REITS (VGSLX) revisited again as inflation hedge in IRA

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JSnyder
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REITS (VGSLX) revisited again as inflation hedge in IRA

Post by JSnyder »

I am considering moving 10-20% of my bond allocation into Vanguard Real Estate Index Fund Admiral Shares (VGSLX) as an inflation hedge.

I am more afraid of inflation then I am a market decline. I am seeing inflation everywhere and I disagree with the Fed's assessment that it is temporary. I think there is a stickiness to wage growth and price increases. I don't think it will just turn off when the Fed increases interest rates, slows down on quantitative easing or people go back to work post-Covid.

Instead the conspiracy theorist in me sees inflation as a solution to the Fed's deficit problem. If you can pay past fixed rate debts with tomorrows inflated dollars then you can effectively decrease the budget deficit and the US debt.

But what should I do about inflation in my investment portfolio. I don't see the solution in money market or bonds. Especially while quantitative easing is going on. I have 0 interest in cybercurrencies. Historically commodities do well during inflationary times but I do not see a shortage in raw materials. Instead see shortages in labor, shipping, and computer chips. Also in the past consumer staples seemed to keep up with in inflation. But I see erosion in the ability for the large consumer product companies (Heinz, Proctor and Gamble, Kellogg) to command premium pricing. I see consumers increasing willing to consider substitutes, a diverse marketplace of products and consumers, and pricing power by large retail and grocery chains.

I could go on with what I don't like but the topic at hand is what I am thinking about: REITS. Specifically Vanguard Real Estate Index Fund Admiral Shares (VGSLX) because I have most of my assets at Vanguard.

I am thinking about initially moving 10% of my bonds into VGSLX with a possible future max of 20%. My allocation is about 80% stocks, 20% bonds. I would make these changes in my tax deferred IRA account.

Can you think of anything I am missing or have not considered?

Thank you in advance for your advice.
bikechuck
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Re: REITS (VGSLX) revisited again as inflation hedge in IRA

Post by bikechuck »

REITS are more equities than bonds. You already own them if you own a total U.S. market equity fund. If you want to tilt to them I would keep your 20% in bonds and sell some of your total market equities to buy extra REITS.
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dziuniek
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Re: REITS (VGSLX) revisited again as inflation hedge in IRA

Post by dziuniek »

I also would replace the stock piece of the portfolio if you're going to tilt into REITS.

For the bond side, you could replace some total bond / treasuries with TIPS if you want.
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nedsaid
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Re: REITS (VGSLX) revisited again as inflation hedge in IRA

Post by nedsaid »

A better move might to move 10% -20% of your bond allocation to TIPS. I would say that TIPS are expensive here but they still provide better protection against unexpected inflation than nominal Treasuries.
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Re: REITS (VGSLX) revisited again as inflation hedge in IRA

Post by Trader Joe »

JSnyder wrote: Sun Sep 12, 2021 8:38 pm I am considering moving 10-20% of my bond allocation into Vanguard Real Estate Index Fund Admiral Shares (VGSLX) as an inflation hedge.

I am more afraid of inflation then I am a market decline. I am seeing inflation everywhere and I disagree with the Fed's assessment that it is temporary. I think there is a stickiness to wage growth and price increases. I don't think it will just turn off when the Fed increases interest rates, slows down on quantitative easing or people go back to work post-Covid.

Instead the conspiracy theorist in me sees inflation as a solution to the Fed's deficit problem. If you can pay past fixed rate debts with tomorrows inflated dollars then you can effectively decrease the budget deficit and the US debt.

But what should I do about inflation in my investment portfolio. I don't see the solution in money market or bonds. Especially while quantitative easing is going on. I have 0 interest in cybercurrencies. Historically commodities do well during inflationary times but I do not see a shortage in raw materials. Instead see shortages in labor, shipping, and computer chips. Also in the past consumer staples seemed to keep up with in inflation. But I see erosion in the ability for the large consumer product companies (Heinz, Proctor and Gamble, Kellogg) to command premium pricing. I see consumers increasing willing to consider substitutes, a diverse marketplace of products and consumers, and pricing power by large retail and grocery chains.

I could go on with what I don't like but the topic at hand is what I am thinking about: REITS. Specifically Vanguard Real Estate Index Fund Admiral Shares (VGSLX) because I have most of my assets at Vanguard.

