How much TIPS during accumulation phase?

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How much TIPS during accumulation phase?

Post by Sunny Sarkar » Mon Dec 30, 2013 8:53 pm

Hello friends,

I am struggling with understanding the role, and hence allocation, of TIPS during the accumulation phase of the investment life-cycle. In addition to a nominal bond fund like TBM, how much "direct" inflation protection from TIPS is necessary and/or appropriate during this phase?

Best wishes,
Sunny

p.s. Our target allocation for TIPS is 50% of bonds, which I admit I did not put much thought into, and we are 25 years from retirement.
"Cost matters". "Stay the course". "Press on, regardless". ― John C. Bogle

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Re: How much TIPS during accumulation phase?

Post by abuss368 » Mon Dec 30, 2013 10:26 pm

I have thought of this as well. One theory is if still in the working years, your human capital and routine adjustments should be fine resulting in less of a need for TIPS. Another theory is that if during retirement one has a pension with a COLA adjustment, Social Security provides a COLA adjustment as needed, where is the need.

I do not like the 8.5 duration on the intermediate TIPS fund and the infrequent dividend income. I also do not like the fact that nominal treasuries are now being bought in the fund as noted in the fund report and another thread.

To me, a little too many folks are way too quick to jump on the TIPS bandwagon. These folks used to point out how the TIPS fund beat Total Bond. That has since reversed for the most part. A fund of 8.5 in duration during a decade of decreasing rates makes it easy to understand a lot of the funds return was a result of the declining interest rates.

What did our parents generation do and they retired just fine? Nominal and easy to understand bonds that paid routine and predictable interest!

This is a tough call.
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Re: How much TIPS during accumulation phase?

Post by elgob.bogle » Mon Dec 30, 2013 10:40 pm

It is coincidental that you should ask this question as I have just completed a quick re-read of Larry's "The Only Guide to a Winning Bond Strategy You'll Ever Need" in an attempt to answer the very question. In the book, Larry suggests no TIPS at this time due to low interest rate environment plus your being in the accumulation phase. If you do purchase TIPS, go for a shorter duration. In contrast, a person such as myself who is already in retirement and desires an income stream might want to have a longer duration if TIPS are purchased. This is my interpretation of his writings. Recommend that you read the book.

Best regards,

elgob

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Re: How much TIPS during accumulation phase?

Post by joe8d » Mon Dec 30, 2013 10:43 pm

abuss368 wrote:I have thought of this as well. One theory is if still in the working years, your human capital and routine adjustments should be fine resulting in less of a need for TIPS. Another theory is that if during retirement one has a pension with a COLA adjustment, Social Security provides a COLA adjustment as needed, where is the need.

I do not like the 8.5 duration on the intermediate TIPS fund and the infrequent dividend income. I also do not like the fact that nominal treasuries are now being bought in the fund as noted in the fund report and another thread.

To me, a little too many folks are way too quick to jump on the TIPS bandwagon. These folks used to point out how the TIPS fund beat Total Bond. That has since reversed for the most part. A fund of 8.5 in duration during a decade of decreasing rates makes it easy to understand a lot of the funds return was a result of the declining interest rates.

What did our parents generation do and they retired just fine? Nominal and easy to understand bonds that paid routine and predictable interest!

This is a tough call.
+1
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Re: How much TIPS during accumulation phase?

Post by abuss368 » Mon Dec 30, 2013 10:55 pm

elgob.bogle wrote:In contrast, a person such as myself who is already in retirement and desires an income stream might want to have a longer duration if TIPS are purchased.
That has to be a volatile income stream compared to Total Bond Index Fund.

I found the product description from Vanguard's website helpful:

Product summary
This fund is designed to protect investors from the eroding effect of inflation by investing in securities that seek to provide a “real” return. The fund invests in bonds that are backed by the full faith and credit of the federal government and whose principal is adjusted quarterly based on inflation. In addition to typical movement in bond prices, income can fluctuate more in this fund because payments depend on inflation changes. Investors with a long-term time horizon may wish to consider this fund as a complement to an already diversified fixed income portfolio.
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Re: How much TIPS during accumulation phase?

Post by Sunny Sarkar » Mon Dec 30, 2013 11:28 pm

Found this in the Vanguard whitepaper on TRFs...
Vanguard wrote:While the risk of inflation is prevalent throughout an investor’s life cycle, it’s primarily in the later stages that investors must focus on investment tools to provide some protection. This is because for investors in the accumulation stage, inflation protection can be effectively provided from salaries and higher real returning assets, such as equities. But once in retirement, it is much more difficult to add to a portfolio through additional earnings. As a result, investors must balance the need for preservation of their capital though bonds and cash, as well as preservation of their purchasing power. Given that inflation-protected securities adjust to changes in inflation quickly, TIPS are an appropriate substitute for a portion of the portfolio’s equity allocation during retirement.

Vanguard dedicates a portion of each TDF’s total fixed income allocation to U.S. Treasury Inflation Protected Securities as a diversifier in the more conservative portfolios, beginning five years prior to retirement and reaching a maximum allocation of 20% of the portfolio at age 72
So... no TIPS until five years to retirement?
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Re: How much TIPS during accumulation phase?

Post by Leeraar » Tue Dec 31, 2013 1:26 am

Sunny Sarkar wrote:Hello friends,

I am struggling with understanding the role, and hence allocation, of TIPS during the accumulation phase of the investment life-cycle. In addition to a nominal bond fund like TBM, how much "direct" inflation protection from TIPS is necessary and/or appropriate during this phase?

Best wishes,
Sunny

p.s. Our target allocation for TIPS is 50% of bonds, which I admit I did not put much thought into, and we are 25 years from retirement.
Sunny,

At your age (mid 40s?) I would suggest zero TIPS while you contemplate the problem of how to protect yourself against (unexpected) inflation.

