are TIPS expensive? or are they cheap?

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grok87
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are TIPS expensive? or are they cheap?

Post by grok87 » Sat Jun 01, 2019 9:13 am

Well it's been an interesting week in the bond market. Tips yields have dropped, along with nominal treasuries. Currently yields:

5 year TIP: 0.33%
10 year TIP: 0.38%
30 year TIP: 0.73%

So the question is, with yields this low, are tips too expensive?

My answer is no. I'm actually going to argue that Tips are cheap. To see why let's start by looking at nominal treasury yields and the implied break-even inflation levels (BEI):

5 year nominal treasury: 1.91%======> 5 year BEI = 1.58%
10 year nominal treasury: 2.12% =====> 10 year BEI = 1.74%
30 year nominal treasury: 2.57% =====> 30 year BEI = 1.84%
===> 5x5 BEI = 1.90% ( this is the BEI for the 2024-2029 period)
===>20x10 BEI = 1.89% (this is the BEI for the 2029-2049 period)

To make sense of these numbers i think it helps to consider two things.

a) The 5 year BEI repesents near term inflation. i think the best guide here is what recent CPI reports have been showing. here are the year-over-year inflation numbers from the most recent 6 CPI reports:

April: 2.00%
March: 1.86%
February: 1.52%
january: 1.55%
December: 1.91%
November: 2.18%
average of these 6 numbers = 1.84%

So if i had to pick an a-priori estimate for expected inflation over the next 5 years, that would be my number: 1.84%. Based on that I expect 5 year TIPS to outpeform 5 year treasuries by 0.26%. i.e. 5 year TIPS look cheap.

b) for the longer term, i think it's helpful to compare 5x5 BEI and 20x10 BEI to the fed's inflation target. As many know that is 2% but it is actually the PCE inflation that they look at. CPI tends to run about 20 bps hotter than that (not sure why). Stated differently, based on fed policy we might expect long term CPI to run at 2.20%. So i expect long term tips to outperform nominals by about 0.30% (i.e. 2.20% - 1.90%). So again 10 year and 30 year tips look cheap.

TL/DR: I expect 5,10 and 30 year tips to beat treasuries by 0.26%-0.30% per year if you hold to maturity.

cheers,
grok
Last edited by grok87 on Mon Jun 03, 2019 5:08 pm, edited 2 times in total.
RIP Mr. Bogle.

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nedsaid
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Re: are tips expensive? or are they cheap?

Post by nedsaid » Sat Jun 01, 2019 9:19 am

Grok, TIPS look relatively cheap to me as well. That is because I remember the higher inflation of the 1970's. Just hard for me to believe that inflation is going to stay below 2% forever. But I could be wrong. Perhaps the world of the 1970's will never return. I remember the whiffs of deflation we experienced in the aftermath of the 2008-2009 financial crisis.

Pretty much, if inflation stays very subdued then TIPS are expensive. If inflation ticks up above 2%, then TIPS look cheap. I keep TIPS to guard against unexpected inflation.
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Re: are tips expensive? or are they cheap?

Post by stan1 » Sat Jun 01, 2019 9:31 am

Trying to time inflation is difficult with a lot of fiscal and monetary policy levers in place and readily being used. I definitely would not bet on a revision to historic mean anytime soon.

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Blueskies123
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Re: are tips expensive? or are they cheap?

Post by Blueskies123 » Sat Jun 01, 2019 9:47 am

Larry Swedroe has written several similar articles. I am about 50% in TIPS and 50% in Treasuries and CD's with just a little in corporates.

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Doc
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Re: are tips expensive? or are they cheap?

Post by Doc » Sat Jun 01, 2019 10:02 am

I don't worry about unexpected inflation in the short run. Even if it soars in the next five years I'm not going to lose that much over five years.

Unexpected inflation in the long run could be a problem. Even an extra 2 or three percent over 20 years is something I might care about. But accepting 0.73% real over 20 years does not give me a warm cozy feeling.

Therefore for me, no TIPS in the short run and none in the long run under current real yields. Heck might as well throw in the mid term too. It's going to be different from both the long and the short run? Not.

With this logic TIPS are expensive in this market.
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Re: are tips expensive? or are they cheap?

Post by DaufuskieNate » Sat Jun 01, 2019 10:02 am

I think there's a risk-based explanation for what's going on here. In 2008, the market "learned" that fixed-rate U.S. Treasuries are perhaps the safest and most liquid asset class in the world. TIP's not so much. Right now, with concerns about global equity markets, investors are moving into Treasuries to diversify their equity holdings. These investors are willing to pay a premium for the insurance provided by the world's safest asset class in the form of lower yields. So, if you are unconcerned about these risks, TIP's look cheap. If you are more interested in positioning your portfolio for a downturn in equities, TIP's may not look so cheap. So, I guess the answer to the question is that TIP's look expensive to some and cheap to others. Isn't that what makes a market?
Last edited by DaufuskieNate on Sat Jun 01, 2019 10:09 am, edited 1 time in total.

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Re: are tips expensive? or are they cheap?

Post by jeffyscott » Sat Jun 01, 2019 10:06 am

Maybe both TIPS and nominals are expensive, given that ~2.35% is available on 1-6 mo. t-bills and brokered CDs are 2.4% and above for any term :?:
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grok87
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Re: are tips expensive? or are they cheap?

Post by grok87 » Sat Jun 01, 2019 10:39 am

DaufuskieNate wrote:
Sat Jun 01, 2019 10:02 am
I think there's a risk-based explanation for what's going on here. In 2008, the market "learned" that fixed-rate U.S. Treasuries are perhaps the safest and most liquid asset class in the world. TIP's not so much. Right now, with concerns about global equity markets, investors are moving into Treasuries to diversify their equity holdings. These investors are willing to pay a premium for the insurance provided by the world's safest asset class in the form of lower yields. So, if you are unconcerned about these risks, TIP's look cheap. If you are more interested in positioning your portfolio for a downturn in equities, TIP's may not look so cheap. So, I guess the answer to the question is that TIP's look expensive to some and cheap to others. Isn't that what makes a market?
agree. that's a useful way to think about it.

i mostly buy tips for my retirement tips ladder, which is a substitute for the inflation linked pension i don't have. so from that perspective it is a riskless asset.
RIP Mr. Bogle.

