Nominal or inflation-protected bonds?

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Amadis_of_Gaul
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Nominal or inflation-protected bonds?

Post by Amadis_of_Gaul » Sun Nov 03, 2019 2:17 pm

I continue to reflect, as I have been, on what long-term changes I want to make to my asset allocation. Recently, I've spent considerable thought exploring lifecycle investing. The notion of constructing a "bulletproof" portfolio with a floor of inflation-protected securities and an aspirational portfolio of equities appeals to me. I don't want to get clobbered by '70s stagflation (or worse)!

However, let's say that The Great Depression, Part 2, strikes the year I begin my retirement. Equities are going to get hammered, duh. I think, though, that TIPS funds won't thrive either. TIPS aren't as liquid as Treasurys, they are vulnerable to deflation (yes, you get the face value back, but you lose any principal adjustments), and their yield will decline as inflation does.

As a result, in Year 1 of GD2, the "floor" portion of a stock fund/TIPS fund portfolio won't be enough to pay for necessary expenses. I'll have to pull from the aspirational portfolio at a time when the aspirational portfolio can least support it, and I'll have to keep doing that for as long as GD2 continues. At that point, the risk of running out of money rises significantly. I don't think a lifecycle-finance portfolio is built to handle a deflationary depression. I know that if I use a TIPS ladder instead of duration-matched TIPS funds, the problem is diminished, but IMO, such a complex portfolio increases the likelihood of behavioral errors. Diminished-capacity me or my non-Boglehead widow are likely to make mistakes with a TIPS ladder.

On the other hand, the traditional Boglehead 3FP (especially if it is built with nominal Treasury funds instead of Total Bond), despite being much simpler, is likely to ride out the storm fairly well. Nominal Treasurys should soar in an environment like that, and you can eat off your bond holdings for a good long time.

If all this is so, does it really make sense to go to all the trouble of building a lifecycle portfolio? It seems to me that you are not escaping probabilistic investing after all. You might as well just shove as much money in a 3FP as you can and hope the inflation bugbear doesn't show up until after you croak.

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Re: Nominal or inflation-protected bonds?

Post by arcticpineapplecorp. » Sun Nov 03, 2019 3:39 pm

have you read this article:

https://www.nytimes.com/2009/04/26/your ... 6stra.html

It took 4 1/2 years to bounce back from the 1929 crash (not 25 years as commonly assumed) because of :
1. deflation
2. dividends
3. the dow vs the market
In fact, according to a Hulbert Financial Digest study of down markets since 1900, the average recovery time is just over two years, when factors like inflation and dividends are taken into account. The longest was the recovery from the December 1974 low; it took more than eight years for the market to return to its previous peak, which was reached in late 1972.

None of this, of course, guarantees that stocks will have a quick recovery from the market decline that began in October 2007. But it suggests that the historical record isn’t as bleak as it looks.
source: https://www.nytimes.com/2009/04/26/your ... 6stra.html
cash is best during times of deflation because the value of your money increases, rather than decreases. But we haven't had much deflation since the Depression, so stocks have been a better investment than cash.
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Re: Nominal or inflation-protected bonds?

Post by SimpleGift » Sun Nov 03, 2019 3:41 pm

Amadis_of_Gaul wrote:
Sun Nov 03, 2019 2:17 pm
Nominal or inflation-protected bonds?
Short answer: Both, in my view. An allocation to high-quality nominal bonds for deflation protection and an allocation to TIPS for protection against unexpected inflation.

One can refine this allocation further, since one's exposure to the risks of unexpected inflation will likely increase with age (chart below). Early in life, with a significant lifetime earning potential still remaining, one can expect their earnings to keep pace with inflation. With increasing age and the shrinking of one's "human capital," more portfolio inflation protection is likely to be needed.
Personally, as our bond allocation has increased with age, our allocation to TIPS has also increased. Now in retirement, our breakdown is about 60% high-quality nominal bonds and 40% TIPS (both short and longer term).
Last edited by SimpleGift on Sun Nov 03, 2019 3:43 pm, edited 1 time in total.

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Re: Nominal or inflation-protected bonds?

Post by Horton » Sun Nov 03, 2019 3:42 pm

If deflation occurs then the cost to fund your standard of living might get cheaper too.

You could have half your fixed income in TIPS and the other in nominal bonds. This is a naive way to protect against both inflation and deflation. You could also take a look at the Permanent Portfolio, which attempts get by in all types of market conditions.
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Re: Nominal or inflation-protected bonds?

Post by Kevin M » Sun Nov 03, 2019 4:02 pm

Amadis_of_Gaul wrote:
Sun Nov 03, 2019 2:17 pm
<snip>
However, let's say that The Great Depression, Part 2, strikes the year I begin my retirement. Equities are going to get hammered, duh. I think, though, that TIPS funds won't thrive either.
<snip>
As a result, in Year 1 of GD2, the "floor" portion of a stock fund/TIPS fund portfolio won't be enough to pay for necessary expenses. I'll have to pull from the aspirational portfolio at a time when the aspirational portfolio can least support it, and I'll have to keep doing that for as long as GD2 continues.
This is incorrect.

To the extent TIPS fund your living costs in an inflationary environment, they also will do so in a deflationary environment. This is another way of saying that to the extent your living costs are related to the CPI, TIPS will be fine for you regardless of inflation, since they will provide about the same real return in either case. With deflation, your living costs will decline about the same as the decline in your TIPS income stream, again, assuming your living costs are well correlated with the CPI.

To the extent your living costs are not well-correlated with the CPI, TIPS may not reliably fund your living costs in either inflationary or deflationary environments.

Having said that, I agree with others that holding both some TIPS and some nominal Treasuries provides a better hedge against deflation than all TIPS, just as it provides a better hedge against inflation than all nominal Treasuries. However, it doesn't necessarily provide a more reliable stream of real income, which is the idea behind using TIPS to match real liabilities.

Come to think of it, doesn't the floor on TIPS prices actually provide better protection during extreme deflation than extreme inflation? Once you hit the floor, your real income stream increases if deflation continues.

Kevin
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Taylor Larimore
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Re: Nominal or inflation-protected bonds?

Post by Taylor Larimore » Sun Nov 03, 2019 4:10 pm

Amadis_of_Gaul wrote:
Sun Nov 03, 2019 2:17 pm
I continue to reflect, as I have been, on what long-term changes I want to make to my asset allocation. Recently, I've spent considerable thought exploring lifecycle investing. The notion of constructing a "bulletproof" portfolio with a floor of inflation-protected securities and an aspirational portfolio of equities appeals to me. I don't want to get clobbered by '70s stagflation (or worse)!
Amadis:

Vanguard Total Bond Market Index Fund was introduced by Jack Bogle in 1986. I too, was concerned about its performance during a period of high inflation so I studied the returns of its benchmark index--The U.S. Aggregate Bond Index which goes back to 1976.

The worst U.S. inflation since 1976 was during the late 70s and early 80s with the worst annual inflation being 13.3% in 1979. The ABI gained 2.7% (nominal) during that year. Its worst annual loss was -2.9% in 1994 when U.S. inflation was 2.7%. It gained 16% in 1995 when inflation was 2.5%.

My takeaway was that Vanguard Total Bond Market Index Fund has provided adequate safety during periods of inflation. We sold our Vanguard TIPS fund striving for the simplicity of The Three-Fund Portfolio.

Please read my "Simplicity" link below.

Best wishes.
Taylor
Jack Bogle's Words of Wisdom: "Deep Down I remain absolutely confident that the vast majority of American families will be well served by owning their equity holdings in an all-U.S. stock-market index portfolio and holding their bonds in al all-U.S. bond-market index portfolio."
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Re: Nominal or inflation-protected bonds?

Post by nisiprius » Sun Nov 03, 2019 4:40 pm

arcticpineapplecorp. wrote:
Sun Nov 03, 2019 3:39 pm
have you read this article:

https://www.nytimes.com/2009/04/26/your ... 6stra.html

It took 4 1/2 years to bounce back from the 1929 crash (not 25 years as commonly assumed) because of :
1. deflation
2. dividends
3. the dow vs the market
Who "commonly assumes" it was 25 years? I call strawman on that.

What is commonly overlooked, though--and not mentioned by Hulbert--is that the "recovery" was short-lived. 1935 and 1936 were among the best years in stock market history, and by most measures, yes, the market had recovered by the end of 1936 (7 years total, for some reason Hulbert measures his 4-1/2 from the bottom). But only just barely, and in 1937 it crashed again. That was a decline of -49.93%, so it was just about the same 2008-2009. Apparently the second crash escapes notice because the 1929 crash was so much worse.

