TIPS vs TIPS ETF and speculation

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tonyclifton
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TIPS vs TIPS ETF and speculation

Post by tonyclifton »

A small percentage (1.8%) of our fixed income asset allocation is in the Schwab TIPS ETF (SCHP). This is in a 60/40 portfolio. I first read Swedroe's "The Only Guide to a Winning Bond Strategy You'll Ever Need", this site and the web to better understand TIPS. I bought the TIPS ETF as an alternative to directly buying TIPS. I bought the TIPS ETF expecting a return on principal with unexpected inflation protection and planned to use the money in about 10 years. I also have a similar amount in Schwab Short-Term Treasuries (SCHO) with the same purpose.

SCHP had a big run-up in price in late February, the bottom dropped out in mid-March and then another run-up to present - just like US equities. I don't really get that.

One concern is that I don't really understand what a TIPS ETF is. (I thought it was like a bond ETF - a basket of TIPS with various durations in this case SCHO averages out to 7.7 years). I am wondering if more people are buying it than selling it because they are speculating that inflation is going to happen instead of what TIPS do which is buffer unexpected inflation. Kind of like the recent situation where people were buying an Oil Futures ETF (USO) with the mistaken belief they were buying cheap oil and ended up losing a lot of money. I don't want to be in that situation either!

Another question for a TIPS ETF...If more people buy SCHP doesn't SCHP just buy more TIPS? Or is that also where I am wrong?

To be clear I am not wanting to speculate. Just trying to diversify the fixed income portion of our portfolio.

Thank you for your advice and perspective.
Last edited by tonyclifton on Thu Aug 13, 2020 3:21 pm, edited 1 time in total.
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Re: TIPS vs TIPS ETF and speculation

Post by Robot Monster »

tonyclifton wrote: Thu Aug 13, 2020 12:08 pm A small percentage (1.8%) of our fixed income asset allocation is in the Schwab TIPS ETF (SCHP). This is in a 60/40 portfolio. I first read Swedroe's "The Only Guide to a Winning Bond Strategy You'll Ever Need", this site and the web to better understand TIPS. I bought the TIPS ETF as an alternative to directly buying TIPS. I bought the TIPS ETF expecting a return on principal with unexpected inflation protection and planned to use the money in about 10 years. I also have a similar amount in Schwab Short-Term Treasuries (SCHO) with the same purpose.

SCHP had a big run-up in price in late February, the bottom dropped out in mid-March and then another run-up to present - just like US equities. I don't really get that.

One concern is that I don't really understand what a TIPS ETF is. (I thought it was like a bond ETF - a basket of TIPS with various durations in this case SCHO averages out to 7.7 years). I am wondering if more people are buying it than selling it because they are speculating that inflation is going to happen instead of what TIPS do which is buffer unexpected inflation. Kind of like the recent situation where people were buying an Oil Futures ETF (USO) with the mistaken belief they were buying cheap oil and ended up losing a lot of money. I don't want to be in that situation either!

Another question for a TIPS ETF...If more people buy SCHO doesn't SCHO just buy more TIPS? Or is that also where I am wrong?

To be clear I am not wanting to speculate. Just trying to diversify the fixed income portion of our portfolio.

Thank you for your advice and perspective.
I have no idea what motivates people to buy TIPS. Can't speculate on that.

If SCHO is a Short-Term US Treasury ETF, I would think that means they only hold nominal treasury bonds, not TIPS.
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Re: TIPS vs TIPS ETF and speculation

Post by vineviz »

tonyclifton wrote: Thu Aug 13, 2020 12:08 pm
One concern is that I don't really understand what a TIPS ETF is. (I thought it was like a bond ETF - a basket of TIPS with various durations in this case SCHO averages out to 7.7 years).
Sounds like you understand it: a TIPS ETF is exactly what a bond ETF is, an ETF that holds bonds (in this case all the bonds are TIPS).


tonyclifton wrote: Thu Aug 13, 2020 12:08 pm I am wondering if more people are buying it than selling it because they are speculating that inflation is going to happen instead of what TIPS do which is buffer unexpected inflation.
No, because there can NEVER be more buyers than sellers: every transaction has both parties.

I can't comment on WHY people might be buying or selling TIPS, but because TIPS offer protection against inflation it is reasonable to conclude that when the prospect of high inflation goes down (as it typically does when an economic recession occurs) some investors might conclude that protection against inflation is less valuable to them than it was.

