All in on inflation-linked bonds?

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pacific blue
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All in on inflation-linked bonds?

Post by pacific blue »

I was curious if anyone had a thought on this: I'm a retiree with a 60/40 equities to bonds portfolio, all in a tax-deferred account. About half of the bond portion is currently in an inflation-linked bonds fund. The other half is in a standard bond index fund. Given the low yields of bonds right now, plus the looming threat of inflation, is there any reason not have 100 percent of my bond portfolio in inflation-linked bonds? Any downside I'm not considering? Thanks for your thoughts!
MishkaWorries
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Re: All in on inflation-linked bonds?

Post by MishkaWorries »

I don't think you could go wrong either way. But to me 50/50 looks good. That gives you diversity.

In our retirement accounts we use intermediate treasuries or intermediate Tips. It's not exactly 50/50 but close. I just kinda like the idea of being balanced between the two.

But I'm not a bond or finance guy by a long shot.
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wetgear
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Re: All in on inflation-linked bonds?

Post by wetgear »

I can't predict the future but the equity portion should help hedge against inflation too and I also like diversification so I'd prefer your current portfolio if I was in your shoes.
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retired@50
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Re: All in on inflation-linked bonds?

Post by retired@50 »

100% anything is seldom the correct answer. Except with hindsight.

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grok87
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Re: All in on inflation-linked bonds?

Post by grok87 »

pacific blue wrote: Mon May 03, 2021 5:10 pm I was curious if anyone had a thought on this: I'm a retiree with a 60/40 equities to bonds portfolio, all in a tax-deferred account. About half of the bond portion is currently in an inflation-linked bonds fund. The other half is in a standard bond index fund. Given the low yields of bonds right now, plus the looming threat of inflation, is there any reason not have 100 percent of my bond portfolio in inflation-linked bonds? Any downside I'm not considering? Thanks for your thoughts!
you may find this thread helpful
The 3-legged stool approach to retirement planning

viewtopic.php?t=245377

do you have a pension?
cheers,
grok
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bhough
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Re: All in on inflation-linked bonds?

Post by bhough »

I'm not giving you advice. I'm just telling you what I've learned in the past few months about bonds in this strange environment. (Grok, Vineviz, or other smarter people, feel free to correct me):

Both TIPS and nominals if held directly or held through a bond fund are sold initially at an auction from the Treasury and then sold in the secondary market through a broker. When one purchases a treasury at auction, it can occur one of two ways. If you are a big player, you can place a competitive bid. The Treasury is tasked with raising dollars at the lowest possible rate, so when large entities are competing, the winner is the one that loans the money with the lowest rate. The other way one can acquire treasuries is through a non-competitive purchase. This is what the rest of us do (and I suspect most mutual funds, but I can't prove that). We tell the treasury that we'd like to purchase a $100 10 year TIPS and give them our account number, then on the day of the auction, they deduct from our account what the best price was.

In an effort to understand all this better, I've made several purchases of nominals and TIPS over the last two months. I learn by doing, so it is easier for me to understand things if I do it and then I can see exactly what happens. Here are my purchases through treasurydirect:

19 year 10 month nominal bond that pays 1.875%. I purchased for $95.67. I get $100 in 20 years and 94 cents every 6 months
9 year 11 month nominal note that pays 1.125%. I purchased for $96.35. I get $100 in 10 years and 63 cents every 6 months
7 year nominal note that pays 1.25%. I purchased for $99.67. I get $100 in 7 years and 63 cents every 6 months
5 year nominal note that pays .75%. I purchased for $99.51. I get $100 in 5 years and 38 cents every 6 months.
2 year nominal note that pays 0.125%. I purchased for $99.95. I get $100 in 2 years and 6 cents every 6 months
9 year 11 month TIPS that pays 0.125%. I purchase for $107.11. I get the inflation adjusted equivalent of $100 in 10 years and 6 cents every 6 months
5 year TIPS that pays 0.125%. I purchased for $109.10. I get the inflation adjusted equivalent of $100 in 5 years and 6 cents every 6 months

What this illustrated to me (and I really could have learned this without spending $700 if I just looked at the treasury's links to recent auctions) is that the smart financial corporations who set the prices for these have already baked in their best guess at inflation as it applies to both nominals and treasuries. The benefit of buying TIPS isn't to protect you from expected inflation. The discount you are getting on nominals protect you already. The benefit of buying TIPS is to protect you from unanticipated inflation. This is why the smart kids say to buy half TIPS and half nominals if you are going to buy treasuries. The government adjusts your TIPS principal each year, but you are paying quite a premium to get that "true-up".