Using the Ibbotson SBBI 2015 Classic Yearbook as an objective source--or, at any rate, not my own judgement--and possibly the very same source Hulbert used--their presentation of the data is: (p. 172, selected lines from table 13-4, "Largest Declines in U.S. Stock Market History)

Peak Aug. 1929, Trough May 1932, Decline 79.00%, Recovery Nov. 1936
Peak Feb. 1937, Trough Mar. 1938, Decline 49.93%, Recovery Feb. 1945

I feel that for most purposes, this was a 14 or 15-year bear market, and that saying
So when did the overall stock market really make it back to its pre-crash peak? Just four years and five months after its mid-1932 low...
is technically correct but seriously misleading. In 1936, the window of opportunity to sell and get back to even lasted only three months.

And, of course, it matters whether this time period gets averaged into the "average length of a bear market" as one 14-year bear market or two 7-year markets. Counting it as two 7-year markets is defensible, but only a tiny change would result in its being counted as a single 14-year bear market.
Last edited by nisiprius on Sun Nov 03, 2019 5:44 pm, edited 1 time in total.
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Re: Nominal or inflation-protected bonds?

Post by Kevin M » Sun Nov 03, 2019 4:52 pm

Taylor Larimore wrote:
Sun Nov 03, 2019 4:10 pm
Vanguard Total Bond Market Index Fund was introduced by Jack Bogle in 1986. I too, was concerned about its performance during a period of high inflation so I studied the returns of its benchmark index--The U.S. Aggregate Bond Index which goes back to 1976.

The worst U.S. inflation since 1976 was during the late 70s and early 80s with the worst annual inflation being 13.3% in 1979. The ABI gained 2.7% (nominal) during that year.
<snip>
My takeaway was that Vanguard Total Bond Market Index Fund has provided adequate safety during periods of inflation.
Hi Taylor,

You post this over and over, but it doesn't make sense. A nominal return of 2.7% with inflation of 13.3% is a real return of -9.36% (= (1+2.7%) / (1+13.3%) - 1 ). How is a loss of purchasing power of more than 9% providing adequate safety during periods of inflation? This is exactly the scenario in which TIPS do protect purchasing power but nominal bonds do not.

Incidentally, according to the Simba/siamond backtesting spreadsheet, aggregate bond index gained 1.78% in 1979, for a real return of -10.17%.

Kevin
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Re: Nominal or inflation-protected bonds?

Post by JBTX » Sun Nov 03, 2019 4:54 pm

Taylor Larimore wrote:
Sun Nov 03, 2019 4:10 pm
Amadis_of_Gaul wrote:
Sun Nov 03, 2019 2:17 pm
I continue to reflect, as I have been, on what long-term changes I want to make to my asset allocation. Recently, I've spent considerable thought exploring lifecycle investing. The notion of constructing a "bulletproof" portfolio with a floor of inflation-protected securities and an aspirational portfolio of equities appeals to me. I don't want to get clobbered by '70s stagflation (or worse)!
Amadis:

Vanguard Total Bond Market Index Fund was introduced by Jack Bogle in 1986. I too, was concerned about its performance during a period of high inflation so I studied the returns of its benchmark index--The U.S. Aggregate Bond Index which goes back to 1976.

The worst U.S. inflation since 1976 was during the late 70s and early 80s with the worst annual inflation being 13.3% in 1979. The ABI gained 2.7% (nominal) during that year. Its worst annual loss was -2.9% in 1994 when U.S. inflation was 2.7%. It gained 16% in 1995 when inflation was 2.5%.

My takeaway was that Vanguard Total Bond Market Index Fund has provided adequate safety during periods of inflation. We sold our Vanguard TIPS fund striving for the simplicity of The Three-Fund Portfolio.

Please read my "Simplicity" link below.

Best wishes.
Taylor
Jack Bogle's Words of Wisdom: "Deep Down I remain absolutely confident that the vast majority of American families will be well served by owning their equity holdings in an all-U.S. stock-market index portfolio and holding their bonds in al all-U.S. bond-market index portfolio."
Another way to look at this is between the years 1976-1981 the 10 year treasury, a rough proxy for an treasury heavy bond fund, got hammered to the tune of about 40% in real terms. From a prior post of mine:



Unfortunately it is hard to look at how bond funds performed late 70s during inflation, but we can look at 10 year treasuries


http://pages.stern.nyu.edu/~adamodar/Ne ... retSP.html


https://www.minneapolisfed.org/communit ... rates-1913






From 1976 to 1981 the value of a 10 year US treasury was pretty much the same in nominal value. However,during that same peiod cumulative inflation was about 60%. In real terms they lost 38% (although the rebounded pretty quickly after that). We can't know exactly tips would have done, but they most assuredly would have done much better.

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Re: Nominal or inflation-protected bonds?

Post by SimpleGift » Sun Nov 03, 2019 4:58 pm

Taylor Larimore wrote:
Sun Nov 03, 2019 4:10 pm
The worst U.S. inflation since 1976 was during the late 70s and early 80s with the worst annual inflation being 13.3% in 1979.
...(snip)...
My takeaway was that Vanguard Total Bond Market Index Fund has provided adequate safety during periods of inflation.
Not sure how one could possibly come to this conclusion. During the 1977-1981 period (chart below), the cumulative real (inflation-adjusted) losses for the Total Bond Market Index were -35.1%.
It's during exactly these kinds of periods when the inflation-adjusted feature of TIPS shine — and earn their place in one's bond portfolio allocation, especially in retirement.
Last edited by SimpleGift on Sun Nov 03, 2019 5:07 pm, edited 2 times in total.

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Re: Nominal or inflation-protected bonds?

Post by JBTX » Sun Nov 03, 2019 4:59 pm

Kevin M wrote:
Sun Nov 03, 2019 4:52 pm
Taylor Larimore wrote:
Sun Nov 03, 2019 4:10 pm
Vanguard Total Bond Market Index Fund was introduced by Jack Bogle in 1986. I too, was concerned about its performance during a period of high inflation so I studied the returns of its benchmark index--The U.S. Aggregate Bond Index which goes back to 1976.

The worst U.S. inflation since 1976 was during the late 70s and early 80s with the worst annual inflation being 13.3% in 1979. The ABI gained 2.7% (nominal) during that year.
<snip>
My takeaway was that Vanguard Total Bond Market Index Fund has provided adequate safety during periods of inflation.
Hi Taylor,

You post this over and over, but it doesn't make sense. A nominal return of 2.7% with inflation of 13.3% is a real return of -9.36% (= (1+2.7%) / (1+13.3%) - 1 ). How is a loss of purchasing power of more than 9% providing adequate safety during periods of inflation? This is exactly the scenario in which TIPS do protect purchasing power but nominal bonds do not.

Incidentally, according to the Simba/siamond backtesting spreadsheet, aggregate bond index gained 1.78% in 1979, for a real return of -10.17%.

Kevin
I agree. See my post after yours. Over a 5 year period bonds got destroyed in real terms. But they did recover fairly quickly after that.

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Re: Nominal or inflation-protected bonds?

Post by JBTX » Sun Nov 03, 2019 5:05 pm

Amadis_of_Gaul wrote:
Sun Nov 03, 2019 2:17 pm
I continue to reflect, as I have been, on what long-term changes I want to make to my asset allocation. Recently, I've spent considerable thought exploring lifecycle investing. The notion of constructing a "bulletproof" portfolio with a floor of inflation-protected securities and an aspirational portfolio of equities appeals to me. I don't want to get clobbered by '70s stagflation (or worse)!

However, let's say that The Great Depression, Part 2, strikes the year I begin my retirement. Equities are going to get hammered, duh. I think, though, that TIPS funds won't thrive either. TIPS aren't as liquid as Treasurys, they are vulnerable to deflation (yes, you get the face value back, but you lose any principal adjustments), and their yield will decline as inflation does.

As a result, in Year 1 of GD2, the "floor" portion of a stock fund/TIPS fund portfolio won't be enough to pay for necessary expenses. I'll have to pull from the aspirational portfolio at a time when the aspirational portfolio can least support it, and I'll have to keep doing that for as long as GD2 continues. At that point, the risk of running out of money rises significantly. I don't think a lifecycle-finance portfolio is built to handle a deflationary depression. I know that if I use a TIPS ladder instead of duration-matched TIPS funds, the problem is diminished, but IMO, such a complex portfolio increases the likelihood of behavioral errors. Diminished-capacity me or my non-Boglehead widow are likely to make mistakes with a TIPS ladder.

On the other hand, the traditional Boglehead 3FP (especially if it is built with nominal Treasury funds instead of Total Bond), despite being much simpler, is likely to ride out the storm fairly well. Nominal Treasurys should soar in an environment like that, and you can eat off your bond holdings for a good long time.

If all this is so, does it really make sense to go to all the trouble of building a lifecycle portfolio? It seems to me that you are not escaping probabilistic investing after all. You might as well just shove as much money in a 3FP as you can and hope the inflation bugbear doesn't show up until after you croak.
If you want to assume the future will always be some subset of the US past, then yes, if you can wait out 10 years a 3 fund will almost always be fine. If you look beyond the US, at a more protracted inflation scenario, or perhaps a Japan scenario, the results may differ.

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Re: Nominal or inflation-protected bonds?