Rather than trying to guess why other investors are doing whatever they are doing, though, I think it's important for people to focus on their own needs and risks. Just assume the market is generally pricing in all the macroeconomic news relatively efficiently, which frees you up to simply focus on financial planning. If SOME of your future consumption is tied to the rate of inflation (i.e. you don't expect to stop eating if food prices go up) then SOME of your bond holdings should be in TIPS or a TIPS fund. "Some" could be anywhere from 0% to 100%, of course, but unless you have some specific information that tells you how much "some" should be, just figure that around 50% of your bonds in TIPS by the time your retire is a good rule of thumb.
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Re: TIPS vs TIPS ETF and speculation

Post by tonyclifton »

Robot Monster wrote: Thu Aug 13, 2020 2:03 pm If SCHO is a Short-Term US Treasury ETF, I would think that means they only hold nominal treasury bonds, not TIPS.
Sorry, that was a typo. I meant SCHP. I corrected the original post.
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Re: TIPS vs TIPS ETF and speculation

Post by GRP »

A market can easily have more buyers than sellers or vice versa. I could be the only guy in town selling apples and have thousands of buyers buying them from me. :wink:
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Re: TIPS vs TIPS ETF and speculation

Post by Robot Monster »

tonyclifton wrote: Thu Aug 13, 2020 3:22 pm
Robot Monster wrote: Thu Aug 13, 2020 2:03 pm If SCHO is a Short-Term US Treasury ETF, I would think that means they only hold nominal treasury bonds, not TIPS.
Sorry, that was a typo. I meant SCHP. I corrected the original post.
No problem. BTW, there's an upcoming auction on the 30yr TIPS, announced today for auction on Aug 20th. If you have money you don't need to use for 30 years, it's an option. https://tipswatch.com/upcoming-tips-auctions/
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Re: TIPS vs TIPS ETF and speculation

Post by tonyclifton »

vineviz wrote: Thu Aug 13, 2020 2:14 pm Just assume the market is generally pricing in all the macroeconomic news relatively efficiently, which frees you up to simply focus on financial planning.
I hear you on that...And am trying...I just really want to make sure I am correctly understanding what a TIPS ETF is as part of financial planning.
vineviz wrote: Thu Aug 13, 2020 2:14 pm If SOME of your future consumption is tied to the rate of inflation (i.e. you don't expect to stop eating if food prices go up) then SOME of your bond holdings should be in TIPS or a TIPS fund. "Some" could be anywhere from 0% to 100%, of course, but unless you have some specific information that tells you how much "some" should be, just figure that around 50% of your bonds in TIPS by the time your retire is a good rule of thumb.
What you described is the general plan...Over time, add TIPS to become portion of our fixed income asset allocation. I used a TIPS ETF instead of individual TIPS.
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Re: TIPS vs TIPS ETF and speculation

Post by tonyclifton »

Robot Monster wrote: Thu Aug 13, 2020 3:30 pm BTW, there's an upcoming auction on the 30yr TIPS, announced today for auction on Aug 20th. If you have money you don't need to use for 30 years, it's an option. https://tipswatch.com/upcoming-tips-auctions/
Thank you for the link. 30 years is too far away and I am not familiar with how to use the secondary market to sell (if I needed to which is why I felt the TIPS ETF would be easier to sell if necessary).

I have more reading to do! The Mechanics Of Purchasing A TIP In The Secondary Market
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Re: TIPS vs TIPS ETF and speculation

Post by vineviz »

tonyclifton wrote: Thu Aug 13, 2020 3:46 pm
Robot Monster wrote: Thu Aug 13, 2020 3:30 pm BTW, there's an upcoming auction on the 30yr TIPS, announced today for auction on Aug 20th. If you have money you don't need to use for 30 years, it's an option. https://tipswatch.com/upcoming-tips-auctions/
Thank you for the link. 30 years is too far away and I am not familiar with how to use the secondary market to sell (if I needed to which is why I felt the TIPS ETF would be easier to sell if necessary).
I’m not sure how it could be “too far away” unless you’re already retired.

The easiest and lowest risk bond strategy would be to buy a series of TIPS maturing in each year to of your retirement. Series I savings bonds are worth consideration as well.
"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: TIPS vs TIPS ETF and speculation

Post by tonyclifton »

vineviz wrote: Thu Aug 13, 2020 3:57 pm I’m not sure how it could be “too far away” unless you’re already retired.
What I meant by that statement was, as of today, I am fairly certain our family has a life-event happening in 2026 or 2027 (retirement) that is a lot closer than thirty years away. My immediate plan is to prepare for that time frame to avoid the sequence of returns risk. I do intend to be alive in thirty years if that was the concern :)

I am also looking into ladders for TIPS, I Bonds and CDs. I feel like the ladder approach requires a better understanding of future cash needs than I have right now. I'll give that attention.