The problem with TIPS is they protect against one risk (inflation), they provide no leverage (only the TIPS are protected), and they give up prospects for market returns.

I have thought about this a lot, and have more or less decided that the best inflation protection is to invest in companies that provide goods and services, i.e. the stock market. After all, inflation is the increase in the price of goods and services. In the long run, you get inflation protection and market participation. Yes, I know there is no guarantee that stocks will pace inflation over any particular period.

The TIPs discussion often seems to be: I need TIPs, which ones should I get? I advocate a step backwards to look at a bigger picture.

For inflation protection of retirement income, there is (now) no better deal than to delay claiming Social Security. You get an 8% return and inflation protection. SPIAs (both nominal and real) may have a part to play.

I think TIPs may play a short-term role for some people, but I do not think you need them during the accumulation phase, particularly if you are more than two decades from retirement.

L.
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Re: How much TIPS during accumulation phase?

Post by LH » Tue Dec 31, 2013 3:50 am

abuss368 wrote:I have thought of this as well. One theory is if still in the working years, your human capital and routine adjustments should be fine resulting in less of a need for TIPS. Another theory is that if during retirement one has a pension with a COLA adjustment, Social Security provides a COLA adjustment as needed, where is the need.

I do not like the 8.5 duration on the intermediate TIPS fund and the infrequent dividend income. I also do not like the fact that nominal treasuries are now being bought in the fund as noted in the fund report and another thread.

To me, a little too many folks are way too quick to jump on the TIPS bandwagon. These folks used to point out how the TIPS fund beat Total Bond. That has since reversed for the most part. A fund of 8.5 in duration during a decade of decreasing rates makes it easy to understand a lot of the funds return was a result of the declining interest rates.

What did our parents generation do and they retired just fine? Nominal and easy to understand bonds that paid routine and predictable interest!

This is a tough call.
50 50 tips/nominal bonds

In inflation, like 1970s stagflation, nominals get creamed. Not to say I think TIPS will protect from that necessarily completely, as inflation revisions expectantly only go one way. But they will protect better than nominals.

TIPS do better, then nominals do better, yeah, that makes sense, rinse repeat.

There is no definite way to split it, so I go 50/50.

Duration, cuts BOTH ways, if rates rise, duration hurts more, if rates lower, longer duration is better..... Go figure...

What people fail to realize, is they

cannot

time

the bond

market.

This means duration, this means switching from nominals to tips back and forth, this means cash to bonds, this means stocks to bonds, bonds to stocks.

Cannot do it expectantly people.

Most important thing is, ignore the rearview mirror you are looking in, and deluding yourself it means something going forward. Read the 2007 IMF report how things are all clear, read business weeks 1979 death of equities cover issue. Pick a bestselling book from 1981, and read in it how stocks will suck. Read about how 2000s, are the century of Japan in 1989...... Go back, and read 1929 newspaper finance section..... yeah. We KNOW whats coming. False.

On and on and on and on.

My father, in his financial prime in 1970s, refuses to buy any bonds, because nominal bonds sucked then. "certificates of confiscation" is what they were rightly called.

Here is a link: http://www.nytimes.com/2010/10/29/busin ... d=all&_r=0
here is a quote from said link:
The term “certificate of confiscation” was coined in the late 1970s, when inflation was rising. “If you took the coupon payment, adjusted for inflation and taxes, you had a negative real return,” said Leon Cooperman, who may have been the first to use the term. Mr. Cooperman now runs Omega Advisors, a hedge fund manager, but then was a strategist for Goldman Sachs.

By the time the concept became popular, around 1980, Treasury bonds had nominal yields of more than 10 percent and were despised.


Despised for good reason. Its the same reason to hold TIPS (and hope they do not down the adjustment too much, if it gets bad, they will down it some, its just going to be a matter of degree)

If you are in 100 percent nominals and high inflation hits, guess what, its too late to get out. The time to get in TIPS, like anything else, is before you need them. They are down a bit now, great, go into them now.

If inflation goes up, and up, and up, nominals will get killed again. And its not of the interest rate rise type killed, where they make it up over time due to higher interest rate. With inflation, nominals take a permanent loss. No makeup. Its brutal.

Here is what I mean by makeup:

say bond duration 5, say bonds pay 2 percent at time zero and you have 100dollars at time zero. Say there is a jump in interest rates at time 1, to 4 percent.

The nonimal bond fund will drop in value 5*2=10 percent to 90 dollars, BUT it then starts to make money at 4 percent, not 2 percent. Then in 5 years time, it breaks even, then starts to pull away, the sudden rise in interest rates being beneficial after 5 years time........

this is simply true by math.

Inflation, not so.

That is why you buy TIPS. To prevent a 1970s hit to all your bonds. How much do I want to protect, I dunno, 50 percent sounds like a solid number.


(note above post is only minimally a response to the quoted text, more just general)

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Re: How much TIPS during accumulation phase?

Post by Call_Me_Op » Tue Dec 31, 2013 8:19 am

Bottom line - you do not "need" any TIPS. Investors did just fine before TIPS were on the scene. It is not clear that TIPS are better than short nominals in hedging inflation. It depends upon relative duration and the nature of inflation and interest rate changes. If you like TIPS, allocate a portion of your bond allocation to them. Splitting 50-50 TIPS-nominals seems as good as anything.
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Re: How much TIPS during accumulation phase?

Post by abuss368 » Tue Dec 31, 2013 9:16 am

Call_Me_Op wrote:Bottom line - you do not "need" any TIPS. Investors did just fine before TIPS were on the scene.
Agreed. My post above asks "What did our parents generation do and they retired just fine? Nominal and easy to understand bonds that paid routine and predictable interest!"
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Re: How much TIPS during accumulation phase?

Post by abuss368 » Tue Dec 31, 2013 9:21 am

Leeraar wrote: Sunny,

At your age (mid 40s?) I would suggest zero TIPS while you contemplate the problem of how to protect yourself against (unexpected) inflation.