Post by goodenyou » Sun Nov 03, 2019 5:12 pm

Maybe a SPIA or a longevity annuity would be a consideration for a portion of your fixed income. You can choose risk pooling with insurance or a risk premium with the stock market to meet the potential deficiencies in bonds.
Last edited by goodenyou on Sun Nov 03, 2019 5:25 pm, edited 1 time in total.
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Re: Nominal or inflation-protected bonds?

Post by Leif » Sun Nov 03, 2019 5:23 pm

I've checked the allocation of nominal vs. TIPS in target date funds. I recall they have little or no TIPS prior to the target date, then after they ramp up TIPS until they reach an "income" allocation portfolio. I retired a few years ago and I have 20% of my fixed income in TIPS (the rest being nominal, CDs, and cash). Vanguard Income fund gets to about 25% TIPS of the fixed income. A good place to draw in retirement if you find the economy in stagflation.
Last edited by Leif on Sun Nov 03, 2019 8:16 pm, edited 2 times in total.

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Re: Nominal or inflation-protected bonds?

Post by Elysium » Sun Nov 03, 2019 6:21 pm

Kevin M wrote:
Sun Nov 03, 2019 4:52 pm
Taylor Larimore wrote:
Sun Nov 03, 2019 4:10 pm
Vanguard Total Bond Market Index Fund was introduced by Jack Bogle in 1986. I too, was concerned about its performance during a period of high inflation so I studied the returns of its benchmark index--The U.S. Aggregate Bond Index which goes back to 1976.

The worst U.S. inflation since 1976 was during the late 70s and early 80s with the worst annual inflation being 13.3% in 1979. The ABI gained 2.7% (nominal) during that year.
<snip>
My takeaway was that Vanguard Total Bond Market Index Fund has provided adequate safety during periods of inflation.
Hi Taylor,

You post this over and over, but it doesn't make sense. A nominal return of 2.7% with inflation of 13.3% is a real return of -9.36% (= (1+2.7%) / (1+13.3%) - 1 ). How is a loss of purchasing power of more than 9% providing adequate safety during periods of inflation? This is exactly the scenario in which TIPS do protect purchasing power but nominal bonds do not.

Incidentally, according to the Simba/siamond backtesting spreadsheet, aggregate bond index gained 1.78% in 1979, for a real return of -10.17%.

Kevin
Because Taylor is an optimist having lived through so many events. He understands correctly that a positive return in still a positive return regardless of what an inflation number says. Your nominal bond still gained 2.7%, where as your inflation concerns are only related to consumption some of which can be controlled. The more important point which Taylor was making I think is that it is only temporary as the next couple of years inflation were under control and nominal bonds continued to produce positive returns which when averaged out over a period turns out above average inflation. Even if it didn't you still did not go broke.

Some Bogleheads twist themselves over into pretzels over complicated futuristic calculations and projections, this is so much of unnecessary mental gymnastics that only serves to keep you awake and possibly give you undue stress. Instead make it less complicated and go out for a run, walk, hike, sail, whatever else that makes you happy, and life will be good.

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Re: Nominal or inflation-protected bonds?

Post by Amadis_of_Gaul » Sun Nov 03, 2019 8:56 pm

Kevin M wrote:
Sun Nov 03, 2019 4:02 pm
Amadis_of_Gaul wrote:
Sun Nov 03, 2019 2:17 pm
<snip>
However, let's say that The Great Depression, Part 2, strikes the year I begin my retirement. Equities are going to get hammered, duh. I think, though, that TIPS funds won't thrive either.
<snip>
As a result, in Year 1 of GD2, the "floor" portion of a stock fund/TIPS fund portfolio won't be enough to pay for necessary expenses. I'll have to pull from the aspirational portfolio at a time when the aspirational portfolio can least support it, and I'll have to keep doing that for as long as GD2 continues.
This is incorrect.

To the extent TIPS fund your living costs in an inflationary environment, they also will do so in a deflationary environment. This is another way of saying that to the extent your living costs are related to the CPI, TIPS will be fine for you regardless of inflation, since they will provide about the same real return in either case. With deflation, your living costs will decline about the same as the decline in your TIPS income stream, again, assuming your living costs are well correlated with the CPI.

To the extent your living costs are not well-correlated with the CPI, TIPS may not reliably fund your living costs in either inflationary or deflationary environments.

Having said that, I agree with others that holding both some TIPS and some nominal Treasuries provides a better hedge against deflation than all TIPS, just as it provides a better hedge against inflation than all nominal Treasuries. However, it doesn't necessarily provide a more reliable stream of real income, which is the idea behind using TIPS to match real liabilities.

Come to think of it, doesn't the floor on TIPS prices actually provide better protection during extreme deflation than extreme inflation? Once you hit the floor, your real income stream increases if deflation continues.

Kevin
Thanks, Kevin! This is an excellent point. TIPS won't do as well as nominals in deflation, but they shouldn't lose in real terms. I guess the LMP plan is still alive, then!

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Historical data for inflation, stocks and bonds

Post by Taylor Larimore » Sun Nov 03, 2019 9:03 pm

Bogleheads:

For general information, I keep an annual record of U.S. Inflation (CPI-U), the U.S. Aggregate Bond Index Return (benchmark for Vanguard's Total Bond Market Index Fund), and the S&P 500 Index Return:

YEAR--INFLATION--BOND INDEX--S&P 500
1976-------4.9%--------15.6%--------23.8%
1977-------6.7-----------3.0---------(-7.0)
1978-------9.0-----------1.4-----------6.5
1979------13.3-----------1.9---------18.5
1980------12.5-----------2.7---------31.7
1981-------8.9-----------6.3---------(-4.7)
1982-------3.8----------32.6---------20.4
1983-------3.8-----------8.4---------22.3
1984-------3.9----------15.2----------6.1
1985-------3.8----------22.1---------31.2
1986-------1.1----------15.2---------18.5
1987-------4.4-----------2.8-----------5.8
1988-------4.4-----------7.9----------16.5
1989-------4.6----------14.5----------31.5
1990-------6.1-----------8.9----------(-3.1)
1991-------3.1----------16.0----------30.2
1992-------2.9-----------7.4------------7.5
1993-------2.7-----------9.7-----------10.0
1994-------2.7---------(-2.9)-----------1.3
1995-------2.5----------18.5----------37.2
1996-------3.3-----------3.6----------22.7
1997-------1.7-----------9.7----------33.1
1998-------1.6-----------8.7----------28.3
1999-------2.7---------(-0.8)---------20.9
2000-------3.4----------11.6---------(-9.0)
2001-------1.6-----------8.4--------(-11.5)
2002-------2.4----------10.3--------(-22.0)
2003-------1.9-----------4.1----------28.4
2004-------3.3-----------4.3----------10.7
2005-------3.4-----------2.4-----------4.8
2006-------2.5-----------4.3----------15.6
2007-------4.1-----------7.0-----------5.5
2008-------0.1-----------5.2--------(-36.6)
2009-------2.7-----------5.9----------25.9
2010-------1.5-----------6.5----------14.8
2011-------3.0-----------7.7-----------2.1
2012-------1.7-----------4.3----------16.0
2013-------1.5---------(-2.0)---------32.2
2014-------1.6-----------6.0----------13.5
2015-------0.7-----------0.5-----------1.4
2016-------2.1-----------2.6----------12.3
2017-------2.1-----------3.5----------21.8
2018-------1.9-----------0.0---------(-4.7)

Source: U.S. Department of Labor, Barclays, S&P Indices

Past performance does not forecast future performance.

Best wishes.
Taylor
John Bogle's Words of Wisdom: "Real bond returns have varied wildly. As a basis for future expectations, in any realistic time frame, past returns on bonds have been of little assistance in looking ahead."
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Re: Nominal or inflation-protected bonds?

Post by TN_Boy » Sun Nov 03, 2019 9:10 pm

Elysium wrote:
Sun Nov 03, 2019 6:21 pm
Kevin M wrote:
Sun Nov 03, 2019 4:52 pm
Taylor Larimore wrote:
Sun Nov 03, 2019 4:10 pm
Vanguard Total Bond Market Index Fund was introduced by Jack Bogle in 1986. I too, was concerned about its performance during a period of high inflation so I studied the returns of its benchmark index--The U.S. Aggregate Bond Index which goes back to 1976.

The worst U.S. inflation since 1976 was during the late 70s and early 80s with the worst annual inflation being 13.3% in 1979. The ABI gained 2.7% (nominal) during that year.
<snip>
My takeaway was that Vanguard Total Bond Market Index Fund has provided adequate safety during periods of inflation.
Hi Taylor,

You post this over and over, but it doesn't make sense. A nominal return of 2.7% with inflation of 13.3% is a real return of -9.36% (= (1+2.7%) / (1+13.3%) - 1 ). How is a loss of purchasing power of more than 9% providing adequate safety during periods of inflation? This is exactly the scenario in which TIPS do protect purchasing power but nominal bonds do not.