My conclusions from this thread...TIPS ETFs are definitely a basket of TIPS & don't be worried/concerned with other people buying them out of speculation or otherwise. I also need to re-think why I am using a TIPS ETF and not just a direct or secondary purchase of individual TIPS.
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Re: TIPS vs TIPS ETF and speculation

Post by vineviz »

tonyclifton wrote: Thu Aug 13, 2020 5:46 pm
vineviz wrote: Thu Aug 13, 2020 3:57 pm I’m not sure how it could be “too far away” unless you’re already retired.
What I meant by that statement was, as of today, I am fairly certain our family has a life-event happening in 2026 or 2027 (retirement) that is a lot closer than thirty years away. My immediate plan is to prepare for that time frame to avoid the sequence of returns risk. I do intend to be alive in thirty years if that was the concern :)
There’s no better way to “ prepare for that time frame to avoid the sequence of returns risk“ than buying a 30-year TIPS.

Just saying . . .
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Re: TIPS vs TIPS ETF and speculation

Post by tonyclifton »

vineviz wrote: Thu Aug 13, 2020 6:34 pm There’s no better way to “ prepare for that time frame to avoid the sequence of returns risk“ than buying a 30-year TIPS.
Just saying . . .
Message received! I will consider that. Thank you!
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Re: TIPS vs TIPS ETF and speculation

Post by Robot Monster »

vineviz wrote: Thu Aug 13, 2020 6:34 pm
tonyclifton wrote: Thu Aug 13, 2020 5:46 pm
vineviz wrote: Thu Aug 13, 2020 3:57 pm I’m not sure how it could be “too far away” unless you’re already retired.
What I meant by that statement was, as of today, I am fairly certain our family has a life-event happening in 2026 or 2027 (retirement) that is a lot closer than thirty years away. My immediate plan is to prepare for that time frame to avoid the sequence of returns risk. I do intend to be alive in thirty years if that was the concern :)
There’s no better way to “ prepare for that time frame to avoid the sequence of returns risk“ than buying a 30-year TIPS.

Just saying . . .
Okay, so I was all set to participate in the 30yr TIPS auction on the 20th, and then I read an article from the Tipswatch guy who states this TIPS auction "isn't attractive for a buy-and-hold-to-maturity investor" and "absolutely, under no circumstances, buy this TIPS in taxable account". He goes on to say, "Inflation protection is a hot topic these days, and many investors are looking for entry points into TIPS. But I think that the 5- and 10-year auctions are much better targets for investment, and offer more reasonable real yields versus maturity terms."
https://seekingalpha.com/article/436901 ... investment

Any thoughts about this Vineviz?
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Re: TIPS vs TIPS ETF and speculation

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Robot Monster wrote: Mon Aug 17, 2020 12:28 pm Okay, so I was all set to participate in the 30yr TIPS auction on the 20th, and then I read an article from the Tipswatch guy who states this TIPS auction "isn't attractive for a buy-and-hold-to-maturity investor" and "absolutely, under no circumstances, buy this TIPS in taxable account".
I think the author has said the same thing about every 20 and 30 year TIPS auction since he started writing about them. Some past headlines:

Feb 2020: "This New 30-Year TIPS Looks Like A 'Death Star' Investment"
Aug 2019: "This Week's 30-Year TIPS Auction Is Priced For Disaster"
Feb 2019: "This Week's New 30-Year TIPS Still Isn't A Winner"
Oct 2018: "30-Year TIPS Auction: Still Looks Too Risky"
Jun 2018: "Say 'No' To This Week's 30-Year TIPS Auction"
Feb 2018: "A New 30-Year TIPS? Skip It"
Oct 2017: "Is Thursday's 30-Year TIPS Reopening Another Halloween Scare?"
Jun 2017: "30-Year TIPS Reopening Auctions With A Disappointing Real Yield Of 0.88%"
Feb 2017: "This New 30-Year TIPS Might Not Be A Great Investment"
Oct 2016: "Up Next: 30-Year TIPS Reopens At Auction Oct. 20; This One Is Going To Cost You"
Jun 2016: "Coming Wednesday: A Particularly Ugly Reopening Auction For A 30-Year TIPS"

He writes as if he is SURE that real rates will go back up ANY DAY NOW, meanwhile he was advising investors to shun 30-year TIPS when they could have bought them with real yields greater than positive 0.95% but now recommends a 10-year TIPS with a real yield of negative 0.94%???

Guys like this absolutely do not understand interest rate risk, it seems, nor do they understand how futile it is to attempt market timing with bonds. The only thing you can do is ignore writers who publish nonsense like this and stick to the fundamentals: buy bonds whose duration most closely matches your investment horizon.

