Intermediate vs Short Term TIPS Fund

Have a question about your personal investments? No matter how simple or complex, you can ask it here.
BigJohn
Posts: 1330
Joined: Wed Apr 02, 2014 11:27 pm

Intermediate vs Short Term TIPS Fund

Postby BigJohn » Fri May 19, 2017 7:38 pm

I'm wrestling with whether I need to add TIPS to my 3 fund portfolio to improve it's ability to weather a bout of high inflation. I'm 60 and retired two years ago. I set my AA at 35/65 based on an LMP approach. Investments are primarily in TSM/TISM and VG Intermediate Term Bond Index (VBILX) but in taxable I'm using VG Intermediate Term Tax-Exempt (VWIUX). My SWR is below 3%. Overall I don't worry much about outlasting my money but, with a high allocation to nominal bonds I feel a bit unprotected from inflation risk.

Issue one, is my worry valid? If so, how much of my bond allocation should I consider moving to TIPS (I'm considering somewhere around 50%)?

Issue two, assuming I move to TIPs, what's the best approach? I don't want to build my own TIPS ladder as that's inconsistent with my ISP to ensure I value simplicity in how I implement. So my two choices are VG Inflation-Protected fund (VAIPX, 8 year duration, 2.1% YTM) and VG Short-Term Inflation-Protected fund (VTAPX, 2.8 year duration, 1.4% YTM). My first thought was to use the IT version as the TIPS surrogate for my current IT bond fund. However, I note that VG uses the ST version in their target date funds even though they use IT for nominal bonds and I'm not sure why. Any insight into the pros/cons of these two choices would be appreciated.

grok87
Posts: 7335
Joined: Tue Feb 27, 2007 9:00 pm

Re: Intermediate vs Short Term TIPS Fund

Postby grok87 » Sat May 20, 2017 8:02 am

BigJohn wrote:I'm wrestling with whether I need to add TIPS to my 3 fund portfolio to improve it's ability to weather a bout of high inflation. I'm 60 and retired two years ago. I set my AA at 35/65 based on an LMP approach. Investments are primarily in TSM/TISM and VG Intermediate Term Bond Index (VBILX) but in taxable I'm using VG Intermediate Term Tax-Exempt (VWIUX). My SWR is below 3%. Overall I don't worry much about outlasting my money but, with a high allocation to nominal bonds I feel a bit unprotected from inflation risk.

Issue one, is my worry valid? If so, how much of my bond allocation should I consider moving to TIPS (I'm considering somewhere around 50%)?

Issue two, assuming I move to TIPs, what's the best approach? I don't want to build my own TIPS ladder as that's inconsistent with my ISP to ensure I value simplicity in how I implement. So my two choices are VG Inflation-Protected fund (VAIPX, 8 year duration, 2.1% YTM) and VG Short-Term Inflation-Protected fund (VTAPX, 2.8 year duration, 1.4% YTM). My first thought was to use the IT version as the TIPS surrogate for my current IT bond fund. However, I note that VG uses the ST version in their target date funds even though they use IT for nominal bonds and I'm not sure why. Any insight into the pros/cons of these two choices would be appreciated.

Long term is my vote-LTPZ
"...people always live for ever when there is any annuity to be paid them"- Jane Austen

dbr
Posts: 21706
Joined: Sun Mar 04, 2007 9:50 am

Re: Intermediate vs Short Term TIPS Fund

Postby dbr » Sat May 20, 2017 9:07 am

Intermediate TIPS is compatible with the decisions you have already made in choosing intermediate duration bonds elsewhere. You can recognize that all durations of TIPS have the same offset for inflation and also that the interest rate sensitivity is to real rates rather than to nominal rates.

I think Vanguard has some very strange reasoning behind the use of short term TIPS.