Incidentally, according to the Simba/siamond backtesting spreadsheet, aggregate bond index gained 1.78% in 1979, for a real return of -10.17%.

Kevin
Because Taylor is an optimist having lived through so many events. He understands correctly that a positive return in still a positive return regardless of what an inflation number says. Your nominal bond still gained 2.7%, where as your inflation concerns are only related to consumption some of which can be controlled. The more important point which Taylor was making I think is that it is only temporary as the next couple of years inflation were under control and nominal bonds continued to produce positive returns which when averaged out over a period turns out above average inflation. Even if it didn't you still did not go broke.

Some Bogleheads twist themselves over into pretzels over complicated futuristic calculations and projections, this is so much of unnecessary mental gymnastics that only serves to keep you awake and possibly give you undue stress. Instead make it less complicated and go out for a run, walk, hike, sail, whatever else that makes you happy, and life will be good.
I'm sorry, this makes no sense at all. Kevin M and JBTX are 100% correct.

And the statement "a positive return in still a positive return regardless of what an inflation number says" is 100% wrong. Real returns are what matter; investors must understand this fact.

Intermediate and longer term bonds were killed during this timeframe. The mid-sixties - early 80s was a horribly difficult time for investors, with the high inflation being a major cause.

Saying "your inflation concerns are only related to consumption some of which can be controlled" simply avoids thinking about the problem. Any portfolio loss can be addressed via withdrawing less. The point is, the portfolio is losing money. Consumption is why there is a portfolio in the first place ......

Most bonds did terrible during this timeframe, a fact I thought was widely understood.

AlohaJoe
Posts: 4834
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Location: Saigon, Vietnam

Re: Nominal or inflation-protected bonds?

Post by AlohaJoe » Sun Nov 03, 2019 9:21 pm

Amadis_of_Gaul wrote:
Sun Nov 03, 2019 2:17 pm
If all this is so, does it really make sense to go to all the trouble of building a lifecycle portfolio? It seems to me that you are not escaping probabilistic investing after all.
You are correct that it doesn't escape probabilistic investing...but you miss the real reason :happy
Kevin M wrote:
Sun Nov 03, 2019 4:02 pm
With deflation, your living costs will decline about the same as the decline in your TIPS income stream, again, assuming your living costs are well correlated with the CPI.

To the extent your living costs are not well-correlated with the CPI, TIPS may not reliably fund your living costs in either inflationary or deflationary environments.
And Kevin M makes clear where the probabilistic part actually is. LMP advocates are able to look at the easily available data on the probabilities of equities and bonds and talk lucidly about the risks therein and they make good points about taking on more risk in retirement than one actually needs to. There is little data on the probabilities around "personal rate of inflation" relative to CPI, so they ignore it.

Does anyone really, seriously think they have "liability matched my inflation-adjusted expenses for the year 2046"? How much money are you willing to bet that you got it right? $100,000? Not so confident, right?

On the contrary, there's a plethora of evidence, from the CPI-E to longitudinal data sources like the Health and Retirement Study or Consumption and Activities Mail Survey which have made clear that people are completely unable to accurately predict their expenses more than 2 or 3 years out (can you guarantee that your city won't have a special assessment on property taxes in 2032?), that spending habits continue to change during retirement, and that unplanned "spending shocks" are extremely common.

From a 2015 paper on retirement spending:
In the first two years of retirement, 45.9 percent of households spent more than what they had spent just before retirement. [...] In the first two years of retirement, 28.0 percent of households spent more than 120 percent of their preretirement spending. By the sixth year of retirement 23.4 percent of households still did so. [...] Households that spent more in the first two years of retirement were not exclusively high-income households; rather they were distributed similarly across income levels.
(And that isn't even getting into the probabilities of mortality and outliving your TIPS ladder....)

LMP works in the same way the 4% rule works -- probabilistically.

Valuethinker
Posts: 38942
Joined: Fri May 11, 2007 11:07 am

Re: Nominal or inflation-protected bonds?

Post by Valuethinker » Mon Nov 04, 2019 4:19 am

TN_Boy wrote:
Sun Nov 03, 2019 9:10 pm


I'm sorry, this makes no sense at all. Kevin M and JBTX are 100% correct.

And the statement "a positive return in still a positive return regardless of what an inflation number says" is 100% wrong. Real returns are what matter; investors must understand this fact.

Intermediate and longer term bonds were killed during this timeframe. The mid-sixties - early 80s was a horribly difficult time for investors, with the high inflation being a major cause.

Saying "your inflation concerns are only related to consumption some of which can be controlled" simply avoids thinking about the problem. Any portfolio loss can be addressed via withdrawing less. The point is, the portfolio is losing money. Consumption is why there is a portfolio in the first place ......

Most bonds did terrible during this timeframe, a fact I thought was widely understood.
My Lord, yes.

I can remember the look on my parents' faces when the gasoline price doubled almost overnight. Work was no closer, you still had to drive the same number of miles - they drove a 1967 Dodge Dart (same as a Plymouth Valiant) with the 225 Cubic Inch Slant 6* and we were a one car family getting 18-20 mpg, no 8 cylinder gas guzzler for us. Also we heated with oil and that doubled (or tripled) in price. The winter did not get any less cold (in fact there was an awful freeze-up, I think the Mississippi froze, in 1976?).

Price of lettuces went up so high that people stopped buying them. Again basic food items x2 or x3 in very short periods of time, after the Soviet grain crisis let them to buy heavily on world wheat markets.

We forget now that food is so cheap for middle class persons what middle class life in the 1970s was like. Tax rates were far higher, food was a much bigger part of the family budget.

Yes your salary might go up 10%, but prices were racing ahead. City taxes certainly went up, a lot. Did I mention mortgages at 12%?

It's easy to say "change your consumption" but if that is food, or heat, or medical expenses, that's much more difficult to do.

* gas station in Georgia. Mechanic pops the hood, nods up and down and says "best gawd-damned 6 cylinder ever made in America". Favourite of Steven King, etc.

Elysium
Posts: 1809
Joined: Mon Apr 02, 2007 6:22 pm

Re: Nominal or inflation-protected bonds?

Post by Elysium » Mon Nov 04, 2019 9:18 am

TN_Boy wrote:
Sun Nov 03, 2019 9:10 pm
Elysium wrote:
Sun Nov 03, 2019 6:21 pm
Kevin M wrote:
Sun Nov 03, 2019 4:52 pm
Taylor Larimore wrote:
Sun Nov 03, 2019 4:10 pm
Vanguard Total Bond Market Index Fund was introduced by Jack Bogle in 1986. I too, was concerned about its performance during a period of high inflation so I studied the returns of its benchmark index--The U.S. Aggregate Bond Index which goes back to 1976.

The worst U.S. inflation since 1976 was during the late 70s and early 80s with the worst annual inflation being 13.3% in 1979. The ABI gained 2.7% (nominal) during that year.
<snip>
My takeaway was that Vanguard Total Bond Market Index Fund has provided adequate safety during periods of inflation.
Hi Taylor,

You post this over and over, but it doesn't make sense. A nominal return of 2.7% with inflation of 13.3% is a real return of -9.36% (= (1+2.7%) / (1+13.3%) - 1 ). How is a loss of purchasing power of more than 9% providing adequate safety during periods of inflation? This is exactly the scenario in which TIPS do protect purchasing power but nominal bonds do not.

Incidentally, according to the Simba/siamond backtesting spreadsheet, aggregate bond index gained 1.78% in 1979, for a real return of -10.17%.

Kevin
Because Taylor is an optimist having lived through so many events. He understands correctly that a positive return in still a positive return regardless of what an inflation number says. Your nominal bond still gained 2.7%, where as your inflation concerns are only related to consumption some of which can be controlled. The more important point which Taylor was making I think is that it is only temporary as the next couple of years inflation were under control and nominal bonds continued to produce positive returns which when averaged out over a period turns out above average inflation. Even if it didn't you still did not go broke.

Some Bogleheads twist themselves over into pretzels over complicated futuristic calculations and projections, this is so much of unnecessary mental gymnastics that only serves to keep you awake and possibly give you undue stress. Instead make it less complicated and go out for a run, walk, hike, sail, whatever else that makes you happy, and life will be good.
I'm sorry, this makes no sense at all. Kevin M and JBTX are 100% correct.

And the statement "a positive return in still a positive return regardless of what an inflation number says" is 100% wrong. Real returns are what matter; investors must understand this fact.

Intermediate and longer term bonds were killed during this timeframe. The mid-sixties - early 80s was a horribly difficult time for investors, with the high inflation being a major cause.

Saying "your inflation concerns are only related to consumption some of which can be controlled" simply avoids thinking about the problem. Any portfolio loss can be addressed via withdrawing less. The point is, the portfolio is losing money. Consumption is why there is a portfolio in the first place ......