That said, the one caveat I would offer to the 30-year auction is that I think most individual investors should maximize their purchase of Series I savings bonds this year BEFORE (or in addition to) adding to their non-rolling TIPS ladder. The real yield on the Series I savings bonds is much higher than the yield you will get on a TIPS, and they have the same maturity length. The only case I can think of where the TIPS would be preferable to the savings bond would be if you were pre-funding a future annuity purchase.
"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: TIPS vs TIPS ETF and speculation

Post by Angst »

Robot Monster wrote: Mon Aug 17, 2020 12:28 pm Okay, so I was all set to participate in the 30yr TIPS auction on the 20th, and then I read an article from the Tipswatch guy who states this TIPS auction "isn't attractive for a buy-and-hold-to-maturity investor" and "absolutely, under no circumstances, buy this TIPS in taxable account". He goes on to say, "Inflation protection is a hot topic these days, and many investors are looking for entry points into TIPS. But I think that the 5- and 10-year auctions are much better targets for investment, and offer more reasonable real yields versus maturity terms."
https://seekingalpha.com/article/436901 ... investment

Any thoughts about this Vineviz?
I think you mentioned upthread that you were going to consider I Bonds as well as TIPS? IF you were considering $10K or less of 30-year TIPS, I would say to buy the I Bonds as an alternative. That's what I'm doing. I'd be buying the I Bonds as well as TIPS anyhow, but the 2050 rung of the LMP I've been building for a decade now (primarily buying TIPS at auction) was only partially filled back in February at the new issue auction when I bought some of the needed 2050 TIPS. But I don't want to buy the remaining 2050 TIPS I need at this week's auction for the same reasons Tipswatcher doesn't want to, but I will use I Bonds to cover the remainder of that rung. Hopefully real rates will be in positive territory again next year and I'll resume buying TIPS and continue to look at most of my I Bonds as just inflation-protected cash.
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Re: TIPS vs TIPS ETF and speculation

Post by Robot Monster »

vineviz wrote: Mon Aug 17, 2020 1:13 pm
Robot Monster wrote: Mon Aug 17, 2020 12:28 pm Okay, so I was all set to participate in the 30yr TIPS auction on the 20th, and then I read an article from the Tipswatch guy who states this TIPS auction "isn't attractive for a buy-and-hold-to-maturity investor" and "absolutely, under no circumstances, buy this TIPS in taxable account".
I think the author has said the same thing about every 20 and 30 year TIPS auction since he started writing about them. Some past headlines:

Feb 2020: "This New 30-Year TIPS Looks Like A 'Death Star' Investment"
Aug 2019: "This Week's 30-Year TIPS Auction Is Priced For Disaster"
Feb 2019: "This Week's New 30-Year TIPS Still Isn't A Winner"
Oct 2018: "30-Year TIPS Auction: Still Looks Too Risky"
Jun 2018: "Say 'No' To This Week's 30-Year TIPS Auction"
Feb 2018: "A New 30-Year TIPS? Skip It"
Oct 2017: "Is Thursday's 30-Year TIPS Reopening Another Halloween Scare?"
Jun 2017: "30-Year TIPS Reopening Auctions With A Disappointing Real Yield Of 0.88%"
Feb 2017: "This New 30-Year TIPS Might Not Be A Great Investment"
Oct 2016: "Up Next: 30-Year TIPS Reopens At Auction Oct. 20; This One Is Going To Cost You"
Jun 2016: "Coming Wednesday: A Particularly Ugly Reopening Auction For A 30-Year TIPS"

He writes as if he is SURE that real rates will go back up ANY DAY NOW, meanwhile he was advising investors to shun 30-year TIPS when they could have bought them with real yields greater than positive 0.95% but now recommends a 10-year TIPS with a real yield of negative 0.94%???

Guys like this absolutely do not understand interest rate risk, it seems, nor do they understand how futile it is to attempt market timing with bonds. The only thing you can do is ignore writers who publish nonsense like this and stick to the fundamentals: buy bonds whose duration most closely matches your investment horizon.

That said, the one caveat I would offer to the 30-year auction is that I think most individual investors should maximize their purchase of Series I savings bonds this year BEFORE (or in addition to) adding to their non-rolling TIPS ladder. The real yield on the Series I savings bonds is much higher than the yield you will get on a TIPS, and they have the same maturity length. The only case I can think of where the TIPS would be preferable to the savings bond would be if you were pre-funding a future annuity purchase.
Wow, thank you so much! Those headlines certainly put things in perspective. And thank you for putting the market timing nature of what he's suggesting in perspective.
Angst wrote: Mon Aug 17, 2020 1:23 pm I think you mentioned upthread that you were going to consider I Bonds as well as TIPS?...Hopefully real rates will be in positive territory again next year and I'll resume buying TIPS and continue to look at most of my I Bonds as just inflation-protected cash.
Might have been someone else, already maxed out on ibonds. Be careful with that market timing on TIPS!
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Re: TIPS vs TIPS ETF and speculation

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GRP wrote: Thu Aug 13, 2020 3:29 pm A market can easily have more buyers than sellers or vice versa. I could be the only guy in town selling apples and have thousands of buyers buying them from me. :wink:
But for every apple bought there is an apple sold. Each transaction has one buyer and one seller. In that way they are equal.
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Re: TIPS vs TIPS ETF and speculation