The problem with TIPS is they protect against one risk (inflation), they provide no leverage (only the TIPS are protected), and they give up prospects for market returns.

I have thought about this a lot, and have more or less decided that the best inflation protection is to invest in companies that provide goods and services, i.e. the stock market. After all, inflation is the increase in the price of goods and services. In the long run, you get inflation protection and market participation. Yes, I know there is no guarantee that stocks will pace inflation over any particular period.

The TIPs discussion often seems to be: I need TIPs, which ones should I get? I advocate a step backwards to look at a bigger picture.

For inflation protection of retirement income, there is (now) no better deal than to delay claiming Social Security. You get an 8% return and inflation protection. SPIAs (both nominal and real) may have a part to play.

I think TIPs may play a short-term role for some people, but I do not think you need them during the accumulation phase, particularly if you are more than two decades from retirement.

L.
I thought this was a really good post. too many folks jump on the TIPS bandwagon over the years. The sheep mentality as one would rather be incorrect in a group than right by themselves. It used to be an investor had to have the Intermediate Term TIPS fund. Now the debate is Short Term vs. Intermediate Term.

Total Bond Index has worked very well for us.

Keep investing simple.
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Re: How much TIPS during accumulation phase?

Post by ftobin » Tue Dec 31, 2013 10:11 am

Imagine a world in which only TIPS existed, and then only later did nominal bonds came along.

People would be saying "why would you take the extra risk with these new-fangled nominal bonds? You're just subjecting yourself to unexpected inflation risk. Sure you *might* come out ahead due to the inflation premium, but we know what happens when people reach for yield. Our parents were fine with TIPS. These nominal bonds are meant to be sold, not bought, since their value can be quickly eroded away once a bout of inflation hits. Just like stock market crashes, people have a poor grasp of when these unexpected bouts could wipe out their nominal bond portfolio. Stick to what's been tried and true."

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Re: How much TIPS during accumulation phase?

Post by abuss368 » Tue Dec 31, 2013 1:22 pm

Investors mistakenly believe their portfolio has protection from unexpected inflation. The reality is only the TIPS component offers that not the remaining investments.
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Re: How much TIPS during accumulation phase?

Post by FinancialDave » Tue Dec 31, 2013 1:27 pm

abuss368 wrote:Investors mistakenly believe their portfolio has protection from unexpected inflation. The reality is only the TIPS component offers that not the remaining investments.
And unfortunately you can't separate the "TIPS component" from the rest of the bond, so you still suffer the interest rate exposure.

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Re: How much TIPS during accumulation phase?

Post by pingo » Tue Dec 31, 2013 2:04 pm

OP,

I am in the accumulation phase, also. Here's a link to my approach so far, but as much I have tried to reason things through, it's still arbitrary.

abuss368 wrote:Investors mistakenly believe their portfolio has protection from unexpected inflation. The reality is only the TIPS component offers that not the remaining investments.
While that may be true, it is also true that TIPS protect a portfolio from unexpected inflation in a similar sense that having bonds in general "protect" a portfolio when stocks crash.

Perhaps we should shift the phrasing of it to "cushions". TIPS may cushion a portfolio from unexpected inflation, not unlike the way bonds don't protect a stock-bond portfolio from stock crashes, rather it cushions the portfolio from loss.
FinancialDave wrote:And unfortunately you can't separate the "TIPS component" from the rest of the bond, so you still suffer the interest rate exposure.
In which case I guess stocks protect or cushion bonds from interest rate exposure? It seems true enough, but how strange it is to use "protect or cushion" in reference to protecting one from risk when the purpose of stocks is also to expose one to high risk for the potential returns it may provide.

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Re: How much TIPS during accumulation phase?

Post by abuss368 » Tue Dec 31, 2013 2:58 pm

pingo wrote:OP,

I am in the accumulation phase, also. Here's a link to my approach so far, but as much I have tried to reason things through, it's still arbitrary.

abuss368 wrote:Investors mistakenly believe their portfolio has protection from unexpected inflation. The reality is only the TIPS component offers that not the remaining investments.
While that may be true, it is also true that TIPS protect a portfolio from unexpected inflation in a similar sense that having bonds in general "protect" a portfolio when stocks crash.

Perhaps we should shift the phrasing of it to "cushions". TIPS may cushion a portfolio from unexpected inflation, not unlike the way bonds don't protect a stock-bond portfolio from stock crashes, rather it cushions the portfolio from loss.
FinancialDave wrote:And unfortunately you can't separate the "TIPS component" from the rest of the bond, so you still suffer the interest rate exposure.
In which case I guess stocks protect or cushion bonds from interest rate exposure? It seems true enough, but how strange it is to use "protect or cushion" in reference to protecting one from risk when the purpose of stocks is also to expose one to high risk for the potential returns it may provide.
What percentage of fixed income are you presently allocating to TIPS? Do you use the Intermediate Term or Short Term Fund or another inflation bond option such as iBonds and individual TIPS?
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Re: How much TIPS during accumulation phase?

Post by nedsaid » Tue Dec 31, 2013 3:38 pm

There is no magic number in all of this. I have seen recommendations in these forums of up to 50% of a fixed income portfolio. Rick Ferri, if I remember right, recommends 20-30%.

It is just hard to say since we don't know what will happen. A big burst of unexpected inflation would make someone with 100% of their bonds in TIPS look like a genius. If inflation stays very tame, TIPS could be a bit of a drag on the performance of your fixed income portfolio. So the answer is that I really don't know. Nor does anyone else. I have about 13% of my fixed income portfolio in TIPS funds, and about 4% of my total retirement portfolio. It really boils down to your investment philosophy and your beliefs about inflation.

So if you did 20-30% of your fixed income in TIPS, you would be okay. There is just no way to know for sure. Pretty much what you are getting is informed guesses.
Last edited by nedsaid on Tue Dec 31, 2013 3:48 pm, edited 1 time in total.
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Re: How much TIPS during accumulation phase?