Most bonds did terrible during this timeframe, a fact I thought was widely understood.
Absolutely not correct. This is part of the myopic thinking that causes unnecessary confusion. What matters is the portfolio as a whole not just it's individual components. Have a look at the numbers Taylor posted above, it is self explanatory. During the two peak inflation years of 1979-80 when it averaged above 12%, nominal bonds returned positive figures that lagged inflation but S&P 500 returned 18% and 31% in those years. A retiree portfolio should hold at least some in stocks, at the minimum 20%, and combined together the portfolio still beat inflation. No one should hold 100% Total Bond Index as a portfolio, this is an absurd way to think. There are many other ways to protect against inflation, including purchasing SPIA with a portion of your funds which guarantees an income, and there is Social Security, Pensions (for some), on and on..

That said do nominal bonds have risk against inflation, absolutely yes, but there are other means through which you may be already protected, as always it depends on personal situation. That includes inflation concerns which are not the same for all. Holding a little bit of Short Term TIPS / IBonds is fine, but this is not precise math that can be applied universally, and more often than not investors give up a lot of income in return for unnecessary inflation protection since there a premium you pay for this protection.

3funder
Posts: 1060
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Re: Nominal or inflation-protected bonds?

Post by 3funder » Mon Nov 04, 2019 9:32 am

Elysium wrote:
Mon Nov 04, 2019 9:18 am
TN_Boy wrote:
Sun Nov 03, 2019 9:10 pm
Elysium wrote:
Sun Nov 03, 2019 6:21 pm
Kevin M wrote:
Sun Nov 03, 2019 4:52 pm
Taylor Larimore wrote:
Sun Nov 03, 2019 4:10 pm
Vanguard Total Bond Market Index Fund was introduced by Jack Bogle in 1986. I too, was concerned about its performance during a period of high inflation so I studied the returns of its benchmark index--The U.S. Aggregate Bond Index which goes back to 1976.

The worst U.S. inflation since 1976 was during the late 70s and early 80s with the worst annual inflation being 13.3% in 1979. The ABI gained 2.7% (nominal) during that year.
<snip>
My takeaway was that Vanguard Total Bond Market Index Fund has provided adequate safety during periods of inflation.
Hi Taylor,

You post this over and over, but it doesn't make sense. A nominal return of 2.7% with inflation of 13.3% is a real return of -9.36% (= (1+2.7%) / (1+13.3%) - 1 ). How is a loss of purchasing power of more than 9% providing adequate safety during periods of inflation? This is exactly the scenario in which TIPS do protect purchasing power but nominal bonds do not.

Incidentally, according to the Simba/siamond backtesting spreadsheet, aggregate bond index gained 1.78% in 1979, for a real return of -10.17%.

Kevin
Because Taylor is an optimist having lived through so many events. He understands correctly that a positive return in still a positive return regardless of what an inflation number says. Your nominal bond still gained 2.7%, where as your inflation concerns are only related to consumption some of which can be controlled. The more important point which Taylor was making I think is that it is only temporary as the next couple of years inflation were under control and nominal bonds continued to produce positive returns which when averaged out over a period turns out above average inflation. Even if it didn't you still did not go broke.

Some Bogleheads twist themselves over into pretzels over complicated futuristic calculations and projections, this is so much of unnecessary mental gymnastics that only serves to keep you awake and possibly give you undue stress. Instead make it less complicated and go out for a run, walk, hike, sail, whatever else that makes you happy, and life will be good.
I'm sorry, this makes no sense at all. Kevin M and JBTX are 100% correct.

And the statement "a positive return in still a positive return regardless of what an inflation number says" is 100% wrong. Real returns are what matter; investors must understand this fact.

Intermediate and longer term bonds were killed during this timeframe. The mid-sixties - early 80s was a horribly difficult time for investors, with the high inflation being a major cause.

Saying "your inflation concerns are only related to consumption some of which can be controlled" simply avoids thinking about the problem. Any portfolio loss can be addressed via withdrawing less. The point is, the portfolio is losing money. Consumption is why there is a portfolio in the first place ......

Most bonds did terrible during this timeframe, a fact I thought was widely understood.
Absolutely not correct. This is part of the myopic thinking that causes unnecessary confusion. What matters is the portfolio as a whole not just it's individual components. Have a look at the numbers Taylor posted above, it is self explanatory. During the two peak inflation years of 1979-80 when it averaged above 12%, nominal bonds returned positive figures that lagged inflation but S&P 500 returned 18% and 31% in those years. A retiree portfolio should hold at least some in stocks, at the minimum 20%, and combined together the portfolio still beat inflation. No one should hold 100% Total Bond Index as a portfolio, this is an absurd way to think. There are many other ways to protect against inflation, including purchasing SPIA with a portion of your funds which guarantees an income, and there is Social Security, Pensions (for some), on and on..

That said do nominal bonds have risk against inflation, absolutely yes, but there are other means through which you may be already protected, as always it depends on personal situation. That includes inflation concerns which are not the same for all. Holding a little bit of Short Term TIPS / IBonds is fine, but this is not precise math that can be applied universally, and more often than not investors give up a lot of income in return for unnecessary inflation protection since there a premium you pay for this protection.
+1

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SimpleGift
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Re: Nominal or inflation-protected bonds?

Post by SimpleGift » Mon Nov 04, 2019 9:39 am

Elysium wrote:
Mon Nov 04, 2019 9:18 am
What matters is the portfolio as a whole not just it's individual components.
Quite right, but ALL portfolios suffered during the oil and inflation shocks of the 1970s, not just bond-heavy portfolios.

Initially, stock-heavy portfolios were hit the hardest, declining up to 50% within 18 months (chart below). Later, as inflation accelerated, bond-heavy portfolios suffered as well, declining up to 40% by 1981. Once inflation subsided, the various stock/bond mixes all regained their previous real values more or less together after 12 years (black circle).
  • Image
    Note: All returns are total returns, inflation adjusted, with dividends reinvested.
    Sources: Monthly S&P stock returns from Shiller; monthly 10-year Treasury returns from Medium
Inflation-adjusted bonds (had they been available) would have been one of the few asset classes to prosper in this period.

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dodecahedron
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Re: Nominal or inflation-protected bonds?

Post by dodecahedron » Mon Nov 04, 2019 9:41 am

Valuethinker wrote:
Mon Nov 04, 2019 4:19 am

We forget now that food is so cheap for middle class persons what middle class life in the 1970s was like. Tax rates were far higher, food was a much bigger part of the family budget.

Yes your salary might go up 10%, but prices were racing ahead. City taxes certainly went up, a lot. Did I mention mortgages at 12%?

It's easy to say "change your consumption" but if that is food, or heat, or medical expenses, that's much more difficult to do.
Just want to underscore the importance of Valuethinker´s point that ¨Tax rates were far higher [in the 1970s]¨ for bond performance. It added insult to injury for bond performance in the 1970s. There were precious few tax-advantaged places to invest bonds back in those days. Nominal interest payments on bonds were taxed at rates of up to 70% (the top federal rate) with no allowance for the fact that effective real interest rates were actually very negative.

I am grateful to be living in an era with lots of tax-advantaged space for fixed income investments AND the availability of TIPS. (As well as low cost index investments for equities.)

I think often of my maternal grandmother and my mother-in-law, who were both widowed in the 1960s. When I think of the financial tools they had available at the time and the ones available to me, there is so much to be grateful for. They faced fixed high minimum commissions on securities transactions, no index funds, no TIPS, Social Security was not indexed for inflation, absurdly low ceiling on interest rates in FDIC-insured bank accounts, etc.

I remember in the early 70s helping my librarian dad to index a US News & WR book called Teach your wife to be a widow. For nostalgia purposes, I bought a used copy from Amazon a couple years ago. It was an eye-opening reminder of how tough those days were for folks whose labor force participation days were beyond them.

My mother-in-law took to ¨investing¨ in household commodities (i.e., stocking up on bargain sales of things like nonperishable canned foods and paper products, which held their value far better than Treasury bonds and did not generate any taxes in the process.)
Last edited by dodecahedron on Mon Nov 04, 2019 9:45 am, edited 1 time in total.

Topic Author
Amadis_of_Gaul
Posts: 116
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Re: Nominal or inflation-protected bonds?

Post by Amadis_of_Gaul » Mon Nov 04, 2019 9:44 am

AlohaJoe wrote:
Sun Nov 03, 2019 9:21 pm
Amadis_of_Gaul wrote:
Sun Nov 03, 2019 2:17 pm
If all this is so, does it really make sense to go to all the trouble of building a lifecycle portfolio? It seems to me that you are not escaping probabilistic investing after all.
You are correct that it doesn't escape probabilistic investing...but you miss the real reason :happy
Kevin M wrote:
Sun Nov 03, 2019 4:02 pm
With deflation, your living costs will decline about the same as the decline in your TIPS income stream, again, assuming your living costs are well correlated with the CPI.