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Angst wrote: Mon Aug 17, 2020 1:23 pm
Robot Monster wrote: Mon Aug 17, 2020 12:28 pm Okay, so I was all set to participate in the 30yr TIPS auction on the 20th, and then I read an article from the Tipswatch guy who states this TIPS auction "isn't attractive for a buy-and-hold-to-maturity investor" and "absolutely, under no circumstances, buy this TIPS in taxable account". He goes on to say, "Inflation protection is a hot topic these days, and many investors are looking for entry points into TIPS. But I think that the 5- and 10-year auctions are much better targets for investment, and offer more reasonable real yields versus maturity terms."
https://seekingalpha.com/article/436901 ... investment

Any thoughts about this Vineviz?
I think you mentioned upthread that you were going to consider I Bonds as well as TIPS? IF you were considering $10K or less of 30-year TIPS, I would say to buy the I Bonds as an alternative. That's what I'm doing. I'd be buying the I Bonds as well as TIPS anyhow, but the 2050 rung of the LMP I've been building for a decade now (primarily buying TIPS at auction) was only partially filled back in February at the new issue auction when I bought some of the needed 2050 TIPS. But I don't want to buy the remaining 2050 TIPS I need at this week's auction for the same reasons Tipswatcher doesn't want to, but I will use I Bonds to cover the remainder of that rung. Hopefully real rates will be in positive territory again next year and I'll resume buying TIPS and continue to look at most of my I Bonds as just inflation-protected cash.
If the timing of cashing them in exactly 20 years worked for me, I think I'd even take EE bonds over TIPSl, despite not being inflation protected. The doubling in 20 years is about 3.5% nominal, making the break-even inflation rate vs. TIPS about 4%.
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Re: TIPS vs TIPS ETF and speculation

Post by Angst »

jeffyscott wrote: Mon Aug 17, 2020 4:15 pm
Angst wrote: Mon Aug 17, 2020 1:23 pm
Robot Monster wrote: Mon Aug 17, 2020 12:28 pm Okay, so I was all set to participate in the 30yr TIPS auction on the 20th, and then I read an article from the Tipswatch guy who states this TIPS auction "isn't attractive for a buy-and-hold-to-maturity investor" and "absolutely, under no circumstances, buy this TIPS in taxable account". He goes on to say, "Inflation protection is a hot topic these days, and many investors are looking for entry points into TIPS. But I think that the 5- and 10-year auctions are much better targets for investment, and offer more reasonable real yields versus maturity terms."
https://seekingalpha.com/article/436901 ... investment

Any thoughts about this Vineviz?
I think you mentioned upthread that you were going to consider I Bonds as well as TIPS? IF you were considering $10K or less of 30-year TIPS, I would say to buy the I Bonds as an alternative. That's what I'm doing. I'd be buying the I Bonds as well as TIPS anyhow, but the 2050 rung of the LMP I've been building for a decade now (primarily buying TIPS at auction) was only partially filled back in February at the new issue auction when I bought some of the needed 2050 TIPS. But I don't want to buy the remaining 2050 TIPS I need at this week's auction for the same reasons Tipswatcher doesn't want to, but I will use I Bonds to cover the remainder of that rung. Hopefully real rates will be in positive territory again next year and I'll resume buying TIPS and continue to look at most of my I Bonds as just inflation-protected cash.
If the timing of cashing them in exactly 20 years worked for me, I think I'd even take EE bonds over TIPSl, despite not being inflation protected. The doubling in 20 years is about 3.5% nominal, making the break-even inflation rate vs. TIPS about 4%.
Yes, I agree. Actually, over the last 10 years now I've also been buying EE Bonds (in addition to 30-yr TIPS) to "cover" 20-yr rungs of my LMP. I use "quotes" b/c of course EE bonds do not match a future real liability like TIPS do, but the yield curve out 20 years has been favorable to me over most of the past decade and as of now, I consider myself lucky to have chosen this strategy (yes, it was always a gamble which I've monitored). Even with today's yield curve though, I think that buying EE Bonds still entails monitoring the yield curve over time until the remaining YTM of the aging EE Bond rises to a level that nominal treasuries are extremely unlikely to exceed. I think EE Bonds are always a gamble as far as liability matching goes, unlike TIPS.
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Re: TIPS vs TIPS ETF and speculation

Post by vineviz »

Angst wrote: Mon Aug 17, 2020 7:30 pm Yes, I agree. Actually, over the last 10 years now I've also been buying EE Bonds (in addition to 30-yr TIPS) to "cover" 20-yr rungs of my LMP. I use "quotes" b/c of course EE bonds do not match a future real liability like TIPS do, but the yield curve out 20 years has been favorable to me over most of the past decade and as of now, I consider myself lucky to have chosen this strategy (yes, it was always a gamble which I've monitored). Even with today's yield curve though, I think that buying EE Bonds still entails monitoring the yield curve over time until the remaining YTM of the aging EE Bond rises to a level that nominal treasuries are extremely unlikely to exceed. I think EE Bonds are always a gamble as far as liability matching goes, unlike TIPS.
The embedded 20-year “put” option that EE bonds offer is pretty compelling.

