 pm

80% equities is more than enough inflation-protection... There is really no point using TIPS with such an AA. Munis should be a better answer for your taxable account, although I have no knowledge about the OH specifics.

Bubbagump
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Re: Muni vs TIPS vs TBM

Post by Bubbagump » Mon Aug 25, 2014 1:04 am

siamond wrote:80% equities is more than enough inflation-protection...
Are stocks really a hedge against inflation?

http://inflationdata.com/articles/2012/ ... rrelation/
http://www.cbsnews.com/news/how-inflati ... ck-market/

Seems to say there is not a tight correlation.

Regardless, I am certainly in a growth phase, so adding something to maintain NAV doesn't make a terrible amount of sense.

dbr
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Re: Muni vs TIPS vs TBM

Post by dbr » Mon Aug 25, 2014 8:50 am

Bubbagump wrote:
siamond wrote:80% equities is more than enough inflation-protection...
Are stocks really a hedge against inflation?

http://inflationdata.com/articles/2012/ ... rrelation/
http://www.cbsnews.com/news/how-inflati ... ck-market/

Seems to say there is not a tight correlation.

Regardless, I am certainly in a growth phase, so adding something to maintain NAV doesn't make a terrible amount of sense.
Stocks as inflation "protection" is based on the expected real return of stocks being positive. By expected one means the average return over long time periods. In short stocks protect against inflation by outrunning inflation in the long run. If you define hedge as an investment that is correlated with inflation then short TIPS and I-bonds do that. This leads to the absurd conclusion that not short TIPS are not an inflation hedge because although explicitly offset for inflation, interest rate volatility will reduce the correlation.

A different issue that needs understanding is that normally what is meant by a hedge is something that added to all the rest of the investments offsets the risk of inflation by leveraging against inflation. There is no investment that does that, including TIPS. Ironically, if one wants an investment that comes closest to allowing the portfolio as a whole to have positive real return it might just be stocks. A different offset to inflation is savings at a rate that exceeds inflation, based on career income increasing faster than inflation if one has career success and saves like a fiend.

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siamond
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Re: Muni vs TIPS vs TBM

Post by siamond » Mon Aug 25, 2014 7:04 pm

Bubbagump wrote:
siamond wrote:80% equities is more than enough inflation-protection...
Are stocks really a hedge against inflation?

http://inflationdata.com/articles/2012/ ... rrelation/
http://www.cbsnews.com/news/how-inflati ... ck-market/

Seems to say there is not a tight correlation.

Regardless, I am certainly in a growth phase, so adding something to maintain NAV doesn't make a terrible amount of sense.
Sorry, I should have been more clear. As dbr said, stocks historically provided solid protection against inflation IN THE LONG RUN, just by virtue of higher returns. And there is no reason to believe this will not be the case in the coming decades. TIPS would indeed provide SHORT-TERM protection, but given your age, it seemed to me that the long run was the primary concern, not the short-term.

So my point was that, with your 80% equities, you should be well protected against inflation on the long run, and you don't need to add TIPS on top of that. Which means in turn that a total bond fund or a muni-bonds fund might be the best choice for your remaining 20%. Just my 2 cents!

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