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grok87
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Re: are tips expensive? or are they cheap?

Post by grok87 » Sat Jun 01, 2019 10:41 am

jeffyscott wrote:
Sat Jun 01, 2019 10:06 am
Maybe both TIPS and nominals are expensive, given that ~2.35% is available on 1-6 mo. t-bills and brokered CDs are 2.4% and above for any term :?:
yes but brokered cds have il-iquidity risk and state taxes
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Re: are tips expensive? or are they cheap?

Post by jeffyscott » Sat Jun 01, 2019 10:54 am

grok87 wrote:
Sat Jun 01, 2019 10:41 am
jeffyscott wrote:
Sat Jun 01, 2019 10:06 am
Maybe both TIPS and nominals are expensive, given that ~2.35% is available on 1-6 mo. t-bills and brokered CDs are 2.4% and above for any term :?:
yes but brokered cds have il-iquidity risk and state taxes
True, but I'd not looking to trade them and would hold in an IRA.
Time is your friend; impulse is your enemy. - John C. Bogle

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Re: are tips expensive? or are they cheap?

Post by dbr » Sat Jun 01, 2019 11:03 am

All bonds are expensive now because all interest rates, nominal and real, are historically low.

If you want bonds to be cheap now you have to change the expectation for what is normal to a much lower interest rate than we perhaps used to think should be there.

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Re: are tips expensive? or are they cheap?

Post by garlandwhizzer » Sat Jun 01, 2019 1:46 pm

dbr wrote:

All bonds are expensive now because all interest rates, nominal and real, are historically low.
1+

I believe this to be entirely true. In developed markets there is huge demand for safe yield among the aging and wealthy investing class. This in combination with historically low interest rates and QE from central banks is a potent combination to keep rates low and bond prices high. This situation may persist for quite a long time. One thing that will break this cycle is persistently rising inflation and rapid and persistent economic growth which now seems a long way off. Hopefully the DM world as a whole will not go the way of Japan which has been struggling to create even modest inflation and economic growth for 29 years without success. I don't believe we will follow Japan's example but clearly all DMs currently have challenges posed by unfavorable demographics and high levels of total debt. Fortunately rates for financing that debt are now low.

Garland Whizzer

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grok87
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Re: are tips expensive? or are they cheap?

Post by grok87 » Sat Jun 01, 2019 2:03 pm

garlandwhizzer wrote:
Sat Jun 01, 2019 1:46 pm
dbr wrote:

All bonds are expensive now because all interest rates, nominal and real, are historically low.
1+

I believe this to be entirely true. In developed markets there is huge demand for safe yield among the aging and wealthy investing class. This in combination with historically low interest rates and QE from central banks is a potent combination to keep rates low and bond prices high. This situation may persist for quite a long time. One thing that will break this cycle is persistently rising inflation and rapid and persistent economic growth which now seems a long way off. Hopefully the DM world as a whole will not go the way of Japan which has been struggling to create even modest inflation and economic growth for 29 years without success. I don't believe we will follow Japan's example but clearly all DMs currently have challenges posed by unfavorable demographics and high levels of total debt. Fortunately rates for financing that debt are now low.

Garland Whizzer
Agree. I should have made the title “are tips cheap relative to nominal treasuries”...
RIP Mr. Bogle.

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Re: are tips expensive? or are they cheap?

Post by dodecahedron » Sat Jun 01, 2019 3:15 pm

dbr wrote:
Sat Jun 01, 2019 11:03 am
All bonds are expensive now because all interest rates, nominal and real, are historically low.
Real aftertax interest rates are considerably higher than they were in the late 1970s and early 1980s.

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Re: are TIPS expensive? or are they cheap?

Post by Northern Flicker » Sat Jun 01, 2019 3:49 pm

10-year breakeven inflation is now 1.74%.
5-year breakeven inflation is now 1.59%.

TIPS are now cheaper relative to nominal treasuries by that measure than they were when breakeven rates were recently above 2%.

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Re: are tips expensive? or are they cheap?

Post by klaus14 » Sat Jun 01, 2019 4:00 pm

DaufuskieNate wrote:
Sat Jun 01, 2019 10:02 am
I think there's a risk-based explanation for what's going on here. In 2008, the market "learned" that fixed-rate U.S. Treasuries are perhaps the safest and most liquid asset class in the world. TIP's not so much. Right now, with concerns about global equity markets, investors are moving into Treasuries to diversify their equity holdings. These investors are willing to pay a premium for the insurance provided by the world's safest asset class in the form of lower yields. So, if you are unconcerned about these risks, TIP's look cheap. If you are more interested in positioning your portfolio for a downturn in equities, TIP's may not look so cheap. So, I guess the answer to the question is that TIP's look expensive to some and cheap to others. Isn't that what makes a market?
isn't what happened to TIPS was an illiquidity anomaly specific to 2008?
TIPS should behave very similar to treasuries in a 2001 style market correction or recession.

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Re: are TIPS expensive? or are they cheap?

Post by klaus14 » Sat Jun 01, 2019 4:07 pm

As others mentioned, breakeven inflation rate for 5 years TIPS (1.59) is actually less than inflation expectations.

People argue TIPS isn't needed for young investors but from a risk management/diversification point of view, including TIPS improves returns by protecting against unexpected inflation. Given that they are rather cheap now, i don't see a reason not to include them.

Dealing with individual bonds is hard so i am holding VAIPX in my tax advantaged accounts.