I think it’s also worth repeating that the goal of retirement income planning is NOT to create a hedge against inflation, per se, but to match income to future consumption.

For most retirees, consumption is NOT constant in real terms so including some nominal assets like likely reduces inflation risk as opposed to increasing it.
"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: TIPS vs TIPS ETF and speculation

Post by Robot Monster »

vineviz wrote: Mon Aug 17, 2020 8:28 pm
Angst wrote: Mon Aug 17, 2020 7:30 pm Yes, I agree. Actually, over the last 10 years now I've also been buying EE Bonds (in addition to 30-yr TIPS) to "cover" 20-yr rungs of my LMP. I use "quotes" b/c of course EE bonds do not match a future real liability like TIPS do, but the yield curve out 20 years has been favorable to me over most of the past decade and as of now, I consider myself lucky to have chosen this strategy (yes, it was always a gamble which I've monitored). Even with today's yield curve though, I think that buying EE Bonds still entails monitoring the yield curve over time until the remaining YTM of the aging EE Bond rises to a level that nominal treasuries are extremely unlikely to exceed. I think EE Bonds are always a gamble as far as liability matching goes, unlike TIPS.
The embedded 20-year “put” option that EE bonds offer is pretty compelling.

I think it’s also worth repeating that the goal of retirement income planning is NOT to create a hedge against inflation, per se, but to match income to future consumption.

For most retirees, consumption is NOT constant in real terms so including some nominal assets like likely reduces inflation risk as opposed to increasing it.
Unsure if I'm following this. If my consumption is $100K in today's dollars, if average inflation is 4% for the next 30 years, I might be spending $324K in 2050. I don't know what I'll need to spend in 2050, it's all tied to inflation, which is what TIPS itself is tied to, thus the allure of TIPS. Let me ask you a question in plain terms, though, vineviz, since you seem extremely knowledgeable in this arena. If someone has a portfolio consisting of what is below, would you recommend them buying a million in this 30yr TIPS auction or just keeping the money in the money market? Let's say the goal is to live off of roughly $100K per year in today's money.

$21 million cash, mostly Vanguard Treasury Money Market Fund (VUSXX)
$2 million Vanguard Inflation-Protected Securities Fund Admiral Shares (VAIPX)
$1 million Vanguard Intermediate-Term Treasury Index Fund Admiral Shares (VSIGX)
$2 million stocks

I have to say, this question is causing a lot of stress on my end of things due to the negative interest rate and the approximately $160K premium, and would very much appreciate your input.

EDit: Age 46 years old. A simple 'yes' or 'no' will suffice. Just a sanity check.
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vineviz
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Re: TIPS vs TIPS ETF and speculation

Post by vineviz »

Robot Monster wrote: Tue Aug 18, 2020 1:45 pm
Unsure if I'm following this. If my consumption is $100K in today's dollars, if average inflation is 4% for the next 30 years, I might be spending $324K in 2050. I don't know what I'll need to spend in 2050, it's all tied to inflation, which is what TIPS itself is tied to, thus the allure of TIPS.
I want to avoid getting bogged down in jargon if I can, but it's a subtle point that I may not be able to fully convey.

Even though the price of goods tends to go up with inflation (that's what it measures after all, at least in principle), the amount we consume doesn't necessarily go up in lockstep. One reason is substitution: if the cost of beef goes up by 80% I may simply substitute chicken or pork rather than pay more for the beef.

If I REALLY prefer beef to pork or chicken, I won't like this substitution much and should probably find a way to protect myself from having to make the substitution. If, on the other hand, I like port or chicken very nearly as much as other meats then I'm less sensitive to the inflation in the price of beef.

Consumers make these kinds of decisions all the time, and the evidence suggests that retirees do it too. Not everything is completely substitutable, of course, but you can imagine that each items you expect to buy in retirement can be plotted along spectrum from completely unsubstitutable at one end to easily substitutable at the other end.

Things like food, clothing, shelter, taxes, etc. might be near the "unsubstitutable" end while things like "going out to the movies" or "buying new books in hardcover on their release date" might be near the " easily substitutable" end. If movie theaters or book publishers jack up their prices a lot, you might be perfectly happy to just rent the movie later on iTunes or wait for the paperback edition.

