Dude2 wrote:No mention of TIPS which is disappointing.
The entire industry seems to be blind to the existence of TIPS, which are awesome inflation-indexed bonds
Unfortunately, there's a lot of misunderstanding about TIPS and bonds, in general:
- Bonds (including TIPS) are not cash investments. A high-quality bond fund fluctuates in value according to its average duration. The higher its average duration, the higher its volatility.
- Nowhere, on stock certificates and bond contracts, is there any written promise that their market prices should be correlated (or not) at any point in time.
It's not because some gurus
claim that "bonds are negatively correlation with stocks during crises
" that it becomes true! Yet, because such statements are repeated so often, supported with carefully selected data-mined historical snapshots, some people start to believe them.
As a result, lots of people got confused when total-market TIPS funds lost 12% in 3 months in 2008. Yet, TIPS funds just did what was they're mathematically expected to do: they fluctuated according to their average duration.
The performance of TIPS, in 2008, deserves a closer inspection. Let's look at the three months that got people confused:
The chart shows that the total return of the iShares TIPS Bond ETF
(TIP), a total TIPS market index ETF, was a cumulative
loss of 12% over that period.
But, that was in nominal dollars! Let's not forget that we're dealing with inflation-indexed bonds, here.
As a matter of fact, the Consumer Price Index (CPI) happened to fluctuate pretty wildly during this period. By considering the CPI-adjusted performance of iShares' TIP, over these three months, we discover that its CPI-adjusted cumulative loss was 8%
, a significantly smaller loss, which is totally in line with the average duration of the ETF. This can be confirmed by clicking on the small "i" besides the $8,898 Final Balance
to reveal the inflation-adjusted final balance
of $9,177 on this PortfolioVIsualizer
It can also be useful to look at the bigger picture. Here's a growth chart for the wider 18-month period, spanning from June 2007 to November 2008, inclusively, where I show the performance of three total-market index ETFs representing three assets:
- TIP: total TIPS market (blue)
- VTI: total US stock market (orange)
- VXUS: total non-US stock markets (green)
While TIPS mildly
fluctuated according to their duration, stocks wildly
fluctuated, US stocks losing 48% and international stocks losing 55% over a period of 13 months.
I would say that TIPS did their work to dampen the volatility of stocks in a portfolio.
Dude2 wrote:Also, this discussion deviates from the notion of "take your risk on the equity side." Risk management via different flavor of bonds is not something recommended for personal investors much around here. Sometimes, with Vanguard, one wonders who the audience is that they are addressing.
I don't listen to gurus
, not even those who suggest to "take your risks on the equity side
All financial assets are risky, but don't necessarily exhibit the same risks. Of course, some assets (such as stocks) are generally riskier
than others (such as bonds).
Personally, I expose my portfolio to an equal-weight
allocation of four different investment-grade assets
*, using total-market index ETFs, representing a 50/50 allocation to stocks and bonds:
- Investment-grade domestic stocks
- Investment-grade international stocks, which are exposed to currency fluctuations
- Domestic nominal bonds
- Domestic inflation-indexed bonds
* I exclude speculative assets such as junk bonds, penny stocks, and commodities.
I don't invest into currency-hedged international bonds, because they use derivatives
to hedge currency. I don't invest, either, into international bonds exposed to currency fluctuations, as this would be akin to investing into foreign currencies. I consider that my allocation to international stocks already provides me with enough exposure to foreign currencies.
I didn't consider past returns
or future return predictions
, when choosing my asset allocation. Instead, I studied the fundamental nature of the assets. Stocks are certificates of ownership entitling me to future dividends. International stocks are transacted and pay dividends using foreign currencies. Bonds are legal contracts promising specific payments on specific future dates. Inflation-indexed bonds, in particular, index their future payments to the CPI.
Mathematics limit the volatility of nominal bonds in nominal terms, and the volatility of inflation-indexed bonds in inflation-indexed terms.
As a result, nominal bonds
act as a nominal ballast
and inflation-indexed bonds
act as an inflation-indexed ballast
for my portfolio.
Bogleheads investment philosophy |
Lifelong Portfolio: 25% each of (domestic/international)stocks/(nominal/inflation-indexed)bonds |