Post by gkaplan » Tue Dec 31, 2013 3:40 pm

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Re: How much TIPS during accumulation phase?

Post by stlutz » Tue Dec 31, 2013 6:55 pm

One thing keeps getting said in the various TIPS threads--"TIPS don't produce consistent income". That's not really true.

Nominal bonds provide higher interest payments while allowing your principal to shink in real terms.
TIPS provide less interest while protecting the value of your principal.

If the market guesses the level of future inflation correctly, it really doesn't matter which you hold as a standalone investment--they both provide the same returns in different ways.

The last two recessions have been deflationary ones. For someone with a lot of equities, this has made nominals a better diversifier. If we had stagflation (even at a lower level of inflation than in the 70s), TIPS would probably be a better diversifier.

Which you view as more likely will influence your choice.

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Re: How much TIPS during accumulation phase?

Post by pingo » Tue Dec 31, 2013 8:06 pm

abuss368 wrote:What percentage of fixed income are you presently allocating to TIPS? Do you use the Intermediate Term or Short Term Fund or another inflation bond option such as iBonds and individual TIPS?
4% SSgA U.S. Inflation Protected Bond Index Fund (no ticker); ER 0.06%; average duration 8.3 years.

There is a disconnect between our view of the need (or lack thereof) of a TIPS fund and the reality of our present and expected future holdings. In case it matters, I'll attempt to explain.

TIPS aren't absolutely necessary for anyone, but they may be useful, comforting, diversifying, whatever, for many. We figure we probably don't need TIPS until we begin moving our stock allocation to less than 50% of our portfolio. All else being equal, for each percentage point we reduce our equity allocation below 50%, we will probably replace it with 1 percentage point of TIPS (not to exceed 20% of the portfolio). We have not reached that stage, but we do have 4% in intermediate-term TIPS index fund because we've invested in a manner that gives us the peace of mind we need to stay the course.

Here's the long version:

I expect to have a pension that will equal half my current income and that will be COLA'd up to 2% per year. The average of our ages is 40 with a total combined portfolio of 75% Stocks / 25% Bonds. It is on course to be no less aggressive than 50% Stock/ 50% Bonds when I retire at 65 (possibly 60/40 at retirement). For several years, we used target date funds from Vanguard and our employers. TIPS are not a part of those target funds (yet), but the more I learned about my employer target funds, the less comfortable I became. The costs weren't terrible (< 0.50%), but it's a custom target date fund with permanent, fixed allocations to a hedge fund and an "unconstrained" fund--not unconstrained bonds, mind you, unconstrained period. Those holdings combined make up 15% of assets in every one of my employer target date funds, from the 2055 fund to the retirement income fund. (Sheesh.)

So, a couple years ago, I separated out the assets using the same equity allocations plus Stable Value for "bonds". Mrs. Pingo insists we keep the target funds in our other accounts and I respect that. (Besides, I like them, too.) I used the stable value fund (ER 0.27%) for "bonds" since at the time I couldn't understand my employer's "Core Plus Full Discretion" bond fund (ER 0.30%). Afterwards, that bond option became a hybrid fund of the "Core Plus" and another firm's "Core" bond fund, making the option more attractive, but overwhelmingly skewed toward corporate bonds and MBS (average duration is 6.5 years). At the same time, my employer began offering the SSgA intermediate-term TIPS index fund (ER 0.06%; average duration of 8.3 years).

I decided to do an even split of my employer bonds between the hybrid bond option, TIPS and stable value, which gives me weighted bond ER of 0.20%, an average, market-like duration of 5.18 years and I get healthy market-like doses of Corporates, MBS and high quality Treasuries (via TIPS). It's not perfect, but it's helps me sleep well.

So for me the TIPS fund is necessary even though it might otherwise be ignored. We'll keep it, too, but there has been another change of circumstances that will diminish it's prominence in the portfolio. I now have enough assets to justify using a Self-Directed Brokerage option, but I have left the bonds in the employer plan because there is a required account minimum. I hold all the stocks on the brokerage-side. I keep the original 3 "bond" funds in a holding pattern, using small amounts of new contributions to maintain the 3-way balance. This way, downward fluctuations shouldn't push those assets below the account minimum. The vast majority of new bond purchases are of a commission-free Intermediate-Term Treasury ETF on the brokerage side since the Total Bond Index fund option would be 19 basis points more expensive.

So, when we reach 60% Stocks / 40% Bonds, our Target Funds will begin introducing Short-Term TIPS, but the effect on the whole portfolio will be that of far less than 1% per year, based on account sizes and contributions.

Like I have said, we don't think TIPS are necessary for us in terms of our stage in life, all else being equal. But all else isn't equal, it's an index fund with a 0.06% ER that lowers the overall cost of bonds in my employer plan while improving the quality and diversification of our bonds holdings.
Last edited by pingo on Thu Jan 02, 2014 10:34 pm, edited 2 times in total.

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Re: How much TIPS during accumulation phase?

Post by abuss368 » Tue Dec 31, 2013 10:19 pm

stlutz wrote: Nominal bonds provide higher interest payments while allowing your principal to shink in real terms.
TIPS provide less interest while protecting the value of your principal.
I would expect for an investor with nominal bonds that if the monthly dividend income was reinvested (or some portion was reinvested) this should not be an issue in terms of the principal decreasing in real terms.
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Re: How much TIPS during accumulation phase?

Post by G-Money » Tue Dec 31, 2013 11:12 pm

abuss368 wrote:
stlutz wrote: Nominal bonds provide higher interest payments while allowing your principal to shink in real terms.
TIPS provide less interest while protecting the value of your principal.
I would expect for an investor with nominal bonds that if the monthly dividend income was reinvested (or some portion was reinvested) this should not be an issue in terms of the principal decreasing in real terms.
But if you're reinvesting the dividend, then it doesn't matter that nominal bonds "pay routine and predictable interest." :P
Don't assume I know what I'm talking about.

