Inflation, TIPS and asset allocation

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Mr.BB
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Inflation, TIPS and asset allocation

Post by Mr.BB »

We were discussing the growing debt problem in this country and inflation. I know TIPS are a good buffer in times of increased inflation (of course you don't know when and how much rates would increase). But in general, right now I believe the rate of inflation is around 2%. If inflation was to increase to 5% (just guessing), what percent of your total portfolio would need to be in TIPS to offset the inflation/rate increase?
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Elysium
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Re: Inflation, TIPS and asset allocation

Post by Elysium »

This matters to those who are spending from their portfolio. They would need to have enough inflation protection to cover the spending needs. Can't answer without specific scenarios.
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Re: Inflation, TIPS and asset allocation

Post by alex_686 »

100%. TIPS is the only perfect hedge against inflation. And as a prefect hedge it carries a high cost.

You may be better off looking at imperfect hedges like real asset, such as equities and real estate.
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FIREchief
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Re: Inflation, TIPS and asset allocation

Post by FIREchief »

alex_686 wrote: Sat Aug 08, 2020 9:56 pm 100%. TIPS is the only perfect hedge against inflation. And as a prefect hedge it carries a high cost.
High cost? Not really. Compared to the other safe fixed income (nominal US treasuries) there is little or no cost. Compared to riskier bonds, perhaps 1% yield. :confused
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Re: Inflation, TIPS and asset allocation

Post by Cyclesafe »

Considering an entire portfolio, if 100% TIPS they would have a high opportunity cost relative to (hopefully) inflating real estate and equity.
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Re: Inflation, TIPS and asset allocation

Post by dbr »

People are correctly pointing out that TIPS are adjusted for inflation themselves but do not offset inflation losses in anything else. Hence the result that if you want an inflation protected portfolio using TIPS to do that, then the portfolio has to be 100% TIPS. There is precedent for that in the concept of the TIPS ladder liability matching portfolio. It is also an argument that if you are going to own bonds, those bonds should be 100% TIPS.

I don't know of any rule matching TIPS allocation to what you think the rate of unexpected inflation is going to be. Larry Swedroe has sometimes suggested how far the bond allocation should be switched to TIPS or how far the TIPS duration should be lengthened depending on the real interest rate. I think in those suggestions all long TIPS becomes the idea when real rates go higher than 2%-3% or more. That is a moot point right now.
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Re: Inflation, TIPS and asset allocation

Post by alex_686 »

FIREchief wrote: Sun Aug 09, 2020 12:33 am
alex_686 wrote: Sat Aug 08, 2020 9:56 pm 100%. TIPS is the only perfect hedge against inflation. And as a prefect hedge it carries a high cost.
High cost? Not really. Compared to the other safe fixed income (nominal US treasuries) there is little or no cost. Compared to riskier bonds, perhaps 1% yield. :confused
TIPS have a embedded inflation option. a.k.a. Insurance. What is the cost of that insurance?

I don’t have the numbers in front of me, but the coat has been fairly high and not worth it. It can only beat out a Treasury if there is a big unexpected spike in inflation. Otherwise it trails.
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Re: Inflation, TIPS and asset allocation

Post by Dude2 »

It's a shame that the Total Bond Market Index does not include TIPS in proportion to market weight. Then perhaps we'd all feel good about only holding TBM without worrying about the exact proportion we, as Bogleheads, should hold in TIPS. Let the market decide. Right?

According to a Vanguard paper (https://personal.vanguard.com/pdf/rpd23.pdf), at the end of 2008, TIPS were 8% of Treasuries or 4% of the US taxable bond universe (no munis, no high-yield, no world bonds).

According to Morningstar (https://www.morningstar.com/articles/80 ... -delivered), at the 20 year mark of their existence (2017), the TIPS market grew to 9% of Treasuries.

A simple Boglehead formula could be: Decide percentage of TBM to hold in my portfolio, subdivide that into a 95% TBM, 5% TIPS fund of some flavor (maybe the Fidelity FIPDX index fund).
Last edited by Dude2 on Sun Aug 09, 2020 8:23 am, edited 1 time in total.
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columbia
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Re: Inflation, TIPS and asset allocation

Post by columbia »

By definition, one can't predict when unexpected inflation will happen, but there is certainly a finite number of potential causes.

So what are they these days?
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Re: Inflation, TIPS and asset allocation

Post by vineviz »

alex_686 wrote: Sun Aug 09, 2020 8:10 am
TIPS have a embedded inflation option. a.k.a. Insurance. What is the cost of that insurance?
Most research says the “cost” is approximately zero.
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Re: Inflation, TIPS and asset allocation

Post by Ramjet »

columbia wrote: Sun Aug 09, 2020 8:22 am By definition, one can't predict when unexpected inflation will happen, but there is certainly a finite number of potential causes.

So what are they these days?
Beats me. Can you think of any? Someone will mention the Fed printing of money or buying assets but I don't think the majority of that money is getting into consumers hands
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Re: Inflation, TIPS and asset allocation

Post by alex_686 »

vineviz wrote: Sun Aug 09, 2020 9:08 am
alex_686 wrote: Sun Aug 09, 2020 8:10 am
TIPS have a embedded inflation option. a.k.a. Insurance. What is the cost of that insurance?
Most research says the “cost” is approximately zero.
Define cost. I will grant it is a nuanced issue.

The cost is fixed, the spread between a nominal Treasury and a TIPS.

The payoff is variable and asymmetrical. High probability of a low inflation and thus a low payoff that will underperform, a low probability of high inflation and a high payoff.