KyleAAA
Posts: 6141
Joined: Wed Jul 01, 2009 5:35 pm
Contact:

Re: Intermediate vs Short Term TIPS Fund

Postby KyleAAA » Sat May 20, 2017 9:50 am

With such a low allocation to equities yes, I think it would be wise to inflation-protect a significant portion of your fixed-income allocation. Half of fixed income would be well within the realm of reasonable (I use half, myself). Intermediate term is consistent with what you've already chosen. I think if you go with the short term fund you should probably also go with a smaller allocation.

BigJohn
Posts: 1330
Joined: Wed Apr 02, 2014 11:27 pm

Re: Intermediate vs Short Term TIPS Fund

Postby BigJohn » Sat May 20, 2017 12:11 pm

dbr/Kyle, thanks for the comments

grok87 wrote:Long term is my vote-LTPZ

grok, although a higher yield is certainly nice, I've always stayed away from long bonds because their interest rate sensitivity was just too great. Now that I've retired, I'm looking at my bonds as the liability matching part of my portfolio to cover 30 years of minimal living expenses and am even more loath to take the increased interest rate risk. I actually consider keeping my entire bond allocation in VG ST Bond Index rather than IT but decided that was too conservative and that I could'should accept the interest rate risk of IT.

With this background, would you still advocate a LT TIPS fund? If so, can you elaborate a bit on why? Thanks.

User avatar
Phineas J. Whoopee
Posts: 6265
Joined: Sun Dec 18, 2011 6:18 pm

Re: Intermediate vs Short Term TIPS Fund

Postby Phineas J. Whoopee » Sat May 20, 2017 3:41 pm

In order to meet your financial objectives, how much risk do you need to take, including inflation risk?

Intermediate-term TIPS are protected against inflation as much as short-term TIPS, but the trade-off is the same as for any other bonds, just in real, after-inflation terms. Shorter-term TIPS can usually be expected to fluctuate in value less than intermediate-term ones, and usually can be expected to return less over time.

My suggestion, and it won't come as a surprise to long-time forum readers, is to think carefully about precisely what you're trying to accomplish, then construct a portfolio to achieve it, even though success is never guaranteed.

To what extent are you exposed to inflation risk? If one has a CPI-adjusted pension, and is looking forward to Social Security retirement benefits which are CPI-adjusted, exposure to inflation risk is much less than it would be for somebody not in those circumstances.

There is no uniform TIPS answer for everybody, although I agree with some others here that a very small percentage of one's portfolio in inflation-adjusted fixed income likely will make little difference, just as any other small allocation to any particular asset class.

PJW

BigJohn
Posts: 1330
Joined: Wed Apr 02, 2014 11:27 pm

Re: Intermediate vs Short Term TIPS Fund

Postby BigJohn » Sat May 20, 2017 5:05 pm

Phineas J. Whoopee wrote:Intermediate-term TIPS are protected against inflation as much as short-term TIPS, but the trade-off is the same as for any other bonds

Thanks PJW. One of my key questions was whether the above statement was true. I thought it was but seeing VG choose IT nominal bonds but then ST TIPS for their target date funds had me second guessing myself.

Phineas J. Whoopee wrote:To what extent are you exposed to inflation risk? If one has a CPI-adjusted pension, and is looking forward to Social Security retirement benefits which are CPI-adjusted, exposure to inflation risk is much less than it would be for somebody not in those circumstances.

Good questions, I think I have fairly high exposure which is why I'm working on this change. No pension and planning on deferring SS until age 70 which is 10 years away. So 100% of my income is from this portfolio for the next 10 years. After that I expect SS to be somewhere around 50% of annual income so still heavily dependent on portfolio.

dbr
Posts: 21706
Joined: Sun Mar 04, 2007 9:50 am

Re: Intermediate vs Short Term TIPS Fund

Postby dbr » Sun May 21, 2017 8:53 am

BigJohn wrote:
Phineas J. Whoopee wrote:Intermediate-term TIPS are protected against inflation as much as short-term TIPS, but the trade-off is the same as for any other bonds

Thanks PJW. One of my key questions was whether the above statement was true. I thought it was but seeing VG choose IT nominal bonds but then ST TIPS for their target date funds had me second guessing myself.