I am thinking about initially moving 10% of my bonds into VGSLX with a possible future max of 20%. My allocation is about 80% stocks, 20% bonds. I would make these changes in my tax deferred IRA account.

Can you think of anything I am missing or have not considered?

Thank you in advance for your advice.
Let us know how this works out for you.
Northern Flicker
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Re: REITS (VGSLX) revisited again as inflation hedge in IRA

Post by Northern Flicker »

The Fed doesn't have to be right for you to be wrong. Inflation may indeed not prove to be as temporary as the Fed projects. But with lots of assets on the balance sheet that can be sold, and rates near zero, the Fed more or less has unprecedented headroom to make accelerated inflation temporary if it persists.

What would be the effect of selling off treasuries from the balance sheet and destroying the cash raised, and raising the Fed rate to 4%?
My postings are my opinion, and never should be construed as a recommendation to buy, sell, or hold any particular investment.
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JSnyder
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Re: REITS (VGSLX) revisited again as inflation hedge in IRA

Post by JSnyder »

Northern Flicker wrote: Sun Sep 12, 2021 10:25 pm The Fed doesn't have to be right for you to be wrong. Inflation may indeed not prove to be as temporary as the Fed projects. But with lots of assets on the balance sheet that can be sold, and rates near zero, the Fed more or less has unprecedented headroom to make accelerated inflation temporary if it persists.

What would be the effect of selling off treasuries from the balance sheet and destroying the cash raised, and raising the Fed rate to 4%?
If the Fed rapidly sells off short term treasuries I suspect that the underlying value of those treasuries to go down as investors are unwilling or unable to absorb the treasuries without demanding a higher interest rate. If the Fed raises interest rates I suspect similarly the underlying value of these short term treasuries will decrease.

I suspect the stock market would go down as money market and bonds become more attractive. I also suspect that fewer companies and individuals would borrow money because of the increased rates slowing down the housing market and company investment spending. I also suspect if done to rapidly that companies and banks would slow activity and raise cash due to uncertain business conditions.

As an investor I expect my Vanguard Total Bond Market would go down in the short term because the underlying assets are paying an interest rate lower than the market rate. As indicated earlier I expect my Total Stock Market would also go down as equities become less attractive and increase business risk slows economic activity.

But if I own a REIT which owns a cell phone tower at a fixed rate of 2.5% with inflation at 4% then my underlying REIT asset should appreciate in value.
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Re: REITS (VGSLX) revisited again as inflation hedge in IRA

Post by JBTX »

REITS did well in the last inflation scare, I think. They may again.

Here are some issues to consider:

REITS yields are around 2.0-2.5%. I can remember when they were at least 3 times that much. If inflation and yields go up, that usually implies price going down or flattening.

REITS include retail space (malls and strip malls) and office space, both of which may experience future challenge as we move away from brick and mortar and trend towards more work at home. There is also residential, but you have to wonder how much more appreciation is there. Any increase in rates could slow down home buying activity.

REITS are not substitutes for bonds. REITS did worse that the total market stock index in 2008 downturn.

There may be a place for REITS in your portfolio but understand they have their own specific risks and they aren't a pure inflation hedge.
typical.investor
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Re: REITS (VGSLX) revisited again as inflation hedge in IRA

Post by typical.investor »

JSnyder wrote: Sun Sep 12, 2021 8:38 pm I am more afraid of inflation then I am a market decline. I am seeing inflation everywhere and I disagree with the Fed's assessment that it is temporary. I think there is a stickiness to wage growth and price increases. I don't think it will just turn off when the Fed increases interest rates, slows down on quantitative easing or people go back to work post-Covid.
OK, rate hikes seemed to work for Volker late '70s early '80s, but ok let's assume it doesn't work.
JSnyder wrote: Sun Sep 12, 2021 8:38 pm Instead the conspiracy theorist in me sees inflation as a solution to the Fed's deficit problem. If you can pay past fixed rate debts with tomorrows inflated dollars then you can effectively decrease the budget deficit and the US debt.
OK, let's not call it a conspiracy but yeah sure the perhaps the US could choose that path.
JSnyder wrote: Sun Sep 12, 2021 8:38 pm But what should I do about inflation in my investment portfolio.
Well, good question then.
JSnyder wrote: Sun Sep 12, 2021 8:38 pm I could go on with what I don't like but the topic at hand is what I am thinking about: REITS. Specifically Vanguard Real Estate Index Fund Admiral Shares (VGSLX) because I have most of my assets at Vanguard.