TIPS have historically underperformed their nominal counterparts. One option is that the market has consistently overestimated infatuation. The other option is that the market overpays for the insurance on a high inflation state. (Overpays might not be exactly the right word).

I favor this option. Partly due to market structure. Partly on investors utility function and risk aversion.
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Re: Inflation, TIPS and asset allocation

Post by alex_686 »

Dude2 wrote: Sun Aug 09, 2020 8:21 am It's a shame that the Total Bond Market Index does not include TIPS in proportion to market weight.
TIPS are not a good candidate For an index. They are relatively illiquid and the illiquidity is not uniformed across the market. Thus it is not a efficient market.
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Re: Inflation, TIPS and asset allocation

Post by Robot Monster »

Realize a change to 5% inflation would be massive, sky high above the Fed's 2% target. Cash might handily beat TIPS in this environment if the Fed hikes interest rates. The last time inflation was anywhere near 5% was in the late 80's. Note how much higher interest rates were over inflation:

Year--Inflation--Interest rate
1987 4.4% 6.75%
1988 4.4% 9.75%
1989 4.6% 8.25%
1990 6.1% 7.00%
1991 3.1% 4.00%
https://www.thebalance.com/u-s-inflatio ... st-3306093

Going by recent news (below) the Fed could very well allow inflation to heat up slightly past 2%. But 5% blows past slightly. Blows it out of the water.

"Fed officials would take a more relaxed view by allowing for periods in which inflation would run slightly above the central bank’s 2% target, to make up for past episodes in which inflation ran below the target."
https://www.wsj.com/articles/fed-weighs ... 1596360600
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Re: Inflation, TIPS and asset allocation

Post by nedsaid »

Robot Monster wrote: Sun Aug 09, 2020 10:13 am Realize a change to 5% inflation would be massive, sky high above the Fed's 2% target. Cash might handily beat TIPS in this environment if the Fed hikes interest rates.
Except that the Fed may choose to keep interest rates below inflation to inflate away the national debt. We did this after WWII. Unemployment might also still be relatively high in your scenario and this might also keep the Fed from raising rates. Also keep in mind the Stagflation experienced in the 1970s. I don't believe we will see stagflation but it could happen again.
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Re: Inflation, TIPS and asset allocation

Post by Robot Monster »

alex_686 wrote: Sat Aug 08, 2020 9:56 pm 100%. TIPS is the only perfect hedge against inflation. And as a prefect hedge it carries a high cost.

You may be better off looking at imperfect hedges like real asset, such as equities and real estate.
If you do 100% TIPS in a taxable account, if inflation rockets up, you could be facing some pretty high tax numbers because of the way TIPS are taxed. You may actually have to sell TIPS in order to pay the taxes.
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Re: Inflation, TIPS and asset allocation

Post by vineviz »

Robot Monster wrote: Sun Aug 09, 2020 10:24 am
alex_686 wrote: Sat Aug 08, 2020 9:56 pm 100%. TIPS is the only perfect hedge against inflation. And as a prefect hedge it carries a high cost.

You may be better off looking at imperfect hedges like real asset, such as equities and real estate.
If you do 100% TIPS in a taxable account, if inflation rockets up, you could be facing some pretty high tax numbers because of the way TIPS are taxed. You may actually have to sell TIPS in order to pay the taxes.
A taxable gain is still a gain: 70% of 100 is preferable to 100% of 0.
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Re: Inflation, TIPS and asset allocation

Post by Robot Monster »

nedsaid wrote: Sun Aug 09, 2020 10:20 am
Robot Monster wrote: Sun Aug 09, 2020 10:13 am Realize a change to 5% inflation would be massive, sky high above the Fed's 2% target. Cash might handily beat TIPS in this environment if the Fed hikes interest rates.
Except that the Fed may choose to keep interest rates below inflation to inflate away the national debt. We did this after WWII. Unemployment might also still be relatively high in your scenario and this might also keep the Fed from raising rates. Also keep in mind the Stagflation experienced in the 1970s. I don't believe we will see stagflation but it could happen again.
You made two good points.

Unemployment might still be high. Indeed, it's not a guarantee the Fed would hike rates to fight inflation if there is also high unemployment. If unemployment is 10% and inflation is 5%, there really is no guarantee which way they would lean, so that's why I say cash might handily beat TIPS. (Perhaps it's best to own both TIPS and cash?)

The Fed kept rates low after WWII. I was curious how the Fed could let inflation run explosively hot during '47 and '51. Well, doing a quick search I find:

Independence and insulation from political pressures are essential to the ability of a nation’s central bank to conduct monetary policy (Federal Reserve Bank of Richmond 2013). During World War II and its aftermath the Federal Reserve did not enjoy such independence. In 1951, however, the Treasury Department and the Fed reached an agreement now known as the Treasury-Federal Reserve Accord. This accord effected the “liberation of monetary policy” and laid the foundation for the modern Federal Reserve.
https://www.federalreservehistory.org/e ... fed_accord

So, seems the Fed underwent a sea change in '51, and that the Fed of today isn't the Fed of old.
Last edited by Robot Monster on Sun Aug 09, 2020 10:44 am, edited 4 times in total.
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Re: Inflation, TIPS and asset allocation

Post by Robot Monster »

vineviz wrote: Sun Aug 09, 2020 10:30 am
Robot Monster wrote: Sun Aug 09, 2020 10:24 am
alex_686 wrote: Sat Aug 08, 2020 9:56 pm 100%. TIPS is the only perfect hedge against inflation. And as a prefect hedge it carries a high cost.