Vanguard issued a paper in which they put forward the somewhat bizarre contention that the measure of inflation protection in an investment is getting high correlation of return with inflation. Short TIPS are better correlated with inflation than intermediate TIPS because short TIPS have less interest rate volatility on top of variability due to inflation. But that is an odd criterion because all TIPS are indexed, compensated, exactly for inflation. Longer TIPS are just more volatile, but that has nothing to do with inflation.

NiceUnparticularMan
Posts: 1224
Joined: Sat Mar 11, 2017 7:51 am

Re: Intermediate vs Short Term TIPS Fund

Postby NiceUnparticularMan » Sun May 21, 2017 9:19 am

Last I looked, around 5-7 years, you actually got positive yield on TIPS. I like that because I kinda hate the idea of TIPS actually losing money in real terms.

If you go out all the way to the end of the yield curve, you might get around 1%. Whoopee. With a yield curve that flat, I don't see much appeal to going beyond that 5-7 year range.

That said, my only TIPS are a small allocation I get through a Real Return fund. That's indexed to Bloomberg Barclays US Treasury Inflation
Protected Securities (TIPS) Index, which is a broad index (same index as the ETF TIP). However, it has approximately an 8.5 year weighted maturity and 7.75 year effective duration, so that's good enough for me.

grok87
Posts: 7335
Joined: Tue Feb 27, 2007 9:00 pm

Re: Intermediate vs Short Term TIPS Fund

Postby grok87 » Sun May 21, 2017 8:59 pm

BigJohn wrote:dbr/Kyle, thanks for the comments

grok87 wrote:Long term is my vote-LTPZ

grok, although a higher yield is certainly nice, I've always stayed away from long bonds because their interest rate sensitivity was just too great. Now that I've retired, I'm looking at my bonds as the liability matching part of my portfolio to cover 30 years of minimal living expenses and am even more loath to take the increased interest rate risk. I actually consider keeping my entire bond allocation in VG ST Bond Index rather than IT but decided that was too conservative and that I could'should accept the interest rate risk of IT.

With this background, would you still advocate a LT TIPS fund? If so, can you elaborate a bit on why? Thanks.


so your goal is to cover 30 years of minimal living expense. so why not a 30 year tips ladder? there is no interest rate risk if you hold bonds to maturity.

back to the fund question. well a tips ladder is in a sense a bond fund- ie a bunch of bonds. for example if we ignore the coupons, a 30 year tips ladder would have an average maturity and an average duration of 15 years. once you add in the coupons it would be a bit less. by comparison LTPZ has a real duration of about 22.5. so to get down to closer to the 15 years you could do an 2:1 mix of LTPZ and I-Bonds. that would give you a real duration of 15 (since the real duration of ibonds is zero- ie they have no real interest rate risk).

the main difference if you go the ibonds/LTPZ route is that you would have to keep managing the mix of the two to get the duration you want. For example after 2 years you would need a 28 year TIPS ladder with average maturity of 14 years. in theory that would mean a 62:38 mix of LTPZ and I-bonds assuming the duration of LTPZ remains the same.

i think perhaps your concern is- what if interest rates spike just after i buy causing my LTPZ to lose value? One approach to deal with this might be to target a somewhat shorter duration than strict liability matching might suggest. For example you could do a 50/50 mix of Ibonds and LTPZ which would put your real duration at about 11.25, ie somewhat shorter than the 15 above. there are a couple of advantages of somewhat shorter duration:

1) you would lose less if real interest rates spike
2) you could live off the ibonds for quite a while (15 years) before needing to touch LTPZ.
3) in the meantime you could reinvest LTPZ's coupons in the fund which would increase the real duration of your portfolio back more toward the Liability matching target.