I guess one issue is that if deflation occurs, then TIPS would suffer a lot and nominal bonds would shine. So I also hold long term treasuries (equal amount to my gold + TIPS holding)

But honestly, i don't see deflation happening in US. Our politicians are too eager to spend. They will be happy to push even larger deficit spending if deflation risk appears.

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Re: are TIPS expensive? or are they cheap?

Post by JackoC » Sat Jun 01, 2019 4:21 pm

grok87 wrote:
Sat Jun 01, 2019 9:13 am

My answer is no. I'm actually going to argue that Tips are cheap. To see why let's start by looking at nominal treasury yields and the implied break-even inflation levels (BEI):

5 year nominal treasury: 1.91%======> 5 year BEI = 1.58%
10 year nominal treasury: 2.12% =====> 10 year BEI = 1.74%
30 year nominal treasury: 2.57% =====> 30 year BEI = 1.84%
===> 5x5 BEI = 1.90% ( this is the BEI for the 2024-2029 period)
===>20x10 BEI = 1.89% (this is the BEI for the 2029-2049 period)
I generally agree. Other recent threads have gotten into the Cleveland Fed's inflation expectation model (purported to be independent of TIPS prices and used to judge them) although as you peel away layers of the onion of that model things don't necessarily get clearer it seems from some of those past discussions. Anyway latest top line result seen here, says market's expectation of inflation over the next 10 yrs per the model, not TIPS is 1.80%, close to the TIPS breakeven.
https://www.clevelandfed.org/en/our-res ... tions.aspx

But TIPS are providing insurance so you'd expect the TIPS breakeven to be higher than the inflation expectation...except in the real world you also should get compensated by a liquidity premium to hold TIPS, or thought of another way you shouldn't *give up* as much yield to hold TIPS as you give up to get the ultra liquidity/flight-to-quality destination benefit of nominal US treasuries. If those two cancel out and inflation only has to meet the market expectation to breakeven holding TIPS, then TIPS are relatively attractive, to buy and hold. We all know TIPS are not ideal for the limited part of a fixed income portfolio subject to immediate sale to rebalance asset allocation or meet emergency cash needs.

Also I think it's reasonable to make a judgement without considering that model that a long term TIPS BE below 2% is just low. Of course one could be wrong about that. But if it were a choice between TIPS and nominals now I'd go TIPS for sure.

It gets more complicated when recognizing that best yielding CD's yield so much more than nominal treasuries now. Best 5 yr CD's are 3.40%, 5 yr point on the Treasury Daily YC 5/31 was 1.93%: 1.47% spread, exceptionally high. Each investor has to run the numbers for their state tax rate (CD's state taxable TIPS not) and consider their liquidity needs but it's hard to ignore that big a spread for basically same risk. It's not the product of an efficient market where we'd need to explain what real risk makes that spread so high right now. It's so high because treasury yields have dropped like a stone lately, but very few CD investors act on a hair trigger when that happens, so banks can leave stale rates dangling out there for awhile without getting destroyed the way they would if they acted that way in the professional fixed income market. If the 5 yr T yield stays down here, CD rates like that will be gone soon.

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Re: are TIPS expensive? or are they cheap?

Post by Reb Tevye » Sat Jun 01, 2019 5:27 pm

To test my understanding of matters...

Wouldn’t it also be fair to say that “half the people” think TIPS are expensive and “half the people” think TIPS are cheap? Or else the price/yields would be something other than what they are?

(Ignoring folks who think the TIPS porridge is exactly “just right” today?)
(and not getting too exact about literally “half the people” vs “half the dollar-weighted people”, etc)
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Re: are TIPS expensive? or are they cheap?

Post by klaus14 » Sat Jun 01, 2019 5:31 pm

Reb Tevye wrote:
Sat Jun 01, 2019 5:27 pm
To test my understanding of matters...

Wouldn’t it also be fair to say that “half the people” think TIPS are expensive and “half the people” think TIPS are cheap? Or else the price/yields would be something other than what they are?

(Ignoring folks who think the TIPS porridge is exactly “just right” today?)
(and not getting too exact about literally “half the people” vs “half the dollar-weighted people”, etc)
you are right. but individuals can have different needs compared to median investor (dollar-weighted). if you care more about unexpected inflation compared to median investor, then TIPS are cheap for you. My guess is median investor doesn't care much about inflation due to recent history.

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Re: are TIPS expensive? or are they cheap?

Post by unclescrooge » Sat Jun 01, 2019 5:34 pm

klaus14 wrote:
Sat Jun 01, 2019 4:07 pm
But honestly, i don't see deflation happening in US. Our politicians are too eager to spend. They will be happy to push even larger deficit spending if deflation risk appears.
So you're implying that deficit spending is inflationary?

Based on what's happened in the aftermath of the great recession, think the opposite has been true.

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Re: are TIPS expensive? or are they cheap?

Post by klaus14 » Sat Jun 01, 2019 5:38 pm

unclescrooge wrote:
Sat Jun 01, 2019 5:34 pm
klaus14 wrote:
Sat Jun 01, 2019 4:07 pm
But honestly, i don't see deflation happening in US. Our politicians are too eager to spend. They will be happy to push even larger deficit spending if deflation risk appears.
So you're implying that deficit spending is inflationary?

Based on what's happened in the aftermath of the great recession, think the opposite has been true.
deficit spending being inflationary is common sense. Search for inflation in wikipedia article.

if we didn't have deficit spending after great recession, it would've been even lower inflation.

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Re: are TIPS expensive? or are they cheap?

Post by JackoC » Sat Jun 01, 2019 5:46 pm

klaus14 wrote:
Sat Jun 01, 2019 5:31 pm
Reb Tevye wrote:
Sat Jun 01, 2019 5:27 pm
To test my understanding of matters...

Wouldn’t it also be fair to say that “half the people” think TIPS are expensive and “half the people” think TIPS are cheap? Or else the price/yields would be something other than what they are?