You may be better off looking at imperfect hedges like real asset, such as equities and real estate.
If you do 100% TIPS in a taxable account, if inflation rockets up, you could be facing some pretty high tax numbers because of the way TIPS are taxed. You may actually have to sell TIPS in order to pay the taxes.
A taxable gain is still a gain: 70% of 100 is preferable to 100% of 0.
Won't argue with that! Just wanted people to be aware of the possibility of having to sell TIPS because of the odd way TIPS are taxed. Correct me if I'm wrong about this, vv, but if interest rates significantly shoot up above inflation, this would cause the market price of TIPS to go down significantly in value--not a good time to be selling?
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Re: Inflation, TIPS and asset allocation

Post by vineviz »

Robot Monster wrote: Sun Aug 09, 2020 10:41 am Won't argue with that! Just wanted people to be aware of the possibility of having to sell TIPS because of the odd way TIPS are taxed. Correct me if I'm wrong about this, vv, but if interest rates significantly shoot up above inflation, this would cause the market price of TIPS to go down significantly in value--not a good time to be selling?
IMHO, no one should be buying individual bonds of any sort (inflation-linked or nominal) except to fund a non-rolling ladder in which the bond principal will be spent at maturity.

I know people do this, but the interest rate risk it creates (and which you describe) is an unnecessary risk to be exposing yourself to.
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Re: Inflation, TIPS and asset allocation

Post by nedsaid »

Robot Monster wrote: Sun Aug 09, 2020 10:33 am
nedsaid wrote: Sun Aug 09, 2020 10:20 am
Robot Monster wrote: Sun Aug 09, 2020 10:13 am Realize a change to 5% inflation would be massive, sky high above the Fed's 2% target. Cash might handily beat TIPS in this environment if the Fed hikes interest rates.
Except that the Fed may choose to keep interest rates below inflation to inflate away the national debt. We did this after WWII. Unemployment might also still be relatively high in your scenario and this might also keep the Fed from raising rates. Also keep in mind the Stagflation experienced in the 1970s. I don't believe we will see stagflation but it could happen again.
You made two good points.

Unemployment might still be high. Indeed, it's not a guarantee the Fed would hike rates to fight inflation if there is also high unemployment. If unemployment is 10% and inflation is 5%, there really is no guarantee which way they would lean, so that's why I say cash might handily beat TIPS. (Perhaps it's best to own both TIPS and cash?)

The Fed kept rates low after WWII. I was curious how the Fed could let inflation run explosively hot during '47 and '51. Well, doing a quick search I find:

Independence and insulation from political pressures are essential to the ability of a nation’s central bank to conduct monetary policy (Federal Reserve Bank of Richmond 2013). During World War II and its aftermath the Federal Reserve did not enjoy such independence. In 1951, however, the Treasury Department and the Fed reached an agreement now known as the Treasury-Federal Reserve Accord. This accord effected the “liberation of monetary policy” and laid the foundation for the modern Federal Reserve.
https://www.federalreservehistory.org/e ... fed_accord

So, seems the Fed underwent a sea change in '51, and that the Fed of today isn't the Fed of old.
Except now the Federal Debt has ballooned again and this new debt taken on to fight the coronavirus crisis will not be repaid. In fact, over most of our history the national debt has grown and grown. One way to reduce debt is to reduce it through inflation.

The Fed is independent but still works hand in glove with the US Treasury to assure that the US Government is always funded.

A problem with my scenario is that Japan has actually tried to stimulate inflation a bit and stubbornly inflation hovers close to zero. There will be an uptick from time to time but inflation dutifully will ease right back down. We could see whiffs of deflation again here in the U.S. as we did in the aftermath of the 2008-2009 financial crisis and bear market. So inflation might not go up even if the Fed desires it.
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Re: Inflation, TIPS and asset allocation

Post by vineviz »

Robot Monster wrote: Sun Aug 09, 2020 10:33 am So, seems the Fed underwent a sea change in '51, and that the Fed of today isn't the Fed of old.
Indeed, this is true and important. There are many other important factors, of course, which make the bond markets pre-1980 different from the one we've experienced since then.

One of these is that even through the 1950s and 1960s the Fed wasn't even discussing the idea that real rates and nominal rates could be different.

This distinction, and the policy implications thereof, seem basic to us now but only because of the lessons we learned from the Fed being blindsided by inflation from the mid-1960s to the late 1970s.
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Re: Inflation, TIPS and asset allocation

Post by FIREchief »

alex_686 wrote: Sun Aug 09, 2020 8:10 am
FIREchief wrote: Sun Aug 09, 2020 12:33 am
alex_686 wrote: Sat Aug 08, 2020 9:56 pm 100%. TIPS is the only perfect hedge against inflation. And as a prefect hedge it carries a high cost.
High cost? Not really. Compared to the other safe fixed income (nominal US treasuries) there is little or no cost. Compared to riskier bonds, perhaps 1% yield. :confused
TIPS have a embedded inflation option. a.k.a. Insurance. What is the cost of that insurance?