For this and other age-related reasons, people just generally tend to consume less as they get further into retirement. Their spending grows at LESS than the rate of inflation BUT their Social Security income grows at EXACTLY the rate of inflation. As a result, their portfolio income (what they take from their wealth portfolio) tends to take on shape that looks something like this:

Image

The shape and slope will be different for everyone, but it's rarely a straight upward sloping line. The particular example I showed is barely upward sloping at all, suggesting that it may not be necessary (or optimal) to allocate the whole bond portfolio to TIPS.
Robot Monster wrote: Tue Aug 18, 2020 1:45 pm Let me ask you a question in plain terms, though, vineviz, since you seem extremely knowledgeable in this arena. If someone has a portfolio consisting of what is below, would you recommend them buying a million in this 30yr TIPS auction or just keeping the money in the money market? Let's say the goal is to live off of roughly $100K per year in today's money.

$21 million cash, mostly Vanguard Treasury Money Market Fund (VUSXX)
$2 million Vanguard Inflation-Protected Securities Fund Admiral Shares (VAIPX)
$1 million Vanguard Intermediate-Term Treasury Index Fund Admiral Shares (VSIGX)
$2 million stocks
Okay, that's a challenging example that definitely deserves a much more comprehensive answer than I can provide here. But I'll take a stab at telling you what I'd do If I had a windfall (i.e. someone just handed me that portfolio).

Let's assume the age of this investor is mid- to late-40s, and we can therefore imagine a roughly 50-year investment horizon. The big and important question is whether the investor has Social Security and/or other income sources besides just the portfolio. If "yes" my answer might change, but for now let's assume "no".

I'd buy $750k of the 30-year TIPS at this auction, and spend another $750k in the next few weeks to construct a ladder of additional TIPS in the secondary market covering years 5 through 29 (I think you'll see why in a minute).

The remaining portofolio I'd split as follows:

$6 million in Vanguard Inflation-Protected Securities Fund Admiral Shares (VAIPX)
$6 million in Vanguard Long-Term Bond ETF (BLV)
$7 million in Vanguard U.S. Multifactor Fund Admiral Shares (VFMFX)
$5 million in Vanguard Total International Stock Index Fund Admiral Shares (VTIAX)
$500k in Vanguard Treasury Money Market Fund (VUSXX)

For the first five years I'd withdraw the $100k for spending PLUS another $400k (or thereabouts) for use in adding to the TIPS ladder (including buying a new 30-year TIPS). By year 5 I'd have a pretty solid income floor constructed, but taking it slow in constructing the portfolio would allow me some flexibility in making sure I was comfortable with the path I was on.
"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: TIPS vs TIPS ETF and speculation

Post by Robot Monster »

vineviz wrote: Tue Aug 18, 2020 3:57 pm
Robot Monster wrote: Tue Aug 18, 2020 1:45 pm
Unsure if I'm following this. If my consumption is $100K in today's dollars, if average inflation is 4% for the next 30 years, I might be spending $324K in 2050. I don't know what I'll need to spend in 2050, it's all tied to inflation, which is what TIPS itself is tied to, thus the allure of TIPS.
I want to avoid getting bogged down in jargon if I can, but it's a subtle point that I may not be able to fully convey.

Even though the price of goods tends to go up with inflation (that's what it measures after all, at least in principle), the amount we consume doesn't necessarily go up in lockstep. One reason is substitution: if the cost of beef goes up by 80% I may simply substitute chicken or pork rather than pay more for the beef.

If I REALLY prefer beef to pork or chicken, I won't like this substitution much and should probably find a way to protect myself from having to make the substitution. If, on the other hand, I like port or chicken very nearly as much as other meats then I'm less sensitive to the inflation in the price of beef.

Consumers make these kinds of decisions all the time, and the evidence suggests that retirees do it too. Not everything is completely substitutable, of course, but you can imagine that each items you expect to buy in retirement can be plotted along spectrum from completely unsubstitutable at one end to easily substitutable at the other end.

Things like food, clothing, shelter, taxes, etc. might be near the "unsubstitutable" end while things like "going out to the movies" or "buying new books in hardcover on their release date" might be near the " easily substitutable" end. If movie theaters or book publishers jack up their prices a lot, you might be perfectly happy to just rent the movie later on iTunes or wait for the paperback edition.

For this and other age-related reasons, people just generally tend to consume less as they get further into retirement. Their spending grows at LESS than the rate of inflation BUT their Social Security income grows at EXACTLY the rate of inflation. As a result, their portfolio income (what they take from their wealth portfolio) tends to take on shape that looks something like this:

Image

The shape and slope will be different for everyone, but it's rarely a straight upward sloping line. The particular example I showed is barely upward sloping at all, suggesting that it may not be necessary (or optimal) to allocate the whole bond portfolio to TIPS.
Robot Monster wrote: Tue Aug 18, 2020 1:45 pm Let me ask you a question in plain terms, though, vineviz, since you seem extremely knowledgeable in this arena. If someone has a portfolio consisting of what is below, would you recommend them buying a million in this 30yr TIPS auction or just keeping the money in the money market? Let's say the goal is to live off of roughly $100K per year in today's money.