(Ignoring folks who think the TIPS porridge is exactly “just right” today?)
(and not getting too exact about literally “half the people” vs “half the dollar-weighted people”, etc)
you are right. but individuals can have different needs compared to median investor (dollar-weighted). if you care more about unexpected inflation compared to median investor, then TIPS are cheap for you. My guess is median investor doesn't care much about inflation due to recent history.
Right but also liquidity. Which is where past discussions about TIPS have pointed to a common misunderstanding. A lot of times people are down on TIPS because they believe nominal treasuries will 'go up more' when the stock market goes down. That seems likely if past patterns persist (though they might or might not), but your say 40% nominal treasuries going up when your 60% stocks do down is only relevant for the much smaller proportion of 40% you'd actually sell to get back to 60/40 stock/bond. For the rest, the bump in treasury prices compared v. TIPS or CD's not going up as much or 'just laying there' is really just a psychological boost. They are all going to pay what they promised you with very high and virtually equal degree of certainty. In short there's no reason to care if TIPS you aren't actually going to sell fluctuate differently in price from nominal treasuries, or reason to care CD's don't fluctuate at all if holding to maturity is consistent with liquidity needs for that particular 'layer' of your portfolio.

The driving force in the huge divergence of TIPS and nominal prices in 2009 was professional market players who actually need the super liquidity of nominal treasuries. TIPS then became indeed ridiculously cheap for investors who could just hold them to maturity. TIPS supposed projection of years of deflation at that time was in fact mainly a huge liquidity premium. Which the vast majority of retail investors on most of their fixed income holdings, could simply have reaped. On a less dramatic level this is true of TIPS a lot of the time: the liquidity premium will occasionally tick up and make them more attractive for investors who have no logical reason to assume their liquidity need happens to be the same as the weighted avg of the market, or that it has changed. As well as of course no reason to think their inflation aversion is necessarily the same as the weighted average of the market or changes with the market average either.

There's no contradiction to efficient markets in seeing that various instruments can be more or less attractive to various people in general, or that they can get cheaper or more expensive relative to individual need.

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Re: are TIPS expensive? or are they cheap?

Post by Doc » Sat Jun 01, 2019 6:00 pm

JackoC wrote:
Sat Jun 01, 2019 5:46 pm
TIPS then became indeed ridiculously cheap for investors who could just hold them to maturity
But I couldn't hold them to maturity because I had to sell ALL of them to rebalance. Catch 22.
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Re: are TIPS expensive? or are they cheap?

Post by unclescrooge » Sat Jun 01, 2019 6:53 pm

klaus14 wrote:
Sat Jun 01, 2019 5:38 pm
unclescrooge wrote:
Sat Jun 01, 2019 5:34 pm
klaus14 wrote:
Sat Jun 01, 2019 4:07 pm
But honestly, i don't see deflation happening in US. Our politicians are too eager to spend. They will be happy to push even larger deficit spending if deflation risk appears.
So you're implying that deficit spending is inflationary?

Based on what's happened in the aftermath of the great recession, think the opposite has been true.
deficit spending being inflationary is common sense. Search for inflation in wikipedia article.

if we didn't have deficit spending after great recession, it would've been even lower inflation.
If it was common sense, prominent economists wouldn't have opposing views about it.

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Re: are TIPS expensive? or are they cheap?

Post by ThrustVectoring » Sat Jun 01, 2019 7:11 pm

TIPS are currently priced like the treasury's 2% inflation target will consistently get undershot like they've been doing under the current economic policy.

This can easily change - the undershoot is because the treasury is unwilling to take into account previous undershooting into future inflation control. Your cruise control will do this - if you've consistently been going slower than you want for enough time, it'll adjust itself to feed more gas to prevent long-term divergence.

"Control theory" is taught to electrical engineering undergrads, and this is a pretty straightforward application of it. I'd honestly be surprised if the fed doesn't start announcing its plans to correct for future under-inflation in the future. And for better or for worse, the consensus plan is 2% year-over-year inflation, so that's likely how TIPS will eventually get priced IMO.
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Re: are TIPS expensive? or are they cheap?

Post by grok87 » Sat Jun 01, 2019 7:25 pm

JackoC wrote:
Sat Jun 01, 2019 4:21 pm
grok87 wrote:
Sat Jun 01, 2019 9:13 am

My answer is no. I'm actually going to argue that Tips are cheap. To see why let's start by looking at nominal treasury yields and the implied break-even inflation levels (BEI):

5 year nominal treasury: 1.91%======> 5 year BEI = 1.58%
10 year nominal treasury: 2.12% =====> 10 year BEI = 1.74%
30 year nominal treasury: 2.57% =====> 30 year BEI = 1.84%
===> 5x5 BEI = 1.90% ( this is the BEI for the 2024-2029 period)
===>20x10 BEI = 1.89% (this is the BEI for the 2029-2049 period)
I generally agree. Other recent threads have gotten into the Cleveland Fed's inflation expectation model (purported to be independent of TIPS prices and used to judge them) although as you peel away layers of the onion of that model things don't necessarily get clearer it seems from some of those past discussions. Anyway latest top line result seen here, says market's expectation of inflation over the next 10 yrs per the model, not TIPS is 1.80%, close to the TIPS breakeven.
https://www.clevelandfed.org/en/our-res ... tions.aspx
thanks for the interesting link.
i clicked on the "Ten-Year tips yields vs real yields" tab. Looks like their model says 10 year tips were a screaming by in Nov 2008 (actual real yield of 3.6% vs model at 1.6%) and a screaming sell in december 2012 (actual real yield of -0.8% vs model at -0.2%)
RIP Mr. Bogle.

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grok87
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Re: are TIPS expensive? or are they cheap?