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Re: How much TIPS during accumulation phase?

Post by Valuethinker » Wed Jan 01, 2014 9:59 am

Sunny Sarkar wrote:Hello friends,

I am struggling with understanding the role, and hence allocation, of TIPS during the accumulation phase of the investment life-cycle. In addition to a nominal bond fund like TBM, how much "direct" inflation protection from TIPS is necessary and/or appropriate during this phase?

Best wishes,
Sunny

p.s. Our target allocation for TIPS is 50% of bonds, which I admit I did not put much thought into, and we are 25 years from retirement.
50% is an even handed bet against a repeat of the 70s (inflation) and against deflation (Japan 1990s). The TIPS protect you against the former, the nominal bonds the latter.

TIPS have a relatively low correlation with equities. When inflation is rising, it is generally bad for equities (based on the 1968-1980 period).

If we reran the 1970s, then *only* TIPS and Ibonds would have protected your wealth. Nominal bonds would not. Neither would stocks.

I am not sure there is much one can add to that, really.

Note that as with all bonds, but especially TIPS, where you come in matters. The expected real yield that you get when you buy is the return you get from owning the TIPS. So if real yields are low, you might want to add ST nominal bonds, in the expectation that at some moment real yields will be higher.

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Re: How much TIPS during accumulation phase?

Post by dbr » Wed Jan 01, 2014 10:26 am

Valuethinker wrote:
50% is an even handed bet against a repeat of the 70s (inflation) and against deflation (Japan 1990s). The TIPS protect you against the former, the nominal bonds the latter.

To follow up on that, the ratio of TIPS to nominal should be proportional to the probability of inflation vs the probability of deflation, both being informed guesses. I suspect we should argue for almost everything in TIPS on this concept.

TIPS have a relatively low correlation with equities. When inflation is rising, it is generally bad for equities (based on the 1968-1980 period).

If we reran the 1970s, then *only* TIPS and Ibonds would have protected your wealth. Nominal bonds would not. Neither would stocks.

I am not sure there is much one can add to that, really.

Note that as with all bonds, but especially TIPS, where you come in matters. The expected real yield that you get when you buy is the return you get from owning the TIPS. So if real yields are low, you might want to add ST nominal bonds, in the expectation that at some moment real yields will be higher.

That was where Larry Swedroe was coming from in his older book, since changed to a suggestion that one might shorten TIPS maturities when real yields are low.

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Re: How much TIPS during accumulation phase?

Post by Doc » Wed Jan 01, 2014 11:49 am

dbr wrote:That was where Larry Swedroe was coming from in his older book, since changed to a suggestion that one might shorten TIPS maturities when real yields are low.
Will you clarify "older book" as opposed to some other book? As far as I can tell "The Only Guide to a Winning Bond Strategy You'll Ever Need: The Way Smart Money Preserves Wealth Today" 2006 is the only edition of his "bond book" and that describes a TIPS/nominals trade off with yield. I know that he proposed the shifting maturity strategy later on but was it ever described in a book and if so which one?
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Re: How much TIPS during accumulation phase?

Post by dbr » Wed Jan 01, 2014 12:00 pm

Doc wrote:
dbr wrote:That was where Larry Swedroe was coming from in his older book, since changed to a suggestion that one might shorten TIPS maturities when real yields are low.
Will you clarify "older book" as opposed to some other book? As far as I can tell "The Only Guide to a Winning Bond Strategy You'll Ever Need: The Way Smart Money Preserves Wealth Today" 2006 is the only edition of his "bond book" and that describes a TIPS/nominals trade off with yield. I know that he proposed the shifting maturity strategy later on but was it ever described in a book and if so which one?
Sorry, I don't know the exact books. I don't have any of Larry's books on the shelf anymore as they have been passed on. Unfortunately I didn't keep a set of notes either.

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Re: How much TIPS during accumulation phase?

Post by FinancialDave » Wed Jan 01, 2014 7:21 pm

For me the answer to this question is zero.

There is no historical evidence that I have ever seen that makes TIPS a better investment against inflation than equities.

IMHO bonds serve more as a risk reduction mechanism, not an inflation protection mechanism.

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Re: How much TIPS during accumulation phase?

Post by elgob.bogle » Thu Jan 02, 2014 12:03 am

Here are a two points paraphrased from Chapter 11 in Larry's Bond Book that are, IMHO, worth considering:

For most investors in the accumulation stage, the overriding motivation for including fixed-income assets in a portfolio is risk reduction and not to achieve the highest expected return. During the withdrawal stage, generating the highest expected return at an acceptable level of risk may take priority over risk reduction.

Here are three paraphrased items from the book's example Fixed Income IPS that serve to combine and illustrate many of Larry's points:

- The average maturity of the portfolio will not exceed five years, but cannot be less than two years
- The maximum maturity of any one bond cannot exceed ten years
- Neither Mortgage Backed Securities nor Hybrid Securities may be purchased

You might ask yourself why he would include conditions like these in a Fixed Income IPS. Larry goes into depth on these topics, and does a great job of describing the do's & the don'ts of fixed income investing. I think that every Boglehead should read this book carefully.

Best regards,

elgob

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Re: How much TIPS during accumulation phase?

Post by jhd » Thu Jan 02, 2014 12:31 am

I like David Swensen's analysis of this question. The market sets a price for TIPS based on the expected level of inflation. If inflation is lower than expected, TIPS are worse than bonds. If inflation is higher than expected, they're better. If the market is efficient, it's a coin flip whether TIPS will help or hurt. In that situation, a 50/50 allocation is rational, which is what he recommends.

That said...getting fancy with bonds won't affect a portfolio nearly as much as most other investment decisions one makes (active vs. index, stock/bond allocation, US/international, small/value or not, etc.). Especially if conventional bond durations are kept short.