$21 million cash, mostly Vanguard Treasury Money Market Fund (VUSXX)
$2 million Vanguard Inflation-Protected Securities Fund Admiral Shares (VAIPX)
$1 million Vanguard Intermediate-Term Treasury Index Fund Admiral Shares (VSIGX)
$2 million stocks
Okay, that's a challenging example that definitely deserves a much more comprehensive answer than I can provide here. But I'll take a stab at telling you what I'd do If I had a windfall (i.e. someone just handed me that portfolio).

Let's assume the age of this investor is mid- to late-40s, and we can therefore imagine a roughly 50-year investment horizon. The big and important question is whether the investor has Social Security and/or other income sources besides just the portfolio. If "yes" my answer might change, but for now let's assume "no".

I'd buy $750k of the 30-year TIPS at this auction, and spend another $750k in the next few weeks to construct a ladder of additional TIPS in the secondary market covering years 5 through 29 (I think you'll see why in a minute).

The remaining portofolio I'd split as follows:

$6 million in Vanguard Inflation-Protected Securities Fund Admiral Shares (VAIPX)
$6 million in Vanguard Long-Term Bond ETF (BLV)
$7 million in Vanguard U.S. Multifactor Fund Admiral Shares (VFMFX)
$5 million in Vanguard Total International Stock Index Fund Admiral Shares (VTIAX)
$500k in Vanguard Treasury Money Market Fund (VUSXX)

For the first five years I'd withdraw the $100k for spending PLUS another $400k (or thereabouts) for use in adding to the TIPS ladder (including buying a new 30-year TIPS). By year 5 I'd have a pretty solid income floor constructed, but taking it slow in constructing the portfolio would allow me some flexibility in making sure I was comfortable with the path I was on.
Thank you for that very in-depth response! Especially thank you for the double-confirmation go-ahead on buying the 30yr TIPS. This 30yr TIPS auction, with the nosebleed premium, is a psychological hurtle you have greatly helped me get through.

I'll have to think more about how costs vary with age. The 100K expenses is a ballpark figure that overshoots needs a bit, I think.

The issue of unsubstitutable costs, that aren't captured by PCE, such as medical insurance annual increases, has figured somewhat into my analysis of how well cash will do, in that I simply add buffer to what the official inflation rate will be.

***

Let's consider a cash heavy +TIPS portfolio.

I have developed pessimistic scenarios, and tested them against such a portfolio of cash with an eye on TIPS as a hedge. To give an example,

Scenario 1 - TIPS outperform
A cash portfolio of 24 million, yielding nothing, with $100K annual expenses adjusted by 4% inflation will last 60 years to age 106. In this scenario if the Fed does increase its 2% target to 4%, and yet keeps rates at zero.

Scenario 2 - Cash outperforms
Alternatively, another scenario. The Fed keeps the 2% target. Inflation bubbles up to 4%. Fed raises the rate to 5%.

Scenario 3 - TIPS outperform
The Fed takes rates negative. Inflation bubbles up just below Fed target at 1.9%. Fed keeps rates at zero.

Seems that the core risk of an all cash portfolio is the disparity between rates (whether they be negative or not) and inflation (with the caveat being rising costs not captured by official inflation numbers). TIPS flourish when there is such a disparity.

Please correct me if I misconstrued any of this above. But seems TIPS and cash compliment each other very well.

I realize there might be good reasons to diversify further into the various asset classes you mention, but I'm trying to keep volatility at a minimum. Is it possible to slide by on a TIPS/cash only portfolio? What are scenarios where the other asset classes are needed?

Thank you again for all your help!
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vineviz
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Re: TIPS vs TIPS ETF and speculation

Post by vineviz »

Robot Monster wrote: Wed Aug 19, 2020 10:24 am I realize there might be good reasons to diversify further into the various asset classes you mention, but I'm trying to keep volatility at a minimum. Is it possible to slide by on a TIPS/cash only portfolio? What are scenarios where the other asset classes are needed?
For any reasonable length of retirement (say, 30 years or more) it's hard to imagine a scenario in which only assets with zero or negative real rates of return would support an inflation-adjusted income greater than 2% of the starting portfolio value. On $26 million, that'd be $54k/year.

Allocating at least 1/3 of the portfolio to stocks would roughly double the income the portfolio will support. If a long retirement, such as the example I used, is close to accurate then high portfolio volatility doesn't present the biggest risk to your future income: low expected returns and underdiversification do.
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Re: TIPS vs TIPS ETF and speculation

Post by abuss368 »

1.80% of any holding will not move the needle up or down. I would consider simplifying. Any short or intermediate term investment grade bond fund will provide safety and income to a portfolio.
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