Post by grok87 » Sat Jun 01, 2019 7:26 pm

klaus14 wrote:
Sat Jun 01, 2019 5:38 pm
unclescrooge wrote:
Sat Jun 01, 2019 5:34 pm
klaus14 wrote:
Sat Jun 01, 2019 4:07 pm
But honestly, i don't see deflation happening in US. Our politicians are too eager to spend. They will be happy to push even larger deficit spending if deflation risk appears.
So you're implying that deficit spending is inflationary?

Based on what's happened in the aftermath of the great recession, think the opposite has been true.
deficit spending being inflationary is common sense. Search for inflation in wikipedia article.

if we didn't have deficit spending after great recession, it would've been even lower inflation.
japan has huge debt to gdp levels and hardly any inflation
RIP Mr. Bogle.

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Re: are TIPS expensive? or are they cheap?

Post by fennewaldaj » Sat Jun 01, 2019 9:30 pm

grok87 wrote:
Sat Jun 01, 2019 7:26 pm
klaus14 wrote:
Sat Jun 01, 2019 5:38 pm
unclescrooge wrote:
Sat Jun 01, 2019 5:34 pm
klaus14 wrote:
Sat Jun 01, 2019 4:07 pm
But honestly, i don't see deflation happening in US. Our politicians are too eager to spend. They will be happy to push even larger deficit spending if deflation risk appears.
So you're implying that deficit spending is inflationary?

Based on what's happened in the aftermath of the great recession, think the opposite has been true.
deficit spending being inflationary is common sense. Search for inflation in wikipedia article.

if we didn't have deficit spending after great recession, it would've been even lower inflation.
japan has huge debt to gdp levels and hardly any inflation
Perhaps they would have had outright deflation without the spending?

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Re: are tips expensive? or are they cheap?

Post by FIREchief » Sat Jun 01, 2019 11:47 pm

grok87 wrote:
Sat Jun 01, 2019 10:39 am
i mostly buy tips for my retirement tips ladder, which is a substitute for the inflation linked pension i don't have. so from that perspective it is a riskless asset.
Same here. Thanks for posting this very interesting thread grok87!
I am not a lawyer, accountant or financial advisor. Any advice or suggestions that I may provide shall be considered for entertainment purposes only.

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Re: are TIPS expensive? or are they cheap?

Post by Reb Tevye » Sun Jun 02, 2019 12:09 am

JackoC wrote:
Sat Jun 01, 2019 5:46 pm
klaus14 wrote:
Sat Jun 01, 2019 5:31 pm
Reb Tevye wrote:
Sat Jun 01, 2019 5:27 pm
To test my understanding of matters...

Wouldn’t it also be fair to say that “half the people” think TIPS are expensive and “half the people” think TIPS are cheap? Or else the price/yields would be something other than what they are?

(Ignoring folks who think the TIPS porridge is exactly “just right” today?)
(and not getting too exact about literally “half the people” vs “half the dollar-weighted people”, etc)
you are right. but individuals can have different needs compared to median investor (dollar-weighted). if you care more about unexpected inflation compared to median investor, then TIPS are cheap for you. My guess is median investor doesn't care much about inflation due to recent history.
Right but also liquidity.
...

The driving force in the huge divergence of TIPS and nominal prices in 2009 was professional market players who actually need the super liquidity of nominal treasuries.
...
Interesting, thanks klaus14 and JackoC.
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Re: are TIPS expensive? or are they cheap?

Post by fennewaldaj » Sun Jun 02, 2019 12:12 am

Doc wrote:
Sat Jun 01, 2019 6:00 pm
JackoC wrote:
Sat Jun 01, 2019 5:46 pm
TIPS then became indeed ridiculously cheap for investors who could just hold them to maturity
But I couldn't hold them to maturity because I had to sell ALL of them to rebalance. Catch 22.
Sure if you were willing to sell all bonds to buy equities it ended up working the best. But if you wanted to say maintain a 20% bond allocation you could have sold all your bonds and bought all TIPs and it would have worked quite well. And since they are TIPs it was very obvious it would have worked well.

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Re: are TIPS expensive? or are they cheap?

Post by Doc » Sun Jun 02, 2019 7:31 am

fennewaldaj wrote:
Sun Jun 02, 2019 12:12 am
Doc wrote:
Sat Jun 01, 2019 6:00 pm
JackoC wrote:
Sat Jun 01, 2019 5:46 pm
TIPS then became indeed ridiculously cheap for investors who could just hold them to maturity
But I couldn't hold them to maturity because I had to sell ALL of them to rebalance. Catch 22.
Sure if you were willing to sell all bonds to buy equities it ended up working the best. But if you wanted to say maintain a 20% bond allocation you could have sold all your bonds and bought all TIPs and it would have worked quite well. And since they are TIPs it was very obvious it would have worked well.
:?:
When one needs to rebalance into equities in a market crash one sells bonds. Typically one sells bonds that have increased in price. That's nominal Treasuries not corporate debt. TIPS were toted as being just like nominals except for the inflation protection but they behaved more like corporates in '08.

Selling all my bonds and buying TIPS leaves nothing to buy equities.
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Re: are tips expensive? or are they cheap?

Post by grok87 » Sun Jun 02, 2019 12:51 pm

FIREchief wrote:
Sat Jun 01, 2019 11:47 pm
grok87 wrote:
Sat Jun 01, 2019 10:39 am
i mostly buy tips for my retirement tips ladder, which is a substitute for the inflation linked pension i don't have. so from that perspective it is a riskless asset.
Same here. Thanks for posting this very interesting thread grok87!
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Re: are TIPS expensive? or are they cheap?