I don’t have the numbers in front of me, but the coat has been fairly high and not worth it. It can only beat out a Treasury if there is a big unexpected spike in inflation. Otherwise it trails.
Nobody knows the true cost of that insurance, because it is impossible to break out specific components of the breakeven inflation rate. That said, there is significant evidence that the cost of that insurance has been miniscule or free in recent years. Please note that TIPS have in fact beaten nominal treasuries at numerous times in the recent past without "big unexpected spikes in inflation."
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Re: Inflation, TIPS and asset allocation

Post by FIREchief »

alex_686 wrote: Sun Aug 09, 2020 9:47 am
Dude2 wrote: Sun Aug 09, 2020 8:21 am It's a shame that the Total Bond Market Index does not include TIPS in proportion to market weight.
TIPS are not a good candidate For an index. They are relatively illiquid and the illiquidity is not uniformed across the market. Thus it is not a efficient market.
TIPS are much more liquid than most corporate bonds, and that doesn't stop the total bond funds from buying those.
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Re: Inflation, TIPS and asset allocation

Post by vineviz »

alex_686 wrote: Sun Aug 09, 2020 9:43 am
vineviz wrote: Sun Aug 09, 2020 9:08 am
alex_686 wrote: Sun Aug 09, 2020 8:10 am
TIPS have a embedded inflation option. a.k.a. Insurance. What is the cost of that insurance?
Most research says the “cost” is approximately zero.
Define cost. I will grant it is a nuanced issue.

The cost is fixed, the spread between a nominal Treasury and a TIPS.
That spread is almost 100% described as the expected rate of inflation: the expected real return of nominal Treasuries and TIPS is virtually identical.

In theory the two different bonds each have describable premiums (inflation volatility and liquidity are the ones most commonly described) but the literature investigating these premiums generally concludes that they are both economically small and largely offsetting.
alex_686 wrote: Sun Aug 09, 2020 9:43 am TIPS have historically underperformed their nominal counterparts. One option is that the market has consistently overestimated infatuation. The other option is that the market overpays for the insurance on a high inflation state. (Overpays might not be exactly the right word).
It's important to be careful when judging the performance of TIPS funds vs nominal Treasury funds, especially when trying to undertake a performance attribution analysis OR trying to extrapolate past trends into the future.

TIPS funds appear to have "historically underperformed" nominal Treasury funds precisely because realized inflation has generally come in below expectations AND because expected inflation has generally been declining.

Rather than interpreting this as "overpaying" for inflation protection, the more accurate conclusion is that the market isn't particularly awesome at forecasting future inflation rates. However, there's little-to-no evidence that the forecasting errors are systematic and therefore little basis for concluding that TIPS have "historically underperformed".

Indeed, the historical periods in which TIPS "outperformed" are exactly the ones you'd expect.

Image

As always, the important takeaways in my mind are these: 1) predicting future excess returns in markets is virtually impossible to do reliably, so don't try it; therefore 2) matching the duration and inflation sensitivity of your investments with the duration and inflation sensitivity of your expected future consumption will lower your risk without compromising expected returns.
"Far more money has been lost by investors preparing for corrections than has been lost in corrections themselves." ~~ Peter Lynch
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Re: Inflation, TIPS and asset allocation

Post by FIREchief »

vineviz wrote: Sun Aug 09, 2020 11:35 am
alex_686 wrote: Sun Aug 09, 2020 9:43 am
vineviz wrote: Sun Aug 09, 2020 9:08 am
alex_686 wrote: Sun Aug 09, 2020 8:10 am
TIPS have a embedded inflation option. a.k.a. Insurance. What is the cost of that insurance?
Most research says the “cost” is approximately zero.
Define cost. I will grant it is a nuanced issue.

The cost is fixed, the spread between a nominal Treasury and a TIPS.
That spread is almost 100% described as the expected rate of inflation: the expected real return of nominal Treasuries and TIPS is virtually identical.

In theory the two different bonds each have describable premiums (inflation volatility and liquidity are the ones most commonly described) but the literature investigating these premiums generally concludes that they are both economically small and largely offsetting.
alex_686 wrote: Sun Aug 09, 2020 9:43 am TIPS have historically underperformed their nominal counterparts. One option is that the market has consistently overestimated infatuation. The other option is that the market overpays for the insurance on a high inflation state. (Overpays might not be exactly the right word).
It's important to be careful when judging the performance of TIPS funds vs nominal Treasury funds, especially when trying to undertake a performance attribution analysis OR trying to extrapolate past trends into the future.

TIPS funds appear to have "historically underperformed" nominal Treasury funds precisely because realized inflation has generally come in below expectations AND because expected inflation has generally been declining.

Rather than interpreting this as "overpaying" for inflation protection, the more accurate conclusion is that the market isn't particularly awesome at forecasting future inflation rates. However, there's little-to-no evidence that the forecasting errors are systematic and therefore little basis for concluding that TIPS have "historically underperformed".

Indeed, the historical periods in which TIPS "outperformed" are exactly the ones you'd expect.

Image

As always, the important takeaways in my mind are these: 1) predicting future excess returns in markets is virtually impossible to do reliably, so don't try it; therefore 2) matching the duration and inflation sensitivity of your investments with the duration and inflation sensitivity of your expected future consumption will lower your risk without compromising expected returns.
Thanks for posting this vineviz. It's hard to cut through a lot of the confusion out there regarding TIPS. :beer
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Re: Inflation, TIPS and asset allocation

Post by DollarvsGold »

Hello, not sure if this is the right place to ask this question, but I didn't want to open a new thread.

I'm interested to invest in TIPS, in the form of the iShares TIP ETF. https://www.ishares.com/us/products/239 ... s-bond-etf

The real yield is about -1% at the moment. As far as I know, TIP ETF pays you a monthly distribution, similar to IEF and TLT etc.
Could someone explain me how this works?

For that matter, if nominal bonds yields are negative like in Europe (e.g. -0,5%), would that mean my bond ETF loses 0,5% every year in value, assuming everything else stays the same (no change in yields)? A positive yield would be received via a payout, not sure how it works with negative yields...