Also, TIPS shouldn't be held in taxable accounts, whereas munis work just fine. So TIPS aren't practical for portfolios with limited tax-advantaged space. (This is why I only own a tiny sliver of TIPS today.)

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Re: How much TIPS during accumulation phase?

Post by Valuethinker » Thu Jan 02, 2014 3:07 am

FinancialDave wrote:For me the answer to this question is zero.

There is no historical evidence that I have ever seen that makes TIPS a better investment against inflation than equities.

IMHO bonds serve more as a risk reduction mechanism, not an inflation protection mechanism.

fd
Complex. We don't have a long period of rising inflation when TIPS existed.

We do have a period of rising inflation when equities existed. 1968 to 1980. Equities performed horribly. They did well once the back of inflation was decisively broken by Paul Volker in the early 1980s.

It's fairly well held, I believe, that equities, because they are a high risk asset, pay high returns. However that doesn't mean they are well correlated with inflation -- although better than (nominal) bonds. They are not in and of themselves an inflation hedge, it's just that their long run expected return is high (higher than inflation amongst other things).

Commercial Real Estate has a higher correlation with inflation than stocks (and REITs should, as well). It has been argued so do commodities (I am less clear on this, but it should be true for the 1970s inflationary period).

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Re: How much TIPS during accumulation phase?

Post by Valuethinker » Thu Jan 02, 2014 3:08 am

Note Vanguard paper seemed to suggest only ST TIPS have a strong correlation with inflation. That's why they now offer a ST TIPS fund.

TIPS are volatile-- the implied real interest rate moves around a lot. Particularly at the long end.

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Re: How much TIPS during accumulation phase?

Post by dbr » Thu Jan 02, 2014 10:46 am

Valuethinker wrote:Note Vanguard paper seemed to suggest only ST TIPS have a strong correlation with inflation. That's why they now offer a ST TIPS fund.

TIPS are volatile-- the implied real interest rate moves around a lot. Particularly at the long end.
This is true, but investors should separate the two issues of having an offset to inflation and taking interest rate risk. Posing correlation to inflation as being the same as "insurance" against inflation confounds these two things and confuses the issue. If a person wants to avoid real rate risk, then they can buy short TIPS, but the reason has nothing to do with some bizarre idea about correlation.

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Re: How much TIPS during accumulation phase?

Post by BanditKing » Thu Jan 02, 2014 12:48 pm

In my IPS, I have my total bond allocation at (AGE-20)%, and my TIPS/iBonds as (AGE-20%) of that total, to a maximum of 50% at age 70. Right now I'm 43, so my total is 23% of 23%, or 5.29% of my portfolio.

Right now I meet that need with only ibonds purchased through Treasury Direct, which I do via automatic purchase at $50/week ($2600/yr) and then, if needed, a single "catch up" purchase when I rebalance in May and November. I can also direct my tax refund, up to the $5k cap, towards iBonds as well, if needed.

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Re: How much TIPS during accumulation phase?

Post by FinancialDave » Thu Jan 02, 2014 12:50 pm

Valuethinker wrote:
FinancialDave wrote:For me the answer to this question is zero.

There is no historical evidence that I have ever seen that makes TIPS a better investment against inflation than equities.

IMHO bonds serve more as a risk reduction mechanism, not an inflation protection mechanism.

fd
Complex. We don't have a long period of rising inflation when TIPS existed.

We do have a period of rising inflation when equities existed. 1968 to 1980. Equities performed horribly. They did well once the back of inflation was decisively broken by Paul Volker in the early 1980s.

It's fairly well held, I believe, that equities, because they are a high risk asset, pay high returns. However that doesn't mean they are well correlated with inflation -- although better than (nominal) bonds. They are not in and of themselves an inflation hedge, it's just that their long run expected return is high (higher than inflation amongst other things).

Commercial Real Estate has a higher correlation with inflation than stocks (and REITs should, as well). It has been argued so do commodities (I am less clear on this, but it should be true for the 1970s inflationary period).
The above is all accurate, but I think you might have to agree that an investment that lost 8-9% last year (VIPSX) did not correlate too well with inflation either.

The fact is I don't really need to invest in things that might "attempt" to keep up with inflation, if I invest in things that are "generally" known to beat inflation.

So, if you want risk reduction, then buy risk reduction with the proper duration that fits your situation, but if you want return, then use equities.

fd
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Re: How much TIPS during accumulation phase?

Post by billyt » Thu Jan 02, 2014 1:33 pm

There is no expectation that TIPS total return should match (or correlate with) the inflation rate. TIPS fell last year because real rates increased. Same is true of nominal bonds.

When you invest in TIPS (ladder or fund) you are buying an inflation adjusted income stream, i. e. you are getting a real rate of return.

Right now the Vanguard long term TIPS fund has a barely positive real yield, so one should expect over the long term (1 - 2x duration) that money invested should maintain its purchasing power, but not grow in real terms.

Any other expectation implies that you don't understand what you are investing in.

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Re: How much TIPS during accumulation phase?

Post by Valuethinker » Thu Jan 02, 2014 1:38 pm

FinancialDave wrote:
Valuethinker wrote:
FinancialDave wrote:For me the answer to this question is zero.

There is no historical evidence that I have ever seen that makes TIPS a better investment against inflation than equities.

IMHO bonds serve more as a risk reduction mechanism, not an inflation protection mechanism.

fd
Complex. We don't have a long period of rising inflation when TIPS existed.

We do have a period of rising inflation when equities existed. 1968 to 1980. Equities performed horribly. They did well once the back of inflation was decisively broken by Paul Volker in the early 1980s.

It's fairly well held, I believe, that equities, because they are a high risk asset, pay high returns. However that doesn't mean they are well correlated with inflation -- although better than (nominal) bonds. They are not in and of themselves an inflation hedge, it's just that their long run expected return is high (higher than inflation amongst other things).