Post by JackoC » Sun Jun 02, 2019 3:48 pm

Doc wrote:
Sat Jun 01, 2019 6:00 pm
JackoC wrote:
Sat Jun 01, 2019 5:46 pm
TIPS then became indeed ridiculously cheap for investors who could just hold them to maturity
But I couldn't hold them to maturity because I had to sell ALL of them to rebalance. Catch 22.
I wonder what that situation could be. Let's say an investor is 60/40 stock/'safe'. Say stocks fall 60% and bonds rise 20%. The original '60' stock becomes 24, 40 bonds becomes 48. To get back to 60%/40% you still only have to sell only 19.2 of the 48 bonds, only 40% of them (starting 80/20 it would be 53%, in the limit 2/3's, but 60/40 with 30% stock drop 10% bond rise you only sell 22% of the bonds). Keeping in mind in considering such large and infrequent moves you have to suffer the yield penalty of nominal treasuries v other forms of govt risk all the time for the portion of fixed income you put in treasuries. And right now in the CD v treasury comparison the liquidity of treasuries is very expensive. Other times not quite as much, but it's never free.

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Re: are TIPS expensive? or are they cheap?

Post by Doc » Sun Jun 02, 2019 4:25 pm

JackoC wrote:
Sun Jun 02, 2019 3:48 pm
Say stocks fall 60% and bonds rise 20%.
That's not what happens usually. At least if you are speaking of bonds in general. Nominal Treasuries especially long term, tend to be negatively correlated with equities in times of stock market stress. On the other hand I do not think that corporate bonds behave the same way. In fact they may even be positively correlated to equities during stress.

We don't have a lot of experience with TIPS but in '08 they behaved more like corporates than nominal Treasuries. One can argue that this was due to market inefficiencies (dumping TIPS?) I don't think we can have any confidence about how TIPS will behave in the next stock market crash. But if you are using some of your FI as a counter to equities in the next crash I certainly wouldn't have TIPS as that FI.

I think this is all a completely different aspect to Grok's original "are TIPS expensive? or are they cheap."

As a very wide side track I questions why we call TIPS "they". While I didn't find the answer I did find a reference of sorts "See the TIP Sheet on "Pronouns" for further information." http://www.butte.edu/departments/cas/ti ... nouns.html Maybe the answer is in there somewhere or I could just ask DW except she wouldn't know what TIPS are. :D
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Re: are TIPS expensive? or are they cheap?

Post by JackoC » Sun Jun 02, 2019 4:55 pm

Doc wrote:
Sun Jun 02, 2019 4:25 pm
JackoC wrote:
Sun Jun 02, 2019 3:48 pm
Say stocks fall 60% and bonds rise 20%.
That's not what happens usually. At least if you are speaking of bonds in general. Nominal Treasuries especially long term, tend to be negatively correlated with equities in times of stock market stress.
I meant and the numbers in the example show, stock prices fall 60%, bond prices rise 20%, that is negative (price) correlation. But no that's not actually what usually happens. Usually both stocks and bonds move much less, and historically the price correlation of long bonds and stocks is near zero. But either of those things (smaller moves or less negative correlation) would mean you have to sell an even smaller proportion of the bonds than my example in order to rebalance, usually much smaller. You said you had to sell *all* bonds to rebalance. I still wonder what situation that would be, in numbers.

I don't see how any of the rest is relevant to my point. Which is that typically a small proportion of one's fixed income is subject to sale to rebalance in any likely scenario, but higher liquidity means lower yield, liquidity doesn't come for free. And in times like right now when treasury rates have just dropped and old CD offers still hanging out there, it's extremely expensive in yield terms to buy nominal treasuries rather than best CD's in comparable maturity.

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Re: are TIPS expensive? or are they cheap?

Post by Doc » Sun Jun 02, 2019 6:47 pm

JackoC wrote:
Sun Jun 02, 2019 4:55 pm
You said you had to sell *all* bonds to rebalance.
I meant to say that I sold all my TIPS to rebalance. The rest of my FI portfolio was in corporates which were down even more than the TIPS. If that's not what I said my bad.

Back to the OP's question: Whether or not TIPS are expensive or cheap may depend on what the purpose of Treasuries in general is in your portfolio.

In my situation Treasuries are predominantly for the purpose of rebalancing. And from that perspective TIPS are very expensive at this time.
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Re: are tips expensive? or are they cheap?

Post by jeffyscott » Mon Jun 03, 2019 10:48 am

jeffyscott wrote:
Sat Jun 01, 2019 10:54 am
grok87 wrote:
Sat Jun 01, 2019 10:41 am
jeffyscott wrote:
Sat Jun 01, 2019 10:06 am
Maybe both TIPS and nominals are expensive, given that ~2.35% is available on 1-6 mo. t-bills and brokered CDs are 2.4% and above for any term :?:
yes but brokered cds have il-iquidity risk and state taxes
True, but I'd not looking to trade them and would hold in an IRA.
So partly due to this discussion, I decided to buy a CD at 2.54% YTM with 1.75 years left to maturity (in IRA, of course). :happy
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Re: are TIPS expensive? or are they cheap?

Post by Doc » Mon Jun 03, 2019 11:47 am

From Swedroe's "Winning Bond Book"

Allocation to TIPS vs. short term fixed income

Code: Select all

Real Yield on TIPS	Allocation to TIPS
>3%	                       75 - 100%
>2.5%  <3%	               50 - 75%
>2%    <2.5%	               25 - 50%
>1.5%  <2%	                0  - 25%
<1.5%	                        0%


This was published before '08 so maybe "things have changed" but if not, TIPS are expensive.
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Re: are TIPS expensive? or are they cheap?

Post by stlutz » Mon Jun 03, 2019 9:26 pm

Doc wrote:
Mon Jun 03, 2019 11:47 am
From Swedroe's "Winning Bond Book"

Allocation to TIPS vs. short term fixed income

Code: Select all

Real Yield on TIPS	Allocation to TIPS
>3%	                       75 - 100%
>2.5%  <3%	               50 - 75%
>2%    <2.5%	               25 - 50%
>1.5%  <2%	                0  - 25%
<1.5%	                        0%


This was published before '08 so maybe "things have changed" but if not, TIPS are expensive.
This never made any sense to me. When choosing TIPS vs. nominal Treasuries, one can look at the inflation breakeven and decide whether they think the TIPS market has it wrong or not. When the breakeven falls well below 2%, I go big into TIPS and then back off should the breakeven start getting toward 3%. But using the chart above, suppose the real yield of TIPS was 3% and nominal bond were yielding 7%. Nominals make way more sense then if you are assuming the Fed will largely hit its target of 2% inflation.