Thanks in advance!
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Re: Inflation, TIPS and asset allocation

Post by #Cruncher »

alex_686 wrote: Sun Aug 09, 2020 9:43 amTIPS have historically underperformed their nominal counterparts.
Not universally true. Since 2010 I've been updating a thread, Treasury Notes Return vs Actual TIPS Return, to compare the nominal yield of 5 and 10 year TIPS bought at auction and held to maturity against the yields of nominal Treasuries bought at the time of the auctions. As shown in this graph of 10 year issues from my latest update to that thread, in some cases nominal Treasuries have indeed outperformed TIPS (upward bars), but in other cases they have not (downward bars). The same holds true for 5 year issues.

Image
alex_686, continuing in same post, wrote:One option is that the market has consistently overestimated infatuation.
Looks like your browser's autocorrect thought you were referring to the profitability of dating websites, Alex. :P
alex_686 wrote: Sun Aug 09, 2020 9:47 amTIPS are not a good candidate For an index.
The owners of the many TIPS index funds may disagree. :wink:
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Re: Inflation, TIPS and asset allocation

Post by Robot Monster »

nedsaid wrote: Sun Aug 09, 2020 10:51 am
Robot Monster wrote: Sun Aug 09, 2020 10:33 am
nedsaid wrote: Sun Aug 09, 2020 10:20 am
Robot Monster wrote: Sun Aug 09, 2020 10:13 am Realize a change to 5% inflation would be massive, sky high above the Fed's 2% target. Cash might handily beat TIPS in this environment if the Fed hikes interest rates.
Except that the Fed may choose to keep interest rates below inflation to inflate away the national debt. We did this after WWII. Unemployment might also still be relatively high in your scenario and this might also keep the Fed from raising rates. Also keep in mind the Stagflation experienced in the 1970s. I don't believe we will see stagflation but it could happen again.
You made two good points.

Unemployment might still be high. Indeed, it's not a guarantee the Fed would hike rates to fight inflation if there is also high unemployment. If unemployment is 10% and inflation is 5%, there really is no guarantee which way they would lean, so that's why I say cash might handily beat TIPS. (Perhaps it's best to own both TIPS and cash?)

The Fed kept rates low after WWII. I was curious how the Fed could let inflation run explosively hot during '47 and '51. Well, doing a quick search I find:

Independence and insulation from political pressures are essential to the ability of a nation’s central bank to conduct monetary policy (Federal Reserve Bank of Richmond 2013). During World War II and its aftermath the Federal Reserve did not enjoy such independence. In 1951, however, the Treasury Department and the Fed reached an agreement now known as the Treasury-Federal Reserve Accord. This accord effected the “liberation of monetary policy” and laid the foundation for the modern Federal Reserve.
https://www.federalreservehistory.org/e ... fed_accord

So, seems the Fed underwent a sea change in '51, and that the Fed of today isn't the Fed of old.
Except now the Federal Debt has ballooned again and this new debt taken on to fight the coronavirus crisis will not be repaid. In fact, over most of our history the national debt has grown and grown. One way to reduce debt is to reduce it through inflation.

The Fed is independent but still works hand in glove with the US Treasury to assure that the US Government is always funded.

A problem with my scenario is that Japan has actually tried to stimulate inflation a bit and stubbornly inflation hovers close to zero. There will be an uptick from time to time but inflation dutifully will ease right back down. We could see whiffs of deflation again here in the U.S. as we did in the aftermath of the 2008-2009 financial crisis and bear market. So inflation might not go up even if the Fed desires it.
I'll grant you a scenario which the Fed allows inflation to bubble up much higher than 2% cannot be ruled out. How much higher? I don't know. Could 4% be ruled out? Probably not. But if this scenario is a possibility, so is the scenario where the Fed keeps its current average 2% target and raises rates accordingly. Perhaps hedging against either possibility in the form of cash and TIPS is a reasonable approach.
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Re: Inflation, TIPS and asset allocation

Post by vineviz »

FIREchief wrote: Sun Aug 09, 2020 11:13 am
alex_686 wrote: Sun Aug 09, 2020 9:47 am
Dude2 wrote: Sun Aug 09, 2020 8:21 am It's a shame that the Total Bond Market Index does not include TIPS in proportion to market weight.
TIPS are not a good candidate For an index. They are relatively illiquid and the illiquidity is not uniformed across the market. Thus it is not a efficient market.
TIPS are much more liquid than most corporate bonds, and that doesn't stop the total bond funds from buying those.
Right. The reason TIPS aren't included in total bond market funds isn't liquidity: outstanding par value of TIPS is typically in excess of 25x the minimum liquidity constraint imposed by the Bloomberg Barclays US Aggregate Bond Index for Treasury bonds, for instance.

I've speculated that the reason TIPS are excluded from the aggregate index might be tax-treatment, but it's just as likely that it's merely convention. The aggregate bond index was initially developed as a benchmark for active "core bond" managers and not necessarily as an investable index. The main similarity among the fixed income asset classes excluded from the aggregate index is that core bond fund managers haven't typically invested in them.

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Re: Inflation, TIPS and asset allocation

Post by jeffyscott »

FIREchief wrote: Sun Aug 09, 2020 11:13 am
alex_686 wrote: Sun Aug 09, 2020 9:47 am
Dude2 wrote: Sun Aug 09, 2020 8:21 am It's a shame that the Total Bond Market Index does not include TIPS in proportion to market weight.
TIPS are not a good candidate For an index. They are relatively illiquid and the illiquidity is not uniformed across the market. Thus it is not a efficient market.
TIPS are much more liquid than most corporate bonds, and that doesn't stop the total bond funds from buying those.
It also doesn't stop there being many actual TIPS index funds.
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Re: Inflation, TIPS and asset allocation

Post by vineviz »

DollarvsGold wrote: Sun Aug 09, 2020 12:01 pm Hello, not sure if this is the right place to ask this question, but I didn't want to open a new thread.