hope this helps
"...people always live for ever when there is any annuity to be paid them"- Jane Austen

BigJohn
Posts: 1330
Joined: Wed Apr 02, 2014 11:27 pm

Re: Intermediate vs Short Term TIPS Fund

Postby BigJohn » Mon May 22, 2017 5:55 pm

grok, thanks for taking the time to add the details. I understand your points and that may well be a very appropriate approach for some. I decided some time back that building an individual TIPS ladder isn't something I was willing to consider as one of the objectives for my retirement portfolio is additional simplicity. While simplicity may be a bit less of a worry for the LTPZ/I-Bonds mix, the purchase limit constraint makes this approach impossible to implement in the time frame I need.

BigJohn
Posts: 1330
Joined: Wed Apr 02, 2014 11:27 pm

Re: Intermediate vs Short Term TIPS Fund

Postby BigJohn » Mon May 22, 2017 6:03 pm

dbr wrote:Vanguard issued a paper....

Thanks dbr, I went looking for and found the paper. Here is their summary
Our results imply that a short-term TIPS portfolio may be a more appropriate
inflation-sensitive investment than the broad TIPS market for risk-averse
investors who want their total portfolio to more closely track realized CPI
inflation over short horizons. Of course, the higher inflation correlation of shortterm
TIPS comes at a cost—a lower expected income return versus that of the
broad TIPS market. In this sense, the risk−return trade-offs of investing in a
short-maturity versus a longer-maturity TIPS portfolio parallel those involved
when selecting the interest rate exposure of any other bond portfolio.

It does indeed seem odd that their own conclusion is that the ST vs IT choice is parallel to that for nominal bonds but then they make a different choice that does not parallel using a total bond market fund.

dbr
Posts: 21706
Joined: Sun Mar 04, 2007 9:50 am

Re: Intermediate vs Short Term TIPS Fund

Postby dbr » Mon May 22, 2017 6:14 pm

BigJohn wrote:
dbr wrote:Vanguard issued a paper....

Thanks dbr, I went looking for and found the paper. Here is their summary
Our results imply that a short-term TIPS portfolio may be a more appropriate
inflation-sensitive investment than the broad TIPS market for risk-averse
investors who want their total portfolio to more closely track realized CPI
inflation over short horizons. Of course, the higher inflation correlation of shortterm
TIPS comes at a cost—a lower expected income return versus that of the
broad TIPS market. In this sense, the risk−return trade-offs of investing in a
short-maturity versus a longer-maturity TIPS portfolio parallel those involved
when selecting the interest rate exposure of any other bond portfolio.

It does indeed seem odd that their own conclusion is that the ST vs IT choice is parallel to that for nominal bonds but then they make a different choice that does not parallel using a total bond market fund.


Yes, their conclusion is inexplicably different. Well, actually it is explained by confusing correlation with inflation and actual compensating away of inflation risk, which compensation is equally applied to all maturities of TIPS.

grok87
Posts: 7335
Joined: Tue Feb 27, 2007 9:00 pm

Re: Intermediate vs Short Term TIPS Fund

Postby grok87 » Mon May 22, 2017 7:33 pm

BigJohn wrote:grok, thanks for taking the time to add the details. I understand your points and that may well be a very appropriate approach for some. I decided some time back that building an individual TIPS ladder isn't something I was willing to consider as one of the objectives for my retirement portfolio is additional simplicity. While simplicity may be a bit less of a worry for the LTPZ/I-Bonds mix, the purchase limit constraint makes this approach impossible to implement in the time frame I need.

sure
"...people always live for ever when there is any annuity to be paid them"- Jane Austen


Return to “Investing - Help with Personal Investments”

Who is online

Users browsing this forum: alex_686, #Cruncher, FootballFan5548, garyh, IlikeJackB, inbox788, Jcraz13, joetaf27, Kenkat, psteinx, qwertyjazz, ThePrune, tigerdoc93, Yahoo [Bot] and 93 guests