For the smarter people on the board who don't believe they can time the bond market, choosing between TIPS and nominal bonds is a better strategic decision. For people like you who mostly use bonds to rebalance, longer term nominals make more sense. For those who are say, trying to assemble predictable real income in retirement, TIPS make more sense. And some people may want a balance of the two.

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Re: are TIPS expensive? or are they cheap?

Post by Dialectical Investor » Mon Jun 03, 2019 9:42 pm

stlutz wrote:
Mon Jun 03, 2019 9:26 pm
Doc wrote:
Mon Jun 03, 2019 11:47 am
From Swedroe's "Winning Bond Book"

Allocation to TIPS vs. short term fixed income

Code: Select all

Real Yield on TIPS	Allocation to TIPS
>3%	                       75 - 100%
>2.5%  <3%	               50 - 75%
>2%    <2.5%	               25 - 50%
>1.5%  <2%	                0  - 25%
<1.5%	                        0%


This was published before '08 so maybe "things have changed" but if not, TIPS are expensive.
This never made any sense to me.
A possible reason to focus on real rates is to avoid "second-guessing" the market's pricing of unexpected inflation risk in nominal bond yields. If the premium is larger, one would assume the risk is larger too. (It also could make sense to pursue this strategy, if you wish to take this risk.) Instead you look at the real yield, and if the long-run real yield on the 10-year is, say, 2%, bump it up a little for a liquidity premium, if any, and if the current yield matches this average, allocate half to TIPS; if less than the average, allocate less; and if more than the average, allocate more. Not saying it's a good strategy, but I think that might be where it comes from. Doesn't work so well if the real rate of interest is on a steady decline.

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Re: are TIPS expensive? or are they cheap?

Post by Doc » Tue Jun 04, 2019 8:25 am

I think people are misinterpreting Swedroe. TIPS protect you from unexpected inflation. Inflation estimates in the short term should be reasonably reliable. Therefore short nominals should be equivalent to TIPS except for possibly liquidity issues. As you go out in time inflation estimates become less reliable and some want to buy insurance in case inflation becomes very high some time in the future. Hence they buy TIPS. There is a cost involved in that decision. Swedroe's chart is just a way to measure that insurance cost using the breakeven rate. If historical real rates for a thirty are 3% buying TIPS at 2% is expensive.

The 2006 chart is has several problems. 1) We now have 30 year TIPS not just 10s. 2) The liquidity issues with TIPS in '08 may no longer exist. 3) Do we really expect the low real rates due to unprecedented FED intervention the last ten years will continue to exist.

I think today's TIPS insurance is expensive. But both my wife and I have good pensions unlike many of you youngins so we don't need to worry about unexpected inflation. :D
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Re: are TIPS expensive? or are they cheap?

Post by Doc » Tue Jun 04, 2019 8:42 am

Just caught a news clip.

This week's FED meeting may address what they are going to do about the low inflation?
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Re: are TIPS expensive? or are they cheap?

Post by JackoC » Tue Jun 04, 2019 10:03 am

Doc wrote:
Tue Jun 04, 2019 8:25 am
I think people are misinterpreting Swedroe. TIPS protect you from unexpected inflation. Inflation estimates in the short term should be reasonably reliable. Therefore short nominals should be equivalent to TIPS except for possibly liquidity issues. As you go out in time inflation estimates become less reliable and some want to buy insurance in case inflation becomes very high some time in the future. Hence they buy TIPS. There is a cost involved in that decision. Swedroe's chart is just a way to measure that insurance cost using the breakeven rate. If historical real rates for a thirty are 3% buying TIPS at 2% is expensive.
Again, a framework for analyzing TIPS:
-there is (or should be) a not directly visible insurance cost paid by the investor for stripping away the inflation risk of nominal treasuries
-there is (or should be) a not directly visible liquidity premium paid to the investor to hold TIPS v nominals

Though these premia are not directly visible in market prices, comparison to non TIPS based inflation expectations indicates the *net* of those two premia.

Now, the 10 yr TIPS (10yr is a better term because inflation expectation measures are usually 10 yr) yield around 0.40%, the nominal 10 yr around 2.13%. Those break even at 1.73% 10 yr inflation. The Cleveland Fed inflation expectations model now says the (non-TIPS based) market expectation is 1.80% in 10 yrs. The Philly Fed's survey of economist's 10 yr inflation expectation for 2nd qtr was 2.20%. Even taking the inflation expectation as only 1.73%, that would mean the insurance and liquidity premia would be equal/offsetting. That is not expensive, it tends toward cheap. The fact that long bond realized real returns were higher in the past is entirely irrelevant to that conclusion.

Although, the assumption that the investor can just pocket the liquidity premium is investor dependent. In the I believe unusual case of someone who loads up on corporate bonds as a 'safe' asset to the point where any other fixed income instrument is subject to likely sale for rebalancing, then the liquidity premium of any TIPS couldn't be assumed to go into the investor's pocket. But in a more usual case where an investor mainly buys govt risk for 'bonds', and since a relatively small % of fixed income would likely ever be bought/sold for rebalancing, the investor *can* pocket the liquidity premium offered by TIPS, in at least in a significant proportion of their fixed income holding. Therefore again with the liquidity premium entirely or more than paying for the cost of inflation insurance, TIPS are relatively cheap compared to nominal treasuries*, for the buy and hold component of fixed income.