I'm interested to invest in TIPS, in the form of the iShares TIP ETF. https://www.ishares.com/us/products/239 ... s-bond-etf

The real yield is about -1% at the moment. As far as I know, TIP ETF pays you a monthly distribution, similar to IEF and TLT etc.
Could someone explain me how this works?
Your distributions from the iShares TIPS Bond ETF come in the form of nominal (aka "actual") dollars just like IEF (which has an even MORE negative real yield than TIP at the moment).

Predicting the future NAV of a fund depends on many assumptions, so it's probably not wise and definitely not necessary to try to do that. Negative real yields do imply a decline in future real NAV for both TIP and IEF, but what happens to the nominal NAV is much less predictable. In any case, the nominal SEC yield remains the best estimate of future total return and that's probably the thing to focus on more most planning purposes.
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Re: Inflation, TIPS and asset allocation

Post by jeffyscott »

DollarvsGold wrote: Sun Aug 09, 2020 12:01 pm Hello, not sure if this is the right place to ask this question, but I didn't want to open a new thread.

I'm interested to invest in TIPS, in the form of the iShares TIP ETF. https://www.ishares.com/us/products/239 ... s-bond-etf

The real yield is about -1% at the moment. As far as I know, TIP ETF pays you a monthly distribution, similar to IEF and TLT etc.
Could someone explain me how this works?

For that matter, if nominal bonds yields are negative like in Europe (e.g. -0,5%), would that mean my bond ETF loses 0,5% every year in value, assuming everything else stays the same (no change in yields)? A positive yield would be received via a payout, not sure how it works with negative yields...

Thanks in advance!
You can investigate treasury auctions as one way to see how this works. It's the real YTM that is negative, not the coupon rate.

This may help your understanding:
https://tipswatch.com/2020/07/23/new-10 ... n-history/
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Re: Inflation, TIPS and asset allocation

Post by DollarvsGold »

double post
Last edited by DollarvsGold on Sun Aug 09, 2020 12:56 pm, edited 1 time in total.
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Re: Inflation, TIPS and asset allocation

Post by DollarvsGold »

jeffyscott wrote: Sun Aug 09, 2020 12:42 pm
DollarvsGold wrote: Sun Aug 09, 2020 12:01 pm Hello, not sure if this is the right place to ask this question, but I didn't want to open a new thread.

I'm interested to invest in TIPS, in the form of the iShares TIP ETF. https://www.ishares.com/us/products/239 ... s-bond-etf

The real yield is about -1% at the moment. As far as I know, TIP ETF pays you a monthly distribution, similar to IEF and TLT etc.
Could someone explain me how this works?

For that matter, if nominal bonds yields are negative like in Europe (e.g. -0,5%), would that mean my bond ETF loses 0,5% every year in value, assuming everything else stays the same (no change in yields)? A positive yield would be received via a payout, not sure how it works with negative yields...

Thanks in advance!
You can investigate treasury auctions as one way to see how this works. It's the real YTM that is negative, not the coupon rate.

This may help your understanding:
https://tipswatch.com/2020/07/23/new-10 ... n-history/
Thanks!
Am I right in the assumption that most european bonds have a negative coupon at the moment (at least which shorter duration)? How does it work there?
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Re: Inflation, TIPS and asset allocation

Post by vineviz »

DollarvsGold wrote: Sun Aug 09, 2020 12:56 pm
Am I right in the assumption that most european bonds have a negative coupon at the moment (at least which shorter duration)? How does it work there?
No, negative coupon bonds are virtually unheard of.
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Re: Inflation, TIPS and asset allocation

Post by DollarvsGold »

vineviz wrote: Sun Aug 09, 2020 1:26 pm
DollarvsGold wrote: Sun Aug 09, 2020 12:56 pm
Am I right in the assumption that most european bonds have a negative coupon at the moment (at least which shorter duration)? How does it work there?
No, negative coupon bonds are virtually unheard of.
Ok, but nominal yield (not real, inflation adjusted) is negative for most european bonds. Could you help me to understand that?
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Re: Inflation, TIPS and asset allocation

Post by jeffyscott »

DollarvsGold wrote: Sun Aug 09, 2020 1:58 pm
vineviz wrote: Sun Aug 09, 2020 1:26 pm
DollarvsGold wrote: Sun Aug 09, 2020 12:56 pm
Am I right in the assumption that most european bonds have a negative coupon at the moment (at least which shorter duration)? How does it work there?
No, negative coupon bonds are virtually unheard of.
Ok, but nominal yield (not real, inflation adjusted) is negative for most european bonds. Could you help me to understand that?
That's actually easier to explain. Let's say they sell (auction) a 10 year bond that will pay $1 every 6 months as a coupon and $1000 at maturity, The result of the auction is a price of $1100. So now the buyer has paid $1100 and will get back $20 in interest and then $1000 at maturity in 10 years. That's $1100 to get back a total of $1020 over the subsequent 10 years, thus a negative yield to maturity.
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Re: Inflation, TIPS and asset allocation