I personally think that EE bonds are a better play now than nominals or treasuries given what will happen on the secondary market if you try to sell (if your horizon is at least 20 years). If interest rates rise, you will be trying to sell a TIPS you paid $109 for for less than $100. The 20 year nominal above looks like a good interest rate, but it is subject to the same interest rate risk and EE bonds pay 3.5% vs 1.875% and you can defer taxes on them.

If you say that this doesn't matter if you are holding a bond fund, I assume the bond fund managers are facing the same pressures you are. If interest rates rise, they can hang onto the bond to redeem it and incur the opportunity risk of another investment, or sell at a loss to buy treasuries in the future that will have higher interest rates. Your gains and losses might be blunted by the varying terms of bonds they hold, but they face the same reality you do.

TL;DR: stay at your current allocation. For further information, spend a few quality hours trolling treasurydirect's site as it relates to auction results, looking at both TIPS and nominals.
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Re: All in on inflation-linked bonds?

Post by nisiprius »

I'm very enthusiastic about TIPS, and yet my fixed-income marketable bond holdings are only 60% VAIPX (TIPS fund), 40% VBTLX (Total bond). I just think 100% is extreme and I don't personally have the audacity to go that far.*

In 2004 Scott Burns proposed a Margarita Portfolio of 1/3rd each Vanguard Total Stock, Vanguard Total International, and Vanguard Inflation-Protected Securities. His subsequent articles about it have been pretty equivocal, but the point is that going 100% TIPS for fixed income is respectable enough for one well-known writer to suggest it.

The reservation I have is "why are you talking about this now?" I loved the idea of TIPS and bought my first TIPS in 1998. It's not that I saw any reason to think high inflation was imminent. If inflation occurs, I expect it to take me by surprise. People have been warning of imminent inflation... forever. John C. Bogle said "Time is your friend. Impulse is your enemy." I would not make any big sudden moves because of suddenly thinking you see inflation ahead. The possibility of inflation is always there.



*(If we also include non-marketable series I savings "bonds," then we are over 70% inflation-indexed).
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JohnDindex
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Re: All in on inflation-linked bonds?

Post by JohnDindex »

Has anyone ever simulated what would have happened with tips in 70’s 80’s had they been available?

Would that be impossible to do since tips price a premium for unexpected inflation and it is unknown how much investors would have been willing to pay for that ?
RubyTuesday
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Re: All in on inflation-linked bonds?

Post by RubyTuesday »

TIPS protect you from BOTH expected and unexpected inflation. Nominal protect you from expected inflation and unexpected deflation.

Most of my bonds are inflation protected (Series I and TIPS funds), with balance in Stable Value and CDs at decent rates.

I’m in early retirement and inflation is probably the biggest risk. I’ve got healthy stock allocation and TIPS for this reason.
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Re: All in on inflation-linked bonds?

Post by vineviz »

JohnDindex wrote: Mon May 03, 2021 6:31 pm Has anyone ever simulated what would have happened with tips in 70’s 80’s had they been available?

Would that be impossible to do since tips price a premium for unexpected inflation and it is unknown how much investors would have been willing to pay for that ?
The simulations I've seen suggest that from 1971 to 1981, 10-year TIPS would have outperformed 10-year nominal Treasuries by somewhere between 2% and 3% per year.
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watchnerd
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Re: All in on inflation-linked bonds?

