How much TIPS

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moorso
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How much TIPS

Post by moorso » Fri Aug 09, 2019 7:41 am

I'm hearing a lot about have some amount of inflation protection in your portfolio. I'm currently 30 % stock and 70% bonds and cash. Is there a rule of thumb as to how much would be wise to invest in something like TIPS ? Thank you

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vineviz
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Re: How much TIPS

Post by vineviz » Fri Aug 09, 2019 7:47 am

moorso wrote:
Fri Aug 09, 2019 7:41 am
I'm hearing a lot about have some amount of inflation protection in your portfolio. I'm currently 30 % stock and 70% bonds and cash. Is there a rule of thumb as to how much would be wise to invest in something like TIPS ? Thank you
There’s no simple rule thumb, but personally if I were 70% in bonds & cash then virtually all of the bonds would be TIPS unless Social Security was covering the vast majority of my spending needs.
"Far more money has been lost by investors preparing for corrections than has been lost in corrections themselves." ~~ Peter Lynch

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moorso
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Re: How much TIPS

Post by moorso » Fri Aug 09, 2019 7:58 am

Really? All of that in TIPS seems like a lot. Right now almost all of that is in the total US bond market, some in international bonds trying too stick with a 4 fund portfolio. I wonder what the difference in expected returns might be between US bonds and TIPS if inflation didn't rear it's ugly head in the near future. For reference I am 67 years old

Dude2
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Re: How much TIPS

Post by Dude2 » Fri Aug 09, 2019 8:09 am

I think many people like the answer "half", i.e. 50 % nominal bonds and 50 % TIPS. I like to do half Total Bond Index and half Short Term Inflation Protected Index.

ionball
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Re: How much TIPS

Post by ionball » Fri Aug 09, 2019 8:14 am

I don't know of any rule of thumb. TIPS are a great tool to counter risk of unexpected inflation. Ask yourself: how much unexpected inflation can my current portfolio withstand? If it's a minor concern, consider a small percentage of TIPS or none. If unexpected inflation is a major concern, consider a large percentage of TIPS as protection. Also consider that as your timeframe decreases, inflation will probably have a smaller long range impact to your portfolio versus a longer timeframe.

dbr
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Re: How much TIPS

Post by dbr » Fri Aug 09, 2019 8:42 am

There is no rule of thumb.

I tend to agree that if inflation is a fixed income risk of particular concern to you then logically all your fixed income should be in TIPS, or, if it were practical, in I bonds. If not, then maybe nothing should be in TIPS.

TIPS are such a tiny fraction of the Treasury market, let alone the whole bond market, that I think people tend to get nervous over the prospect of holding half or more of one's wealth only in TIPS, so you get the 50% of bonds suggestion. I am not sure people should be that afraid of TIPS but there has been one instance of a strange but temporary glitch in TIPS prices during the Lehman blowout.

Keep in mind that TIPS themselves avoid inflation risk but do not somehow "immunize" the rest of your portfolio. It could be a reasonable argument that simply positioning the portfolio as a whole to have a significantly positive distribution of real return is good enough. Certainly a portfolio that is more stocks than bonds would not seem to be much helped by holding TIPS.

A proposal suggested by some is the theory of the Liability Matching Portfolio, in which retirement is funded for a first period of years by having a TIPS ladder that is liquidated year by year. That is a proposal that needs to be discussed on the merits.

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vineviz
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Re: How much TIPS

Post by vineviz » Fri Aug 09, 2019 8:44 am

moorso wrote:
Fri Aug 09, 2019 7:58 am
Really? All of that in TIPS seems like a lot. Right now almost all of that is in the total US bond market, some in international bonds trying too stick with a 4 fund portfolio. I wonder what the difference in expected returns might be between US bonds and TIPS if inflation didn't rear it's ugly head in the near future. For reference I am 67 years old
If inflation turns out to be roughly what markets currently expect (i.e. 2% or a little less) then an intermediate-term TIPS fund like Vanguard Inflation-Protected Securities and a total US stock market fund should produce very similar returns. The total bond market fund takes on more credit risk but has slightly more short-term bonds, so it's pretty close to a wash.

If inflation is higher than expected, TIPS will deliver higher returns. If inflation is lower than expected, TIPS will deliver lower returns.

If I were in your shoes, at age 67 and only 30% in stocks, there's no way that I would want to leave my portfolio so exposed to the risk of unexpected inflation. Especially when I had the tools to mitigate it at very little cost. Again, just speaking personally, the bare minimum I'd put in TIPS would be half of my bonds.