Commercial Real Estate has a higher correlation with inflation than stocks (and REITs should, as well). It has been argued so do commodities (I am less clear on this, but it should be true for the 1970s inflationary period).
The above is all accurate, but I think you might have to agree that an investment that lost 8-9% last year (VIPSX) did not correlate too well with inflation either.

The fact is I don't really need to invest in things that might "attempt" to keep up with inflation, if I invest in things that are "generally" known to beat inflation.

So, if you want risk reduction, then buy risk reduction with the proper duration that fits your situation, but if you want return, then use equities.

fd
I think Elroy Dimson has shown pretty conclusively that stocks are not an inflation hedge per se. It's a common confusion. They are a high return real asset, so in the long run, you *should* beat inflation. But the record of stocks when inflation was rising was not good. See the 1970s. There is a lot of academic research on this-- if you searched SSRN as a starter you might find some (also Copeland Weston Shastri probably has some cites- sorry I don't have time to look it up right now).

That's separate from whatever happens with TIPS. Only ST TIPS have a good correlation with inflation (source: Vanguard research, also William Bernstein).

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Re: How much TIPS during accumulation phase?

Post by #Cruncher » Thu Jan 02, 2014 9:13 pm

Valuethinker wrote:TIPS are volatile-- the implied real interest rate moves around a lot. Particularly at the long end. (underline added)
VT, I don't know what you mean by "implied"; but as the following graph shows, short-term and long-term TIPS interest rates have moved up and down about the same over the past four years. If anything long-term rates are a little less volatile . You were probably thinking that long-term TIPS prices are more volatile. This is true because the same % point change in interest rates translates into a much bigger price change for them.
Image
The blue line is the constant maturity 30-year TIPS rate. The red line is the constant maturity 5-year TIPS rate. Both are from the FRED Database. To make relative changes easier to see, the graph adds 2% points to the 5-year rate. For example, at the beginning of 2013 the 30-year rate was about +0.5% and the 5-year rate about -1.4%. But the latter is displayed as +0.6% on the graph.

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Re: How much TIPS during accumulation phase?

Post by MindBogler » Thu Jan 02, 2014 9:23 pm

Maybe I'm the anomaly but I think intermediate bonds are "safe enough" for the FI portion of a portfolio during accumulation. Equities will provide the real return in the long term (even if they fail to keep up with rapid inflation in the short term).

Just my .02 YMMV.

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Re: How much TIPS during accumulation phase?

Post by abuss368 » Thu Jan 02, 2014 10:11 pm

FinancialDave wrote:For me the answer to this question is zero.

There is no historical evidence that I have ever seen that makes TIPS a better investment against inflation than equities.

IMHO bonds serve more as a risk reduction mechanism, not an inflation protection mechanism.

fd
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Re: How much TIPS during accumulation phase?

Post by abuss368 » Thu Jan 02, 2014 10:14 pm

I am on the fence if an investor needs TIPS in the accumulation phase. I would expect investors in the accumulation phase are trying for significant appreciation, not marginal return above CPI.

Hold a few bonds to smooth the ride if you wish - but TIPS may not do that - were they not down 12% in the Fall of '08 and 9% over the last year?
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Re: How much TIPS during accumulation phase?

Post by Doc » Fri Jan 03, 2014 9:46 am

abuss368 wrote:I am on the fence if an investor needs TIPS in the accumulation phase. I would expect investors in the accumulation phase are trying for significant appreciation, not marginal return above CPI.

Hold a few bonds to smooth the ride if you wish - but TIPS may not do that - were they not down 12% in the Fall of '08 and 9% over the last year?
There is a lot of talk lately about bond safety. Safety means different things to different people. Some people think of safety as no credit risk and no change in price. These are the CD advocates. Some people want fixed amount of spending power sometime in the future and don't care about interim prices. These are the long TIPS advocates. Others think of safety as minimum volatility in their overall portfolio. These people may be long nominal Treasury advocates (high AA) or short nominal Treasuries (low AA) advocates. Both are concerned with getting the best negative correlation with equities.

As abuss point illustrates "how much TIPS" depends on what your objective is. The OP's question is somewhat specific especially if you make it early accumulation phase. In an early accumulation phase the with say a 80/20 AA you arguably get the most bang for your FI buck by having all you FI in long nominal Treasuries. No TIPS at all. We might get another '08 in the next thirty years.

(For those of you early accumulators that don't have the stomach for all long nominal Treasuries TBM is often recommended for soundness of sleep. Still no TIPS.)
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Re: How much TIPS during accumulation phase?

Post by Valuethinker » Fri Jan 03, 2014 10:11 am

#Cruncher wrote:
Valuethinker wrote:TIPS are volatile-- the implied real interest rate moves around a lot. Particularly at the long end. (underline added)
VT, I don't know what you mean by "implied"; but as the following graph shows, short-term and long-term TIPS interest rates have moved up and down about the same over the past four years. If anything long-term rates are a little less volatile . You were probably thinking that long-term TIPS prices are more volatile. This is true because the same % point change in interest rates translates into a much bigger price change for them.
Image
The blue line is the constant maturity 30-year TIPS rate. The red line is the constant maturity 5-year TIPS rate. Both are from the FRED Database. To make relative changes easier to see, the graph adds 2% points to the 5-year rate. For example, at the beginning of 2013 the 30-year rate was about +0.5% and the 5-year rate about -1.4%. But the latter is displayed as +0.6% on the graph.
On reflection you are probably right. Thank you.

ie it's the duration of TIPS that is long, and therefore very sensitive to moves in the *real* interest rate. The real interest rate *should* be more stable than the nominal rate, but that hasn't been how it is worked out.

Therefore with long maturity TIPS, because of the long duration, you get high price volatility (or rather than high duration is a measure of the high sensitivity of price movements to changes in the real yield of the instrument).

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Re: How much TIPS during accumulation phase?