In a prolonged covid scenerio, I am not sure REITs are going to be the best against supply shortage inflation. But yeah, if inflation hits perhaps they will help.

In any case, if the US does go down the higher inflation by choice (or inability to raise rates sufficiently to combat it) path, they I would expect a decline in the value of the USD. As such, it would seem that international equities would be a good choice.
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Re: REITS (VGSLX) revisited again as inflation hedge in IRA

Post by Valuethinker »

JSnyder wrote: Sun Sep 12, 2021 8:38 pm I am considering moving 10-20% of my bond allocation into Vanguard Real Estate Index Fund Admiral Shares (VGSLX) as an inflation hedge.

I am more afraid of inflation then I am a market decline. I am seeing inflation everywhere and I disagree with the Fed's assessment that it is temporary. I think there is a stickiness to wage growth and price increases. I don't think it will just turn off when the Fed increases interest rates, slows down on quantitative easing or people go back to work post-Covid.

Instead the conspiracy theorist in me sees inflation as a solution to the Fed's deficit problem. If you can pay past fixed rate debts with tomorrows inflated dollars then you can effectively decrease the budget deficit and the US debt.
You mean the US Treasury? The Fed does not have "a deficit problem". It's a Central Bank-- its' concerns, legally mandated by the US Congress, are with regard to inflation and to a sound economy (usually taken to be rising GDP & employment). The distinction is quite important - both in terms of the purpose and the mindset of the 2 organisations & how the market views them.

To date, markets have not shown a worry about timely payment of coupons and repayment of principal of US govt debt.

The argument is about the inflation-fighting credentials of the Fed. Those are historically pretty good. The current Chairman was appointed by the previous president, a businessman who was not opposed to inflation but was opposed to anything bad for the stock market index. Let's leave it at that.
But what should I do about inflation in my investment portfolio. I don't see the solution in money market or bonds. Especially while quantitative easing is going on. I have 0 interest in cybercurrencies. Historically commodities do well during inflationary times but I do not see a shortage in raw materials. Instead see shortages in labor, shipping, and computer chips. Also in the past consumer staples seemed to keep up with in inflation. But I see erosion in the ability for the large consumer product companies (Heinz, Proctor and Gamble, Kellogg) to command premium pricing. I see consumers increasing willing to consider substitutes, a diverse marketplace of products and consumers, and pricing power by large retail and grocery chains.
That's about the size of it. Everybody is getting squeezed & its hard to find winners. To date, the big digital stocks (FB etc) have been big winners.
I could go on with what I don't like but the topic at hand is what I am thinking about: REITS. Specifically Vanguard Real Estate Index Fund Admiral Shares (VGSLX) because I have most of my assets at Vanguard.

I am thinking about initially moving 10% of my bonds into VGSLX with a possible future max of 20%. My allocation is about 80% stocks, 20% bonds. I would make these changes in my tax deferred IRA account.

Can you think of anything I am missing or have not considered?

Thank you in advance for your advice.
We saw with Covid-19 the risks of commercial RE. Now very few of the big stocks in that fund are in fact city center office properties (the worst hit). There's healthcare. There's cellphone towers. There's distribution & logistics centers - a huge growth market.

In theory, rents grow with inflation in the long run. I am not sure what the empirical evidence for that is or is not.

If you want to protect against US inflation, then TIPS are far and away the best designed instrument for that purpose.
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Re: REITS (VGSLX) revisited again as inflation hedge in IRA

Post by UpperNwGuy »

JSnyder wrote: Sun Sep 12, 2021 8:38 pm I am more afraid of inflation then I am a market decline.
Why? Will inflation really impact you more severely than a market decline?
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JSnyder
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Re: REITS (VGSLX) revisited again as inflation hedge in IRA

Post by JSnyder »

JBTX wrote: Mon Sep 13, 2021 12:16 am REITS did well in the last inflation scare, I think. They may again.

Here are some issues to consider:

REITS yields are around 2.0-2.5%. I can remember when they were at least 3 times that much. If inflation and yields go up, that usually implies price going down or flattening.

REITS include retail space (malls and strip malls) and office space, both of which may experience future challenge as we move away from brick and mortar and trend towards more work at home. There is also residential, but you have to wonder how much more appreciation is there. Any increase in rates could slow down home buying activity.