To the extent your living costs are not well-correlated with the CPI, TIPS may not reliably fund your living costs in either inflationary or deflationary environments.
And Kevin M makes clear where the probabilistic part actually is. LMP advocates are able to look at the easily available data on the probabilities of equities and bonds and talk lucidly about the risks therein and they make good points about taking on more risk in retirement than one actually needs to. There is little data on the probabilities around "personal rate of inflation" relative to CPI, so they ignore it.

Does anyone really, seriously think they have "liability matched my inflation-adjusted expenses for the year 2046"? How much money are you willing to bet that you got it right? $100,000? Not so confident, right?

On the contrary, there's a plethora of evidence, from the CPI-E to longitudinal data sources like the Health and Retirement Study or Consumption and Activities Mail Survey which have made clear that people are completely unable to accurately predict their expenses more than 2 or 3 years out (can you guarantee that your city won't have a special assessment on property taxes in 2032?), that spending habits continue to change during retirement, and that unplanned "spending shocks" are extremely common.

From a 2015 paper on retirement spending:
In the first two years of retirement, 45.9 percent of households spent more than what they had spent just before retirement. [...] In the first two years of retirement, 28.0 percent of households spent more than 120 percent of their preretirement spending. By the sixth year of retirement 23.4 percent of households still did so. [...] Households that spent more in the first two years of retirement were not exclusively high-income households; rather they were distributed similarly across income levels.
(And that isn't even getting into the probabilities of mortality and outliving your TIPS ladder....)

LMP works in the same way the 4% rule works -- probabilistically.
AlohaJoe, this is another solid point! Part of the problem with my perspective is that unlike most people (but probably like a lot of Bogleheads), I have an extremely good idea where my money is going. You want to know how much money my family spends on eating out or medical care in a given year, no problem! I also have a good idea what happens to the average household's expenses when children leave home or the costs of medical care for seniors start climbing. I've additionally reflected long on the impact of the Social Security shortfall. Et cetera, et cetera.

However, I suspect that all that merely shows that I've bought into the end-of-history illusion. It's easy to assume that the future will be like the past and present because the past and present are knowable and the future isn't. Of course, this whole site is filled with people who really like the end-of-history illusion! It's practically a requirement of Boglehead membership that you are making assumptions about the future someplace. I'd guess that's because Bogleheads tend to be intelligent, competent, well-educated folks who are used to taking control of their own lives instead of regarding themselves as passive victims of powerful external forces. I think that mindset is generally adaptive, but it has trouble recognizing the limits that do exist. That's certainly true of me in lots of areas, at least.

Sooo. . . maybe the moral of the story is that I need to accept uncertainty about the future rather than trying to analyze myself into the illusion of certainty and control. I think you bet on the free market because you have to. I also think that diversification seems to be an idea with universal merit (at least, there are records of thinkers from thousands of years ago touting the merits of diversification). Other than that, maybe I simply need to adopt some reasonable asset allocation, throw a sizable amount of money into it, figure it will probably be good enough, and accept the possibility that it won't be.

TN_Boy
Posts: 1183
Joined: Sat Jan 17, 2009 12:51 pm

Re: Nominal or inflation-protected bonds?

Post by TN_Boy » Mon Nov 04, 2019 9:59 am

Elysium wrote:
Mon Nov 04, 2019 9:18 am
TN_Boy wrote:
Sun Nov 03, 2019 9:10 pm
Elysium wrote:
Sun Nov 03, 2019 6:21 pm
Kevin M wrote:
Sun Nov 03, 2019 4:52 pm
Taylor Larimore wrote:
Sun Nov 03, 2019 4:10 pm
Vanguard Total Bond Market Index Fund was introduced by Jack Bogle in 1986. I too, was concerned about its performance during a period of high inflation so I studied the returns of its benchmark index--The U.S. Aggregate Bond Index which goes back to 1976.

The worst U.S. inflation since 1976 was during the late 70s and early 80s with the worst annual inflation being 13.3% in 1979. The ABI gained 2.7% (nominal) during that year.
<snip>
My takeaway was that Vanguard Total Bond Market Index Fund has provided adequate safety during periods of inflation.
Hi Taylor,

You post this over and over, but it doesn't make sense. A nominal return of 2.7% with inflation of 13.3% is a real return of -9.36% (= (1+2.7%) / (1+13.3%) - 1 ). How is a loss of purchasing power of more than 9% providing adequate safety during periods of inflation? This is exactly the scenario in which TIPS do protect purchasing power but nominal bonds do not.

Incidentally, according to the Simba/siamond backtesting spreadsheet, aggregate bond index gained 1.78% in 1979, for a real return of -10.17%.

Kevin
Because Taylor is an optimist having lived through so many events. He understands correctly that a positive return in still a positive return regardless of what an inflation number says. Your nominal bond still gained 2.7%, where as your inflation concerns are only related to consumption some of which can be controlled. The more important point which Taylor was making I think is that it is only temporary as the next couple of years inflation were under control and nominal bonds continued to produce positive returns which when averaged out over a period turns out above average inflation. Even if it didn't you still did not go broke.

Some Bogleheads twist themselves over into pretzels over complicated futuristic calculations and projections, this is so much of unnecessary mental gymnastics that only serves to keep you awake and possibly give you undue stress. Instead make it less complicated and go out for a run, walk, hike, sail, whatever else that makes you happy, and life will be good.
I'm sorry, this makes no sense at all. Kevin M and JBTX are 100% correct.

And the statement "a positive return in still a positive return regardless of what an inflation number says" is 100% wrong. Real returns are what matter; investors must understand this fact.

Intermediate and longer term bonds were killed during this timeframe. The mid-sixties - early 80s was a horribly difficult time for investors, with the high inflation being a major cause.

Saying "your inflation concerns are only related to consumption some of which can be controlled" simply avoids thinking about the problem. Any portfolio loss can be addressed via withdrawing less. The point is, the portfolio is losing money. Consumption is why there is a portfolio in the first place ......

Most bonds did terrible during this timeframe, a fact I thought was widely understood.
Absolutely not correct. This is part of the myopic thinking that causes unnecessary confusion. What matters is the portfolio as a whole not just it's individual components. Have a look at the numbers Taylor posted above, it is self explanatory. During the two peak inflation years of 1979-80 when it averaged above 12%, nominal bonds returned positive figures that lagged inflation but S&P 500 returned 18% and 31% in those years. A retiree portfolio should hold at least some in stocks, at the minimum 20%, and combined together the portfolio still beat inflation. No one should hold 100% Total Bond Index as a portfolio, this is an absurd way to think. There are many other ways to protect against inflation, including purchasing SPIA with a portion of your funds which guarantees an income, and there is Social Security, Pensions (for some), on and on..

That said do nominal bonds have risk against inflation, absolutely yes, but there are other means through which you may be already protected, as always it depends on personal situation. That includes inflation concerns which are not the same for all. Holding a little bit of Short Term TIPS / IBonds is fine, but this is not a precise math, and more often than not investors give up a lot of income in return for unnecessary inflation protection since there a premium you pay for this protection.
I believe you are changing the subject.

"My takeaway was that Vanguard Total Bond Market Index Fund has provided adequate safety during periods of inflation"

The point being addressed, as I quoted above, was the behavior of nominal bonds during periods of high inflation. It is obvious that during the last period of high inflation in the US, nominal bonds of intermediate to long duration suffered.

The high inflation during this period is one reason that historical backtests of various SWR studies find the 60s to early 80s one of the worst, if not the very worst, times to retire.

I am also reacting to the incorrect statement you made (perhaps I shouldn't be so strident but this statement is utterly wrong):

"He understands correctly that a positive return in still a positive return regardless of what an inflation number says"

No, and that's perhaps the main problem I had with the post. Real returns are what matters.

Yes, the portfolio overall is what you focus on, but that wasn't the question. If indeed, " Vanguard Total Bond Market Index Fund has provided adequate safety during periods of inflation" then a 100% total bond portfolio should have been fine during that last period of high inflation. But it wasn't (the index didn't exist prior to 76, but you could have held a mix of similar bonds before then).

Elysium
Posts: 1809
Joined: Mon Apr 02, 2007 6:22 pm

Re: Nominal or inflation-protected bonds?

Post by Elysium » Mon Nov 04, 2019 3:26 pm

TN_Boy wrote:
Mon Nov 04, 2019 9:59 am
Elysium wrote:
Mon Nov 04, 2019 9:18 am
TN_Boy wrote:
Sun Nov 03, 2019 9:10 pm
Elysium wrote:
Sun Nov 03, 2019 6:21 pm
Kevin M wrote:
Sun Nov 03, 2019 4:52 pm

Hi Taylor,

You post this over and over, but it doesn't make sense. A nominal return of 2.7% with inflation of 13.3% is a real return of -9.36% (= (1+2.7%) / (1+13.3%) - 1 ). How is a loss of purchasing power of more than 9% providing adequate safety during periods of inflation? This is exactly the scenario in which TIPS do protect purchasing power but nominal bonds do not.

Incidentally, according to the Simba/siamond backtesting spreadsheet, aggregate bond index gained 1.78% in 1979, for a real return of -10.17%.