Your international bonds might help some in a regime of inflation volatility, so I'd keep those. And I'd also suggest you consider whether you could tolerate a slightly higher equity allocation. Even a move from 30% stocks to 40% or 50% stocks would further help insulate you from the risk of inflation over what could easily be a 30 year retirement, I hope.
"Far more money has been lost by investors preparing for corrections than has been lost in corrections themselves." ~~ Peter Lynch

dbr
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Re: How much TIPS

Post by dbr » Fri Aug 09, 2019 8:46 am

vineviz wrote:
Fri Aug 09, 2019 8:44 am
moorso wrote:
Fri Aug 09, 2019 7:58 am
Really? All of that in TIPS seems like a lot. Right now almost all of that is in the total US bond market, some in international bonds trying too stick with a 4 fund portfolio. I wonder what the difference in expected returns might be between US bonds and TIPS if inflation didn't rear it's ugly head in the near future. For reference I am 67 years old
If inflation turns out to be roughly what markets currently expect (i.e. 2% or a little less) then an intermediate-term TIPS fund like Vanguard Inflation-Protected Securities and a total US stock market fund should produce very similar returns. The total bond market fund takes on more credit risk but has slightly more short-term bonds, so it's pretty close to a wash.

If inflation is higher than expected, TIPS will deliver higher returns. If inflation is lower than expected, TIPS will deliver lower returns.

If I were in your shoes, at age 67 and only 30% in stocks, there's no way that I would want to leave my portfolio so exposed to the risk of unexpected inflation. Especially when I had the tools to mitigate it at very little cost. Again, just speaking personally, the bare minimum I'd put in TIPS would be half of my bonds.

Your international bonds might help some in a regime of inflation volatility, so I'd keep those. And I'd also suggest you consider whether you could tolerate a slightly higher equity allocation. Even a move from 30% stocks to 40% or 50% stocks would further help insulate you from the risk of inflation over what could easily be a 30 year retirement, I hope.
I would second these comments, which are consistent with my original post as well.

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moorso
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Re: How much TIPS

Post by moorso » Fri Aug 09, 2019 9:13 am

Thank you all for the good advice. This question I had all came about because Mike Piper had suggested we have some portion invested in tips or other inflation protection. Wonder what he thinks is a fair percentage to hold.

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Re: How much TIPS

Post by Cody » Fri Aug 09, 2019 9:19 am

Trying to get more concrete here:

In a 50-50 portfolio (stock - bonds) a stock market drop of 50% would mean a portfolio drop of about 25%. Close enough?

Now with a 50-50 portfolio and inflation kicks in at 5% for 5 years.

How will the 50-50 likely (no guarantees) react?

dbr
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Re: How much TIPS

Post by dbr » Fri Aug 09, 2019 9:20 am

moorso wrote:
Fri Aug 09, 2019 9:13 am
Thank you all for the good advice. This question I had all came about because Mike Piper had suggested we have some portion invested in tips or other inflation protection. Wonder what he thinks is a fair percentage to hold.
I can't speak for Mike Piper, but it is common to hear people say things like that. Vanguard puts a small allocation to TIPS in some of their retirement funds. On the principle that one should probably either "need" TIPS or not "need" TIPS a smallish allocation to TIPS has always seemed to me to be silly. In any case it seems to me it would depend on the judgement and preference of the individual investor rather than be a general principle of portfolio design.

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Leif
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Re: How much TIPS

Post by Leif » Fri Aug 09, 2019 9:32 am

The Vanguard Target Retirement Income fund, VTINX, is 30/70. That has 16.6% of the portfolio in short term TIPS. That would be about 24% of the bond portion. The target funds start with a low allocation to TIPS that increases over time.

ADDED: The Target funds have 0% allocation to TIPS until 5 years prior to the target fund "due" date. That ramps to 16.6% at 10 years past the target date.

With a higher bond allocation you have more exposure to the risk of inflation.

I have AA of 50/50. My TIPS (short and long term) is 20% of the bonds or 10% of the portfolio.
Last edited by Leif on Sat Aug 10, 2019 2:58 pm, edited 3 times in total.

dcabler
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Re: How much TIPS

Post by dcabler » Fri Aug 09, 2019 9:32 am

Not sure there really is any rule of thumb. In the past, I chose about 30% of my bonds, but that was fairly arbitrary. Since then, I've decided to use TIPs purely as an inflation protected income stream to augment SS when the time comes (along with some Ibonds). I've set it up to produce a certain amount of income every year till it's exhausted (approx. 15 years after SS starts). The remainder of my portfolio has a fixed 60/40 allocation. Anyway, that's one way to do it. Others on this board have set up TIPs ladders as a bridge between retirement and when they start taking SS. So I know of at least 3 ways to use TIPs, there are doubtless other ways as well.

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Re: How much TIPS

Post by goodenyou » Fri Aug 09, 2019 9:55 am

You cannot have a rule of thumb here. Decisions like this are complex and need to consider total portfolio value and burn rate. Risks of inflation with a portfolio that is far in excess of 25x your expenses is a much different than a portfolio at 25x expenses. I am starting to warm up to the idea of target funds much more now since I am appreciating that the issues of inflation erosion and exposure to alternate vehicles (TIPS) that mitigate this risk are built into the fund. Having it built-in makes it easy for one stop shopping.
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Re: How much TIPS

Post by Tyler Aspect » Fri Aug 09, 2019 10:11 am

In an overview article published by Nuveen (October 2018) I saw they describe the market capitalization of TIPs as 1.3 trillion dollars, while the US Treasury as 13.6 trillion dollars. This means the TIPs is 1/10 the size of the Treasuries. The US Treasury makes up 41.5% of the Bloomberg Barclays U.S. Aggregate Bond Index at the end of year 2018. Therefore by market capitalization ratio the size of the TIPs market is approximately 4% of the US bond market.