Post by DollarvsGold »

jeffyscott wrote: Sun Aug 09, 2020 2:11 pm
DollarvsGold wrote: Sun Aug 09, 2020 1:58 pm
vineviz wrote: Sun Aug 09, 2020 1:26 pm
DollarvsGold wrote: Sun Aug 09, 2020 12:56 pm
Am I right in the assumption that most european bonds have a negative coupon at the moment (at least which shorter duration)? How does it work there?
No, negative coupon bonds are virtually unheard of.
Ok, but nominal yield (not real, inflation adjusted) is negative for most european bonds. Could you help me to understand that?
That's actually easier to explain. Let's say they sell (auction) a 10 year bond that will pay $1 every 6 months as a coupon and $1000 at maturity, The result of the auction is a price of $1100. So now the buyer has paid $1100 and will get back $20 in interest and then $1000 at maturity in 10 years. That's $1100 to get back a total of $1020 over the subsequent 10 years, thus a negative yield to maturity.
Thank you, that helped a lot!
My understanding of bond ETFs is that if interest rates fall, the price of my bond ETF goes up (and vice versa). If interest rates stay the same, the price doesn't move, my result would be the payments received. In case of IEF for example I would get around 0,5% minus taxes if I hold IEF for one year and then sell it (no change in interest rates). Is that correct?
Now the same scenario with nominal negative yielding european bonds ETF(e.g. -0,5%) would I sell at a loss of -0,5% roughly speaking?
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Re: Inflation, TIPS and asset allocation

Post by Angst »

vineviz wrote: Sun Aug 09, 2020 12:32 pm Your distributions from the iShares TIPS Bond ETF come in the form of nominal (aka "actual") dollars just like IEF (which has an even MORE negative real yield than TIP at the moment).
iShares TIPS normally makes distributions on a monthly basis but it has paid $0.000000 for the last three months. Is it retaining what would have otherwise been very small distributions, d/t the prevailing real yield curve? It's an intermediate term fund. Vanguard's short term VTIP ETF pays quarterly, but it skipped both the March and June 2020 distributions. So Vanguard is just retaining them too?
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Re: Inflation, TIPS and asset allocation

Post by jeffyscott »

DollarvsGold wrote: Sun Aug 09, 2020 2:28 pm
jeffyscott wrote: Sun Aug 09, 2020 2:11 pm
DollarvsGold wrote: Sun Aug 09, 2020 1:58 pm
vineviz wrote: Sun Aug 09, 2020 1:26 pm
DollarvsGold wrote: Sun Aug 09, 2020 12:56 pm
Am I right in the assumption that most european bonds have a negative coupon at the moment (at least which shorter duration)? How does it work there?
No, negative coupon bonds are virtually unheard of.
Ok, but nominal yield (not real, inflation adjusted) is negative for most european bonds. Could you help me to understand that?
That's actually easier to explain. Let's say they sell (auction) a 10 year bond that will pay $1 every 6 months as a coupon and $1000 at maturity, The result of the auction is a price of $1100. So now the buyer has paid $1100 and will get back $20 in interest and then $1000 at maturity in 10 years. That's $1100 to get back a total of $1020 over the subsequent 10 years, thus a negative yield to maturity.
Thank you, that helped a lot!
My understanding of bond ETFs is that if interest rates fall, the price of my bond ETF goes up (and vice versa). If interest rates stay the same, the price doesn't move, my result would be the payments received. In case of IEF for example I would get around 0,5% minus taxes if I hold IEF for one year and then sell it (no change in interest rates). Is that correct?
Now the same scenario with nominal negative yielding european bonds ETF(e.g. -0,5%) would I sell at a loss of -0,5% roughly speaking?
I don't know how to answer that specific scenario, but the negative YTM would have to be reflected in a declining share price (NAV).

Use my bond example and assume a fund that contains only that one bond. Let's say there are 100 shares, so initially each share would cost $11 (NAV). This is a fund that never trades, like one of those bulletshare etfs, and interest rates stay exactly the same for 10 years. Then after 10 years the share price would be $10.
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Re: Inflation, TIPS and asset allocation

Post by DollarvsGold »

jeffyscott wrote: Sun Aug 09, 2020 2:42 pm
DollarvsGold wrote: Sun Aug 09, 2020 2:28 pm
jeffyscott wrote: Sun Aug 09, 2020 2:11 pm
DollarvsGold wrote: Sun Aug 09, 2020 1:58 pm
vineviz wrote: Sun Aug 09, 2020 1:26 pm

No, negative coupon bonds are virtually unheard of.
Ok, but nominal yield (not real, inflation adjusted) is negative for most european bonds. Could you help me to understand that?
That's actually easier to explain. Let's say they sell (auction) a 10 year bond that will pay $1 every 6 months as a coupon and $1000 at maturity, The result of the auction is a price of $1100. So now the buyer has paid $1100 and will get back $20 in interest and then $1000 at maturity in 10 years. That's $1100 to get back a total of $1020 over the subsequent 10 years, thus a negative yield to maturity.
Thank you, that helped a lot!
My understanding of bond ETFs is that if interest rates fall, the price of my bond ETF goes up (and vice versa). If interest rates stay the same, the price doesn't move, my result would be the payments received. In case of IEF for example I would get around 0,5% minus taxes if I hold IEF for one year and then sell it (no change in interest rates). Is that correct?
Now the same scenario with nominal negative yielding european bonds ETF(e.g. -0,5%) would I sell at a loss of -0,5% roughly speaking?
I don't know how to answer that specific scenario, but the negative YTM would have to be reflected in a declining share price (NAV).

Use my bond example and assume a fund that contains only that one bond. Let's say there are 100 shares, so initially each share would cost $11 (NAV). This is a fund that never trades, like one of those bulletshare etfs, and interest rates stay exactly the same for 10 years. Then after 10 years the share price would be $10.
Your explanations are great!