Kevin
Because Taylor is an optimist having lived through so many events. He understands correctly that a positive return in still a positive return regardless of what an inflation number says. Your nominal bond still gained 2.7%, where as your inflation concerns are only related to consumption some of which can be controlled. The more important point which Taylor was making I think is that it is only temporary as the next couple of years inflation were under control and nominal bonds continued to produce positive returns which when averaged out over a period turns out above average inflation. Even if it didn't you still did not go broke.

Some Bogleheads twist themselves over into pretzels over complicated futuristic calculations and projections, this is so much of unnecessary mental gymnastics that only serves to keep you awake and possibly give you undue stress. Instead make it less complicated and go out for a run, walk, hike, sail, whatever else that makes you happy, and life will be good.
I'm sorry, this makes no sense at all. Kevin M and JBTX are 100% correct.

And the statement "a positive return in still a positive return regardless of what an inflation number says" is 100% wrong. Real returns are what matter; investors must understand this fact.

Intermediate and longer term bonds were killed during this timeframe. The mid-sixties - early 80s was a horribly difficult time for investors, with the high inflation being a major cause.

Saying "your inflation concerns are only related to consumption some of which can be controlled" simply avoids thinking about the problem. Any portfolio loss can be addressed via withdrawing less. The point is, the portfolio is losing money. Consumption is why there is a portfolio in the first place ......

Most bonds did terrible during this timeframe, a fact I thought was widely understood.
Absolutely not correct. This is part of the myopic thinking that causes unnecessary confusion. What matters is the portfolio as a whole not just it's individual components. Have a look at the numbers Taylor posted above, it is self explanatory. During the two peak inflation years of 1979-80 when it averaged above 12%, nominal bonds returned positive figures that lagged inflation but S&P 500 returned 18% and 31% in those years. A retiree portfolio should hold at least some in stocks, at the minimum 20%, and combined together the portfolio still beat inflation. No one should hold 100% Total Bond Index as a portfolio, this is an absurd way to think. There are many other ways to protect against inflation, including purchasing SPIA with a portion of your funds which guarantees an income, and there is Social Security, Pensions (for some), on and on..

That said do nominal bonds have risk against inflation, absolutely yes, but there are other means through which you may be already protected, as always it depends on personal situation. That includes inflation concerns which are not the same for all. Holding a little bit of Short Term TIPS / IBonds is fine, but this is not a precise math, and more often than not investors give up a lot of income in return for unnecessary inflation protection since there a premium you pay for this protection.
I believe you are changing the subject.

"My takeaway was that Vanguard Total Bond Market Index Fund has provided adequate safety during periods of inflation"

The point being addressed, as I quoted above, was the behavior of nominal bonds during periods of high inflation. It is obvious that during the last period of high inflation in the US, nominal bonds of intermediate to long duration suffered.

The high inflation during this period is one reason that historical backtests of various SWR studies find the 60s to early 80s one of the worst, if not the very worst, times to retire.

I am also reacting to the incorrect statement you made (perhaps I shouldn't be so strident but this statement is utterly wrong):

"He understands correctly that a positive return in still a positive return regardless of what an inflation number says"

No, and that's perhaps the main problem I had with the post. Real returns are what matters.

Yes, the portfolio overall is what you focus on, but that wasn't the question. If indeed, " Vanguard Total Bond Market Index Fund has provided adequate safety during periods of inflation" then a 100% total bond portfolio should have been fine during that last period of high inflation. But it wasn't (the index didn't exist prior to 76, but you could have held a mix of similar bonds before then).
I don't have any disagreements on nominal bonds during high inflationary periods. In the strict mathematical sense you lose to inflation. I was only pointing out that in reality an investor may be okay given they have several options and do not need to go into complicated methods to pay a premium for inflation protection that you may not need. I guess we all get the point, but the statement was not correct as written, fair. Personally, I would start considering TIPS when I get closer to retirement, most likely short TIPS, and a lot may depend on personal situation on how much is needed.

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Preparing for inflation?

Post by Taylor Larimore » Mon Nov 04, 2019 5:18 pm

Bogleheads:

Looking at the record of inflation that I posted above, I think it is fair to say:

Far more money has been lost by investors in preparing for inflation, or anticipating inflation, than has been lost in inflation itself.

Best wishes.
Taylor
Jack Bogle's Words of Wisdom: "Focusing on the long term is far superior to focusing on the short term. It is a lesson too few investors have learned."
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Re: Nominal or inflation-protected bonds?

Post by TN_Boy » Mon Nov 04, 2019 5:51 pm

Elysium wrote:
Mon Nov 04, 2019 3:26 pm

Bunch of stuff snipped

I don't have any disagreements on nominal bonds during high inflationary periods. In the strict mathematical sense you lose to inflation. I was only pointing out that in reality an investor may be okay given they have several options and do not need to go into complicated methods to pay a premium for inflation protection that you may not need. I guess we all get the point, but the statement was not correct as written, fair. Personally, I would start considering TIPS when I get closer to retirement, most likely short TIPS, and a lot may depend on personal situation on how much is needed.
Well, the thread topic was nominal versus inflation indexed bonds. And the real versus nominal return comments were confusing.
But certainly a portfolio may have different types of assets to protect against inflation. Over the long term, stocks should fit that bill. The unfortunate 60s/70s situation of high inflation and a poor stock market left investors of that time with few good choices. Would TIPs have helped a lot? Hard to say since we didn't have them to observe the behavior. But it seems reasonable to assume they would have done better than nominal bonds did.

I don't think a portfolio "needs" TIPs, but I like them and we have a reasonable allocation to them. I believe (hope?) they will act as useful diversifiers should we hit another spell of 70s-like inflation. Many investors do not remember those times, and thus don't worry about them; we've had moderate inflation for a long time now. We have seen that when deflation is a concern (the 08/09 crash) TIPs did not behave all that well.

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Re: Historical data for inflation, stocks and bonds

Post by Kevin M » Mon Nov 04, 2019 6:30 pm

Taylor Larimore wrote:
Sun Nov 03, 2019 9:03 pm
<snip>
YEAR--INFLATION--BOND INDEX--S&P 500
<snip>
1977-------6.7-----------3.0---------(-7.0)
1978-------9.0-----------1.4-----------6.5
1979------13.3-----------1.9---------18.5
1980------12.5-----------2.7---------31.7
1981-------8.9-----------6.3---------(-4.7)
<snip>
First, it would be more useful if the real returns also were included. Second, since this is a thread about bonds we can ignore the S&P 500 returns. Third, since the statement was made that
Taylor wrote:"Vanguard Total Bond Market Index Fund has provided adequate safety during periods of inflation"
, we should be looking at periods of relatively high inflation, which is why I snipped out the rows above.

Plugging these numbers into a spreadsheet, here is the view showing the annual bond real returns, along with the cumulative real returns for these five years.

Image

If Vanguard Total Bond Index Fund had existed, it would have steadily lost purchasing power over those five years, ending up with a cumulative purchasing power loss of -28%. I would not call that "adequate safety during periods of inflation".

As an aside, if anyone wants to get Taylor's numbers into a spreadsheet in usable form, copy/paste his list, then use this formula to extract each number from one row of text into a separate cell, assuming the row of text is in cell H2:

Code: Select all

=SPLIT(H2,"-()%")
Kevin
Wiki ||.......|| Suggested format for Asking Portfolio Questions (edit original post)

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Re: Nominal or inflation-protected bonds?

Post by garlandwhizzer » Mon Nov 04, 2019 8:36 pm

Simplegift wrote:

Short answer: Both, in my view. An allocation to high-quality nominal bonds for deflation protection and an allocation to TIPS for protection against unexpected inflation./quote.

1+

You don't know where the future trouble is going to come from in the long run, so being prepared for both if your time horizon is long is IMO a good idea. Also at the current level of inflation expectations and current break even rates between nominals and TIPS, TIPS are offering protection from unexpected inflation essentially for free. I think some TIPS exposure is a reasonable choice. ST Bonds, T-Bills, and MMF also offer some degree of inflation protection but less so than TIPS.

Garland Whizzer

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Re: Historical data for inflation, stocks and bonds

Post by dodecahedron » Mon Nov 04, 2019 8:55 pm

Kevin M wrote:
Mon Nov 04, 2019 6:30 pm


Plugging these numbers into a spreadsheet, here is the view showing the annual bond real returns, along with the cumulative real returns for these five years.

Image

If Vanguard Total Bond Index Fund had existed, it would have steadily lost purchasing power over those five years, ending up with a cumulative purchasing power loss of -28%. I would not call that "adequate safety during periods of inflation".
Taking taxes into account (since there were few tax advantaged vehicles available back then) would make the real after tax returns even more negative!

Very happy to have a significant chunk of TIPS in my tax-advantaged accounts now.

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Re: Nominal or inflation-protected bonds?