If you just want to buy TIPs for the purpose of additional diversification, you could make it from 4% to 10% of your bond portfolio.
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Re: How much TIPS

Post by bearcub » Fri Aug 09, 2019 11:14 am

27% of my total AA is in the two Vanguard TIPS Funds. 53% of my fixed income is in these funds. Small pension + SS.

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Re: How much TIPS

Post by friar1610 » Fri Aug 09, 2019 1:34 pm

Our overall AA is about 45/55 (and moving slowly toward 50/50 through an orderly transfer of funds). Our IRAs are 100% fixed and we are taking RMDs. Due to an inflation adjusted pension an SS, don't feel a real need for TIPS although we have toyed with putting 25%-50% there. We do have a chunk of older 3.4% fixed I-Bonds in taxable.

We feel that inflation protection is adequately provided by the pension/SS although the future could prove us wrong.
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Re: How much TIPS

Post by FIREchief » Fri Aug 09, 2019 1:59 pm

dbr wrote:
Fri Aug 09, 2019 9:20 am
On the principle that one should probably either "need" TIPS or not "need" TIPS a smallish allocation to TIPS has always seemed to me to be silly.
+1 It seems silly to me too. Basic math takes a beating with such approaches.
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Re: How much TIPS

Post by whomever » Fri Aug 09, 2019 2:16 pm

" I wonder what the difference in expected returns might be between US bonds and TIPS if inflation didn't rear it's ugly head in the near future."

If you run a growth chart of VAIPX (Admiral TIPS) and BND (Total Bond ETF) from 8/1/200 to present (that's approximately when VAIPX was created) you'd have 24522 in BND and 26333 in VAIPX. The lines are essentially parallel after 1996 or so.

Obligatory: past results don't predict future performance...

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galeno
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Re: How much TIPS

Post by galeno » Fri Aug 09, 2019 4:40 pm

Our retirement AA is 40/60. We keep 15% of port (25% of fixed income) in a TIPS ETF.
AA = 40/55/5. Expected CAGR = 3.8%. GSD (5y) = 6.2%. USD inflation (10 y) = 1.8%. AWR = 4.0%. TER = 0.4%. Port Yield = 2.82%. Term = 33 yr. FI Duration = 6.0 yr. Portfolio survival probability = 95%.

DecumulatorDoc
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Re: How much TIPS

Post by DecumulatorDoc » Fri Aug 09, 2019 8:19 pm

It used to be common on this website to hear a lot of folks with 50% of bonds in TIPS. After so many years of tame inflation, TIPS is not as popular now. The highly touted 3 fund portfolio is usually 100% total bond market for fixed income allocation.

I keep 25% of bonds in TIPS for unexpected inflation because...well its unexpected. Maybe its not enough, but its something. No perfect portfolio and no crystal ball.

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Re: How much TIPS

Post by Northern Flicker » Fri Aug 09, 2019 9:01 pm

You may want to arrive at the allocation using a bucketing analysis. First, partition your portfolio into two pieces.

Piece 1 is a traditional 60/40 balanced portfolio. All of your stock would be held there. Since you are 30% stock, your nominal bond allocation will be 20%. This could be in the total bond index (eg VBTLX) or intermediate treasuries (eg VSIGX).

Piece 2 is TIPS and cash. Calculate how much you need in excess of SS to meet expenses over the course of 1 year. Hold this amount in cash and hold this amount in short-term TIPS (eg VTAPX). The remainder goes into an intermediate TIPS fund. You could get fancier and include long-term TIPS as well, but not necessary.

Then forget about all the bucketing. Your allocation is:

30% stocks
20% intermediate nominal bonds
1 year of residual expenses after SS in cash
1 year of residual expenses after SS in short-term TIPS
The rest in intermediate TIPS.

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galeno
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Re: How much TIPS

Post by galeno » Tue Aug 13, 2019 12:22 pm

30% stocks
20% intermediate nominal bonds
1 year of residual expenses after SS in cash
1 year of residual expenses after SS in short-term TIPS
The rest in intermediate TIPS.

With 30% stocks I'd go

10% high yield bonds
20% corp bonds

20% interm US treasuries
15% interm TIPS
05% cash
AA = 40/55/5. Expected CAGR = 3.8%. GSD (5y) = 6.2%. USD inflation (10 y) = 1.8%. AWR = 4.0%. TER = 0.4%. Port Yield = 2.82%. Term = 33 yr. FI Duration = 6.0 yr. Portfolio survival probability = 95%.

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