REITS are not substitutes for bonds. REITS did worse that the total market stock index in 2008 downturn.

There may be a place for REITS in your portfolio but understand they have their own specific risks and they aren't a pure inflation hedge.
Thank you for the insightful post
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JSnyder
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Re: REITS (VGSLX) revisited again as inflation hedge in IRA

Post by JSnyder »

UpperNwGuy wrote: Mon Sep 13, 2021 6:40 am
JSnyder wrote: Sun Sep 12, 2021 8:38 pm I am more afraid of inflation then I am a market decline.
Why? Will inflation really impact you more severely than a market decline?
I have priced into my portfolio expectations and rate of return a 15% drop in the stock market. Since I expect it, I can protect against it. Can I predict or calculate 100%. No. But I can somewhat. For example strategy is to sell bonds to raise cash as necessary during the next market downturn. It is one of the reasons I own bonds.

Inflation IMO is more sneaky and often misunderstood. It is not what you make or your rate or return. IT IS YOUR RATE OF RETURN AFTER INFLATION.

If someone was close to retirement with a 80% bond, 20% stock portfolio and expected to live off that portfolio for 30 years they may not have enough. The reason is bonds are not keeping up with inflation so their being power is eroding every year.

One one hand it is great that retail jobs pay $15 an hour. On the other hand if inflation raises the cost of living to that some amount then the buying power of $15 may be the same as $11. The result is real increase in compensation.

So inflation can be very bad for the saver and retiree and the medicine for inflation (increasing interest rates) can be bad for stock portfolios. So yes I am afraid of inflation.
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JSnyder
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Re: REITS (VGSLX) revisited again as inflation hedge in IRA

Post by JSnyder »

typical.investor wrote: Mon Sep 13, 2021 3:40 am In any case, if the US does go down the higher inflation by choice (or inability to raise rates sufficiently to combat it) path, they I would expect a decline in the value of the USD. As such, it would seem that international equities would be a good choice.
I agree with this suggestion but I would like to point out that when you buy international equities you are buying future rates of return of those equities but also future currency exchange rates. Some of which are dependent on sound government policies of the underlying governments of those foreign equities (and the US).

For example the rate of return of the equities could be great but if the USD strengthens against that foreign currency then your USD rate of return could be flat.

My understanding is currency hedges are used to mute some of these effects but here again, you are buying into the investment advisors ability to use currency hedges.

For these reasons, I currently do not own Vanguard International. But I would agree that international stocks could be a hedge against high US inflation.
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Re: REITS (VGSLX) revisited again as inflation hedge in IRA

Post by typical.investor »

JSnyder wrote: Mon Sep 13, 2021 7:56 am
typical.investor wrote: Mon Sep 13, 2021 3:40 am In any case, if the US does go down the higher inflation by choice (or inability to raise rates sufficiently to combat it) path, they I would expect a decline in the value of the USD. As such, it would seem that international equities would be a good choice.
I agree with this suggestion but I would like to point out that when you buy international equities you are buying future rates of return of those equities but also future currency exchange rates. Some of which are dependent on sound government policies of the underlying governments of those foreign equities (and the US).

For example the rate of return of the equities could be great but if the USD strengthens against that foreign currency then your USD rate of return could be flat.

My understanding is currency hedges are used to mute some of these effects but here again, you are buying into the investment advisors ability to use currency hedges.

For these reasons, I currently do not own Vanguard International. But I would agree that international stocks could be a hedge against high US inflation.
Well, in the case you mention of the US inflating away it’s debt, isn’t it extremely unlikely that the USD appreciates?

I’d rather expect the USD to weaken and see no need for currency hedging if the worry is high US inflation.
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JSnyder
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Re: REITS (VGSLX) revisited again as inflation hedge in IRA

Post by JSnyder »

typical.investor wrote: Mon Sep 13, 2021 8:14 am Well, in the case you mention of the US inflating away it’s debt, isn’t it extremely unlikely that the USD appreciates?

I’d rather expect the USD to weaken and see no need for currency hedging if the worry is high US inflation.
Agree. International stock exposure would be useful in an environment of weakening USD caused by US printing money to pay for US debit.
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Re: REITS (VGSLX) revisited again as inflation hedge in IRA

Post by leo383 »

to a certain extent, the whole thing is based on paying today's debts with tomorrow's money that is worth a little less
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JSnyder
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Re: REITS (VGSLX) revisited again as inflation hedge in IRA

Post by JSnyder »

I have decided against buying VGSLX. The reason is it is an index and it owns troubled sectors (Malls, Hotels, Commercial Real Estates).