One final question for you (or anyone else):
I'm from Europe and look for exposure to the US dollar (so I don't want currency hedging). I figured out to invest in TIPS (for example TIP ETF) is one of the safest ways to do that, because if the dollar rises against the euro, I would profit (normally), but I noticed in a falling dollar environment TIPS tend to do well (because rising inflation in the US often weakens the dollar but is good for TIPS).

So it's a investment in the dollar with a "hedge" against a weak dollar! Does that make sense?
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Re: Inflation, TIPS and asset allocation

Post by FIREchief »

DollarvsGold wrote: Sun Aug 09, 2020 1:58 pm
vineviz wrote: Sun Aug 09, 2020 1:26 pm
DollarvsGold wrote: Sun Aug 09, 2020 12:56 pm
Am I right in the assumption that most european bonds have a negative coupon at the moment (at least which shorter duration)? How does it work there?
No, negative coupon bonds are virtually unheard of.
Ok, but nominal yield (not real, inflation adjusted) is negative for most european bonds. Could you help me to understand that?
It's because "negative coupons" and "negative yield" are not the same thing. For example, if I buy a TIPS at auction today it will have a negative yield but the coupon will be the minimum .125% annual, payable every six months. I just pay a higher premium to buy the TIPS to "prepay" for those coupons.
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: Inflation, TIPS and asset allocation

Post by tipswatcher »

alex_686 wrote: Sat Aug 08, 2020 9:56 pm 100%. TIPS is the only perfect hedge against inflation. And as a prefect hedge it carries a high cost.
I'd argue that investing in TIPS *at this moment in time* is not a perfect hedge against U.S. inflation, since every TIPS currently trading on the secondary market carries a real yield negative to inflation, and it's a fairly deep negative.

On the other hand, I Bonds are a much better hedge, with a fixed rate of 0.0% they will exactly match U.S. inflation and have a 100+ basis-point advantage over a 10-year TIPS. Only one problem: That darn $10,000 per yer per person purchase limit. Time-consuming solution: Buy I Bonds every year, to the max, even if the fixed rate is 0.0%.
TIPS: Perfect investment for imperfect times?
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Re: Inflation, TIPS and asset allocation

Post by 000 »

TIPS seem unlikely to work if severe inflation occurs. See many previous discussions on this board.
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Re: Inflation, TIPS and asset allocation

Post by vineviz »

000 wrote: Sun Aug 09, 2020 4:37 pm TIPS seem unlikely to work if severe inflation occurs. See many previous discussions on this board.
I’ve seen many such discussions, and the arguments for this position are roughly as convincing as the argument that chemtrails are an Illuminati attempt at mind control.
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Re: Inflation, TIPS and asset allocation

Post by vineviz »

tipswatcher wrote: Sun Aug 09, 2020 4:35 pm
alex_686 wrote: Sat Aug 08, 2020 9:56 pm 100%. TIPS is the only perfect hedge against inflation. And as a prefect hedge it carries a high cost.
I'd argue that investing in TIPS *at this moment in time* is not a perfect hedge against U.S. inflation, since every TIPS currently trading on the secondary market carries a real yield negative to inflation, and it's a fairly deep negative.

On the other hand, I Bonds are a much better hedge, with a fixed rate of 0.0% they will exactly match U.S. inflation and have a 100+ basis-point advantage over a 10-year TIPS. Only one problem: That darn $10,000 per yer per person purchase limit. Time-consuming solution: Buy I Bonds every year, to the max, even if the fixed rate is 0.0%.
A negative real yield has no impact on the inflation protection offered by TIPS.

I agree that Series I savings bonds may be preferable for some use cases, but they aren’t universally superior to individuals TIPS.
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Re: Inflation, TIPS and asset allocation

Post by jeffyscott »

vineviz wrote: Sun Aug 09, 2020 5:01 pm chemtrails
You do realize that is the term used for contrails by the conspiracy theorists :?: .
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Re: Inflation, TIPS and asset allocation

Post by vineviz »

jeffyscott wrote: Sun Aug 09, 2020 5:05 pm
vineviz wrote: Sun Aug 09, 2020 5:01 pm chemtrails
You do realize that is the term used for contrails by the conspiracy theorists :?: .
Oh yes.

Our conspiracy theorists seem more interested in CPI than contrails, but the similarities are unsettling.
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Re: Inflation, TIPS and asset allocation

Post by Robot Monster »

tipswatcher wrote: Sun Aug 09, 2020 4:35 pm
alex_686 wrote: Sat Aug 08, 2020 9:56 pm 100%. TIPS is the only perfect hedge against inflation. And as a prefect hedge it carries a high cost.
I'd argue that investing in TIPS *at this moment in time* is not a perfect hedge against U.S. inflation, since every TIPS currently trading on the secondary market carries a real yield negative to inflation, and it's a fairly deep negative.

On the other hand, I Bonds are a much better hedge, with a fixed rate of 0.0% they will exactly match U.S. inflation and have a 100+ basis-point advantage over a 10-year TIPS. Only one problem: That darn $10,000 per yer per person purchase limit. Time-consuming solution: Buy I Bonds every year, to the max, even if the fixed rate is 0.0%.
Why do TIPS need to be perfect? Even Scarlett Johansson has her flaws. TIPS are still wonderful. If inflation bubbles up and the Fed doesn't respond by kicking up rates, TIPS will be a whole load of wonderful. Personally, I've lately been very into the flavorful combination of TIPS and cash. Think about it. If inflation goes lower, you're happy to be in cash. If inflation goes higher, TIPS give you a kiss. If interest rates go up, cash has a party. If rates stay the same and inflation blows higher, TIPS busts a move, moonwalking across the dance floor.
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