Post by DireWolf » Fri Jan 03, 2014 11:38 am

TIPS is the single most anxiety-provoking decision in my portfolio. I think this stems from the fact that the "experts" are not even close in agreement on this asset class. Once you decide if you even need TIPS (which is highly debatable), then you have to decide how much (20% of FI, 50% of FI, etc.), and then you have to decide Short term vs. Intermediate term. It's exhausting quite frankly.

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Re: How much TIPS during accumulation phase?

Post by dbr » Fri Jan 03, 2014 11:47 am

DireWolf wrote:TIPS is the single most anxiety-provoking decision in my portfolio. I think this stems from the fact that the "experts" are not even close in agreement on this asset class. Once you decide if you even need TIPS (which is highly debatable), then you have to decide how much (20% of FI, 50% of FI, etc.), and then you have to decide Short term vs. Intermediate term. It's exhausting quite frankly.
If the experts are not in agreement on the issue, then it should be the LEAST anxiety provoking decision in your portfolio.

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Re: How much TIPS during accumulation phase?

Post by DireWolf » Fri Jan 03, 2014 11:53 am

dbr wrote:If the experts are not in agreement on the issue, then it should be the LEAST anxiety provoking decision in your portfolio.
How so? I would find it much less stressful if there was some sort of consensus... something like... Short-term TIPS fund should occupy about 20% of FI in your portfolio during the accumulation phase.

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Re: How much TIPS during accumulation phase?

Post by dbr » Fri Jan 03, 2014 11:59 am

DireWolf wrote:
dbr wrote:If the experts are not in agreement on the issue, then it should be the LEAST anxiety provoking decision in your portfolio.
How so? I would find it much less stressful if there was some sort of consensus... something like... Short-term TIPS fund should occupy about 20% of FI in your portfolio during the accumulation phase.
Because when experts disagree they are niggling fine points that don't matter to you.

An alternative is to not worry about what experts say and just decide for yourself what properties different bonds have that might matter to you and become your own expert.

One thing that can be guaranteed is that if you try to resolve all possible investing decisions by needing expert consensus, your certain fate will be the looney bin.

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Re: How much TIPS during accumulation phase?

Post by DireWolf » Fri Jan 03, 2014 12:19 pm

dbr wrote:Because when experts disagree they are niggling fine points that don't matter to you..
If they were arguing fine points, I would not be worried about it. But they are arguing huge points... should you even hold TIPS? If so, some say 20% of FI, some say 50%, some say 80%! Also, some recommend Intermediate term (VIPSX) and others recommend Short term (VTIPX). Unfortunately these are not fine points.

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Re: How much TIPS during accumulation phase?

Post by G-Money » Fri Jan 03, 2014 12:27 pm

DireWolf wrote:
dbr wrote:Because when experts disagree they are niggling fine points that don't matter to you..
If they were arguing fine points, I would not be worried about it. But they are arguing huge points... should you even hold TIPS? If so, some say 20% of FI, some say 50%, some say 80%! Also, some recommend Intermediate term (VIPSX) and others recommend Short term (VTIPX). Unfortunately these are not fine points.
I'm with dbr on this one.

I view the decision to own high quality investment grade bonds as deciding to eat ice cream. The particular flavor--vanilla or chocolate, nominal or inflation-protected, shorter or intermediate-term, or some combination thereof--is more a matter of personal taste.
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Re: How much TIPS during accumulation phase?

Post by dbr » Fri Jan 03, 2014 12:47 pm

DireWolf wrote:
dbr wrote:Because when experts disagree they are niggling fine points that don't matter to you..
If they were arguing fine points, I would not be worried about it. But they are arguing huge points... should you even hold TIPS? If so, some say 20% of FI, some say 50%, some say 80%! Also, some recommend Intermediate term (VIPSX) and others recommend Short term (VTIPX). Unfortunately these are not fine points.
What I think is that the current state of low interest rates has provoked a level of hysteria on this forum that has caused discussion issues in bond investing to become magnified totally out of proportion. The discussion can be interesting because bond behavior is complicated and it is an intellectual challenge to try to understand the details.

Here is another solution. When a person does not know how to decide among options then one can simply go half TIPS and half nominal, and one can pick one's duration for both TIPS and nominal bonds at half short term and half intermediate term.*

*I personally am an advocate of the bizarre theory of prime number proportions, meaning that rather than 50/50, it is better to select 47/53 as simple division by two cannot really be right. To decide which asset gets the 47, one performs a best 3 out of 5 tosses of an unbalanced coin, the balance of which is not known in advance.

But, what are the things that can be serious mistakes? That list is left as an exercise for the reader, but I can assure you that buying the wrong proportion in TIPS vs nominals would be in the second ten of a list of ten, the same applying to making a wrong choice between short and intermediate durations of bonds, including cash-like options as well.

Another perspective that is that investors in accumulation don't typically have large bond allocations, perhaps in the range 20%-40%. That being the case, issues in bond investing are not all that important. If a person were invested 80%-100% in bonds there would be more significance to the issues, but likely there would also be more consensus on how to match that investors investments to his objectives.

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Re: How much TIPS during accumulation phase?

Post by jmg229 » Fri Jan 03, 2014 12:50 pm

jhd wrote:I like David Swensen's analysis of this question. The market sets a price for TIPS based on the expected level of inflation. If inflation is lower than expected, TIPS are worse than bonds. If inflation is higher than expected, they're better. If the market is efficient, it's a coin flip whether TIPS will help or hurt. In that situation, a 50/50 allocation is rational, which is what he recommends.
This is more or less my logic, although I'm not committed to the 50% (I go more with 20-30% as Rick Ferri suggests in All About Asset Allocation, I think). I would think that nominal and TIPS together should provide a more predictable return that helps to negate the impact of inflation being above or below market predictions. I am early in my accumulation phase and as I go forward I will probably aim closer towards the 50% as I near retirement.

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