Post by abuss368 » Wed Nov 06, 2019 8:40 pm

Taylor Larimore wrote:
Sun Nov 03, 2019 4:10 pm
Amadis_of_Gaul wrote:
Sun Nov 03, 2019 2:17 pm
I continue to reflect, as I have been, on what long-term changes I want to make to my asset allocation. Recently, I've spent considerable thought exploring lifecycle investing. The notion of constructing a "bulletproof" portfolio with a floor of inflation-protected securities and an aspirational portfolio of equities appeals to me. I don't want to get clobbered by '70s stagflation (or worse)!
Amadis:

Vanguard Total Bond Market Index Fund was introduced by Jack Bogle in 1986. I too, was concerned about its performance during a period of high inflation so I studied the returns of its benchmark index--The U.S. Aggregate Bond Index which goes back to 1976.

The worst U.S. inflation since 1976 was during the late 70s and early 80s with the worst annual inflation being 13.3% in 1979. The ABI gained 2.7% (nominal) during that year. Its worst annual loss was -2.9% in 1994 when U.S. inflation was 2.7%. It gained 16% in 1995 when inflation was 2.5%.

My takeaway was that Vanguard Total Bond Market Index Fund has provided adequate safety during periods of inflation. We sold our Vanguard TIPS fund striving for the simplicity of The Three-Fund Portfolio.

Please read my "Simplicity" link below.

Best wishes.
Taylor
Jack Bogle's Words of Wisdom: "Deep Down I remain absolutely confident that the vast majority of American families will be well served by owning their equity holdings in an all-U.S. stock-market index portfolio and holding their bonds in al all-U.S. bond-market index portfolio."
Thank you for sharing Taylor. Simplicity is very important and something that we appreciate the further down the road of life we continue. We too sold the Vanguard TIPS fund over a decade ago and consolidated with Total Bond Index.
John C. Bogle: "Simplicity is the master key to financial success."

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Re: Nominal or inflation-protected bonds?

Post by Northern Flicker » Wed Nov 06, 2019 11:35 pm

arcticpineapplecorp. wrote:
Sun Nov 03, 2019 3:39 pm
have you read this article:

https://www.nytimes.com/2009/04/26/your ... 6stra.html

It took 4 1/2 years to bounce back from the 1929 crash (not 25 years as commonly assumed)
I don’t think that is quite correct. Stocks bottomed out in 1932, had recovered by 1935, reaching nominal parity to pre-1929 crash by late 1936, only to collapse again in 1937. Perhaps 4.5 years is recovery in real terms given the brutal deflation at that time.
Index fund investor since 1987.

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Re: Nominal or inflation-protected bonds?

Post by Valuethinker » Thu Nov 07, 2019 7:55 am

Northern Flicker wrote:
Wed Nov 06, 2019 11:35 pm
arcticpineapplecorp. wrote:
Sun Nov 03, 2019 3:39 pm
have you read this article:

https://www.nytimes.com/2009/04/26/your ... 6stra.html

It took 4 1/2 years to bounce back from the 1929 crash (not 25 years as commonly assumed)
I don’t think that is quite correct. Stocks bottomed out in 1932, had recovered by 1935, reaching nominal parity to pre-1929 crash by late 1936, only to collapse again in 1937. Perhaps 4.5 years is recovery in real terms given the brutal deflation at that time.
Confirming the observation that once in a generation stock market crashes only really finish when conventional wisdom and common sense has moved entirely against stock investing.

The 1930s. The 1970s. Japan since 1990.

2000-09 was a pretty torrid time for equities, too.

Still too many 100% equity threads around . We all still think equities will always deliver for us.

The turning point may well turn out to have been recent relaxation in US financial regulation. If you think it wasn't until the 1970s that financial deregulation of Wall Street became a thing. And now we have a lit of Too Big To Fail institutions.

The stage is now set for the next bubble and bust. But whether in 6 months or 10 years I have no idea.

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Re: Historical data for inflation, stocks and bonds

Post by TN_Boy » Thu Nov 07, 2019 8:56 am

dodecahedron wrote:
Mon Nov 04, 2019 8:55 pm
Kevin M wrote:
Mon Nov 04, 2019 6:30 pm


Plugging these numbers into a spreadsheet, here is the view showing the annual bond real returns, along with the cumulative real returns for these five years.

Image

If Vanguard Total Bond Index Fund had existed, it would have steadily lost purchasing power over those five years, ending up with a cumulative purchasing power loss of -28%. I would not call that "adequate safety during periods of inflation".
Taking taxes into account (since there were few tax advantaged vehicles available back then) would make the real after tax returns even more negative!

Very happy to have a significant chunk of TIPS in my tax-advantaged accounts now.
Yes, paying taxes on nominal returns that were actually negative real returns is a sad situation!

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Re: Nominal or inflation-protected bonds?

Post by abuss368 » Thu Nov 07, 2019 11:01 am

Valuethinker wrote:
Thu Nov 07, 2019 7:55 am
The stage is now set for the next bubble and bust. But whether in 6 months or 10 years I have no idea.
The beauty and roller coaster called investing. All we Bogleheads can do is stay the course and focus on the things we can control such as keeping costs (and taxes low) and maintaining our desired asset allocation.
John C. Bogle: "Simplicity is the master key to financial success."

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Re: Nominal or inflation-protected bonds?

Post by PaulF » Thu Nov 07, 2019 10:07 pm

Amadis_of_Gaul wrote:
Mon Nov 04, 2019 9:44 am
Sooo. . . maybe the moral of the story is that I need to accept uncertainty about the future rather than trying to analyze myself into the illusion of certainty and control.
This is one of the most sagacious things I have read on BH (or M*) in my time (~13 years) here.

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Two Investment Gems

Post by Taylor Larimore » Fri Nov 08, 2019 9:13 am

Amadis_of_Gaul wrote: Sooo. . . maybe the moral of the story is that I need to accept uncertainty about the future rather than trying to analyze myself into the illusion of certainty and control.
PaulF wrote:This is one of the most sagacious things I have read on BH (or M*) in my time (~13 years) here.
Amadis and Paul:

Your two quotes are gems !!

Thank you and best wishes.
Taylor
Jack Bogle's Words of Wisdom: "In the stock market the more elaborate and abstruse the mathematics the more uncertain and speculative are the conclusions we draw therefrom."
"Simplicity is the master key to financial success." -- Jack Bogle

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Re: Two Investment Gems

Post by Amadis_of_Gaul » Fri Nov 08, 2019 5:50 pm

Taylor Larimore wrote:
Fri Nov 08, 2019 9:13 am
Amadis and Paul:

Your two quotes are gems !!

Thank you and best wishes.
Taylor
Jack Bogle's Words of Wisdom: "In the stock market the more elaborate and abstruse the mathematics the more uncertain and speculative are the conclusions we draw therefrom."
Thanks, Taylor!

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Re: Two Investment Gems

Post by PaulF » Fri Nov 08, 2019 11:32 pm

Taylor Larimore wrote:
Fri Nov 08, 2019 9:13 am
Amadis_of_Gaul wrote: Sooo. . . maybe the moral of the story is that I need to accept uncertainty about the future rather than trying to analyze myself into the illusion of certainty and control.
PaulF wrote:This is one of the most sagacious things I have read on BH (or M*) in my time (~13 years) here.
Amadis and Paul:

Your two quotes are gems !!

Thank you and best wishes.
Taylor
Jack Bogle's Words of Wisdom: "In the stock market the more elaborate and abstruse the mathematics the more uncertain and speculative are the conclusions we draw therefrom."
Thanks, Taylor. That means a lot coming from you, but I will say that IMHO only Amadis wrote a gem! I just acknowledged it. :sharebeer

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Re: Nominal or inflation-protected bonds?

Post by Chicken Little » Sat Nov 09, 2019 11:02 am

I have basic questions.

If housing, healthcare, and tuition have outpaced inflation, and are included in the CPI, are those increases averaged out by cheaper electronics, food, energy, etc?

Inflation has hovered around 2% for a decade. If I had invested in safe bonds in and HSA or a 529, would I have kept up with increased healthcare or tuition costs?

If those big-ticket items are averaged out, does that average actually capture net household inflation, or is the middle-class inflation rate something other than the CPI? How does the fact that wages have been largely flat for the decade impact that?

In planning for future inflation, is there current inflation right now that I haven't adequately accounted for?

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Re: Nominal or inflation-protected bonds?

Post by Phineas J. Whoopee » Sat Nov 09, 2019 3:34 pm

Chicken Little wrote:
Sat Nov 09, 2019 11:02 am
...
If housing, healthcare, and tuition have outpaced inflation, and are included in the CPI, are those increases averaged out by cheaper electronics, food, energy, etc?
...
Here's the basket of goods and services with weightings. You can read it for yourself.

No individual should expect to buy exactly the same basket. Also the price data is based on a monthly nationwide survey. No individual lives in all places simultaneously. It's to be expected live lobster will be less expensive in Maine than in Wyoming, based on transportation costs alone.

PJW

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