Post by watchnerd »

bhough wrote: Mon May 03, 2021 6:07 pm

What this illustrated to me (and I really could have learned this without spending $700 if I just looked at the treasury's links to recent auctions) is that the smart financial corporations who set the prices for these have already baked in their best guess at inflation as it applies to both nominals and treasuries. The benefit of buying TIPS isn't to protect you from expected inflation. The discount you are getting on nominals protect you already. The benefit of buying TIPS is to protect you from unanticipated inflation. This is why the smart kids say to buy half TIPS and half nominals if you are going to buy treasuries. The government adjusts your TIPS principal each year, but you are paying quite a premium to get that "true-up".
Yes, the market guess at inflation that is baked into the price is called the breakeven rate.

https://fred.stlouisfed.org/series/T10YIE

As for half TIPS and half nominals:

The LMP ladder you see in my sig is 50% long TIPS / 50% long STRIPS.

(I love zero coupon nominals for liability matching)
60% Global Market Stocks (VT,FM) | 38% Global Market Bonds | 2% Alts || LMP TIPS/STRIPS || RSU + ESPP
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vineviz
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Re: All in on inflation-linked bonds?

Post by vineviz »

watchnerd wrote: Mon May 03, 2021 9:51 pm
bhough wrote: Mon May 03, 2021 6:07 pm

What this illustrated to me (and I really could have learned this without spending $700 if I just looked at the treasury's links to recent auctions) is that the smart financial corporations who set the prices for these have already baked in their best guess at inflation as it applies to both nominals and treasuries. The benefit of buying TIPS isn't to protect you from expected inflation. The discount you are getting on nominals protect you already. The benefit of buying TIPS is to protect you from unanticipated inflation. This is why the smart kids say to buy half TIPS and half nominals if you are going to buy treasuries. The government adjusts your TIPS principal each year, but you are paying quite a premium to get that "true-up".
Yes, the market guess at inflation that is baked into the price is called the breakeven rate.

https://fred.stlouisfed.org/series/T10YIE

As for half TIPS and half nominals:

The LMP ladder you see in my sig is 50% long TIPS / 50% long STRIPS.

(I love zero coupon nominals for liability matching)
Maybe someday we’ll get the ultimate tool: zero-coupon TIPS.
"Far more money has been lost by investors preparing for corrections than has been lost in corrections themselves." ~~ Peter Lynch
QBoy
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Re: All in on inflation-linked bonds?

Post by QBoy »

vineviz wrote: Tue May 04, 2021 5:34 am
Maybe someday we’ll get the ultimate tool: zero-coupon TIPS.
At the current level of interest rates, that is very close to what TIPS are now. According to Treasury Direct, "if a Treasury note or bond auction results in a yield lower than 0.125 percent, the interest rate will be set at 1/8 of one percent with the price adjusted accordingly (i.e., at a premium)." 0.125 is close to zero.
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watchnerd
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Re: All in on inflation-linked bonds?

Post by watchnerd »

vineviz wrote: Tue May 04, 2021 5:34 am Maybe someday we’ll get the ultimate tool: zero-coupon TIPS.
If I recall correctly, there was talk about them in the early 2000s, but nobody expressed any interest in them.
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Thesaints
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Re: All in on inflation-linked bonds?

Post by Thesaints »

TIPS at 0.125% are almost ZC !

Anyway, the jury is still out regarding future rampant inflation (as measured by the CPI-U). Even the latest batch of data is still quite moderate if one looks at the ex-food/energy numbers.
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Re: All in on inflation-linked bonds?

Post by Watty »

pacific blue wrote: Mon May 03, 2021 5:10 pm Any downside I'm not considering?
You do not seem to be considering the tradeoffs with holding individual TIPS compared to owning TIPS in a mutual fund.

If you want to use TIPS for the long term then buying a ladder of individual TIPS that you can hold to maturity will eliminate the risk of the value going down if(when ?) interest rates go up. There is even a school of thought which says, "When you have won the game, stop playing." which also applies to stock so it is OK to just put your money into a TIPS ladder if you have enough to do that and live the rest of your life.
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pacific blue
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Re: All in on inflation-linked bonds?

Post by pacific blue »

Thanks so much for all the great responses. Much appreciated!
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