Also note from link above, the Cleveland Fed model also calculates the inflation insurance premium separately and says it has collapsed lately. If there's a growing sentiment that inflation risk has diminished, there seems to be, you'd only expect hedging/insuring against it to get cheaper.

*again within the govt risk sphere, best yielding CD's now have a huge yield advantage over nominals. But here just sticking to nominals v TIPS.

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Re: are TIPS expensive? or are they cheap?

Post by Doc » Tue Jun 04, 2019 11:11 am

JackoC wrote:
Tue Jun 04, 2019 10:03 am
In the I believe unusual case of someone who loads up on corporate bonds as a 'safe' asset to the point where any other fixed income instrument is subject to likely sale for rebalancing, then the liquidity premium of any TIPS couldn't be assumed to go into the investor's pocket. But in a more usual case where an investor mainly buys govt risk for 'bonds', and since a relatively small % of fixed income would likely ever be bought/sold for rebalancing,
In '08 I sold some 40% of my FI to rebalance - all TIPS. On the assumption (arguably bad) that the liquidity issues are the same now as they were in '08 I now have that 40% in nominal Treasuries not corporates. And in order to maintain the inflation protection those Treasuries are all short term. Given today's yield curve that is not costing me very much if anything.

Other than that you make some good points but they are not universally applicable.

One likey "disagreement" on this topic is that I think the number of people here that are actually buying equities during market crashes are in the minority. For those people having a bond portfolio of TPS and corporates makes some sense.
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Re: are TIPS expensive? or are they cheap?

Post by FIREchief » Tue Jun 04, 2019 6:29 pm

Doc wrote:
Mon Jun 03, 2019 11:47 am
From Swedroe's "Winning Bond Book"

Allocation to TIPS vs. short term fixed income

Code: Select all

Real Yield on TIPS	Allocation to TIPS
>3%	                       75 - 100%
>2.5%  <3%	               50 - 75%
>2%    <2.5%	               25 - 50%
>1.5%  <2%	                0  - 25%
<1.5%	                        0%
Did the book provide any analysis that led to these recommendations. At first glance, they appear entirely arbitrary, and of little relevance today and likely at the time the book was written. In retrospect, I'm guessing that if a person had totally disregarded that chart and placed 100% FI into 1% real TIPS, they would have done just fine.
I am not a lawyer, accountant or financial advisor. Any advice or suggestions that I may provide shall be considered for entertainment purposes only.

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Re: are TIPS expensive? or are they cheap?

Post by Doc » Wed Jun 05, 2019 6:39 am

FIREchief wrote:
Tue Jun 04, 2019 6:29 pm
Did the book provide any analysis that led to these recommendations. At first glance, they appear entirely arbitrary, and of little relevance today and likely at the time the book was written. In retrospect, I'm guessing that if a person had totally disregarded that chart and placed 100% FI into 1% real TIPS, they would have done just fine.
Appendix B: Real Return versus Nominal Fixed-Income Assets: An Investment Strategy, 8 pages

Don't have time to re-read it now. But in my judgement the current yield/inflation aspects coupled with the strong Fed action over the last ten years I believe has made the probability of high future unexpected inflation less of a probability than it was on '06. Then there is the TIPS liquidity issue that arose in '08 which if still is there is another factor against TIPS.

On the liquidity issue I would ask that if pension funds and annuity providers are now using TIPS in there products would that add to the liquidity problems compared to nominals.

Why don't you email Larry and ask?
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Re: are TIPS expensive? or are they cheap?

Post by Prudence » Wed Jun 05, 2019 7:24 am

Doc wrote:
Tue Jun 04, 2019 11:11 am
JackoC wrote:
Tue Jun 04, 2019 10:03 am
In the I believe unusual case of someone who loads up on corporate bonds as a 'safe' asset to the point where any other fixed income instrument is subject to likely sale for rebalancing, then the liquidity premium of any TIPS couldn't be assumed to go into the investor's pocket. But in a more usual case where an investor mainly buys govt risk for 'bonds', and since a relatively small % of fixed income would likely ever be bought/sold for rebalancing,
In '08 I sold some 40% of my FI to rebalance - all TIPS. On the assumption (arguably bad) that the liquidity issues are the same now as they were in '08 I now have that 40% in nominal Treasuries not corporates. And in order to maintain the inflation protection those Treasuries are all short term. Given today's yield curve that is not costing me very much if anything.

Other than that you make some good points but they are not universally applicable.

One likey "disagreement" on this topic is that I think the number of people here that are actually buying equities during market crashes are in the minority. For those people having a bond portfolio of TPS and corporates makes some sense.
Doc, suppose I decide to hold short term Treasuries instead of a TIPs ladder for protection against unexpected inflation. Can I get that protection with a short term Treasury mutual fund?

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Re: are TIPS expensive? or are they cheap?

Post by dbr » Wed Jun 05, 2019 9:00 am

Prudence wrote:
Wed Jun 05, 2019 7:24 am

Doc, suppose I decide to hold short term Treasuries instead of a TIPs ladder for protection against unexpected inflation. Can I get that protection with a short term Treasury mutual fund?
Doc can answer that question but I would like to add the quibble that you can't buy protection against inflation expected or unexpected either way. The reason is that TIPS, or maybe short bonds, are themselves "protected" against inflation, but those investments don't protect anything else. To do that they would have to gain value faster than inflation to compensate all the rest of the investments that are at risk. That is one reason one can argue that if you are going to buy TIPS at all the only thing you should buy is TIPS. That applies at least within fixed income. How one wants to pair that with equities in a portfolio as a whole is a different issue. It might be that a person having an inflation indexed annuity such as Social Security would add a TIPS ladder to obtain an inflation insured income stream. A person with a fixed annuity or pension cannot buy a TIPS ladder to offset inflation on both the ladder and the annuity although the effect can be diluted this way. There is no such thing as buying "inflation insurance" per se.

This may already be understood and comment disregarded.

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