Instead of VGSLX I would suggest investing in an actively managed REIT fund. But that is not for me as I am a fairly passive investor.

I like the suggestions on TIPS. I just wish I could make more than inflation. TIPS may be a good defense position to be in but I don't see growing your portfolio for retirement on TIPS.

I do like the idea of international exposure as a hedge against weakening USD. I just don't see that happening in the current environment.

For right now I am going to stay the course and do.. nothing new. I will continue our 401K investments into the S&P 500 and Total Bond Indexes.
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dziuniek
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Re: REITS (VGSLX) revisited again as inflation hedge in IRA

Post by dziuniek »

You could also buy financials for inflation protection, maybe.
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Northern Flicker
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Re: REITS (VGSLX) revisited again as inflation hedge in IRA

Post by Northern Flicker »

JSnyder wrote: If the Fed rapidly sells off short term treasuries I suspect that the underlying value of those treasuries to go down as investors are unwilling or unable to absorb the treasuries without demanding a higher interest rate. If the Fed raises interest rates I suspect similarly the underlying value of these short term treasuries will decrease.
The point is that at some point those rising rates will choke off inflation alleviating the need to raise rates further, and falling inflation had downward pressure on bond rates.

And rising rates increases the discount rate used to discount future cash flows back to a present value. That is how bonds are priced when rates rise, causing their price to fall, but it would apply to REITs (or any other stock) as well. There is no guarantee that a REIT will do well with inflation. They have in the past in fact been more sensitive to interest rates than the broad stock market.
Last edited by Northern Flicker on Mon Sep 13, 2021 11:28 pm, edited 1 time in total.
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SpreadsheetsAreFun
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Re: REITS (VGSLX) revisited again as inflation hedge in IRA

Post by SpreadsheetsAreFun »

I think your decision to not change your asset allocation as originally proposed is the right decision. That said, I have some figures that I prepared when analyzing the diversification impact of REITs on one's portfolio. Those might be helpful in case you want to revisit this question at a later point.

The below figures compare the historical data of two US REIT indices with the performance of US Small Caps during the same period. The performance of All Equity REITs is closely matched to that of US Small Caps. The Composite REIT index trails their performance both in return and risk characteristics. You may want to keep that in mind when deciding about the specific type of REIT ETF in case you plan such an investment.
Image
Basically, there are only three periods when the performance between All Equity REITs and US Small Caps deviated significantly: (1) There was a 3 year period during the 1970s stagflation when All Equity REITs had a smaller drawdown. That said, the losses were close to those of US Large Caps. (2) During the Dot-Com period. They performed worse during the boom and better during the bust compared to US Small Caps. (3) During the real estate bubble and during the Great Financial Crisis. This time they outperformed during the boom and performed worse during the bust. Other than that, their performance practically matched.
Image
In consequence, to me, your original proposal was to replace 1/2 of your safe assets with ones that resemble US Small Cap equities, with short-term volatility characteristics that even exceed those of the cap-weighted total stock market. This would have significantly shifted your portfolio risk-return characteristics which, I assume, would likely be contrary to your ISP.
Have a great day. Asset allocation: 18% MTUM, 18% SMLF, 12% IMTM, 12% ISCF, 12% EMGF, 14% GOVT, 14% GLDM
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Re: REITS (VGSLX) revisited again as inflation hedge in IRA

Post by secondopinion »

JSnyder wrote: Sun Sep 12, 2021 8:38 pm I am considering moving 10-20% of my bond allocation into Vanguard Real Estate Index Fund Admiral Shares (VGSLX) as an inflation hedge.

I am more afraid of inflation then I am a market decline. I am seeing inflation everywhere and I disagree with the Fed's assessment that it is temporary. I think there is a stickiness to wage growth and price increases. I don't think it will just turn off when the Fed increases interest rates, slows down on quantitative easing or people go back to work post-Covid.

Instead the conspiracy theorist in me sees inflation as a solution to the Fed's deficit problem. If you can pay past fixed rate debts with tomorrows inflated dollars then you can effectively decrease the budget deficit and the US debt.

But what should I do about inflation in my investment portfolio. I don't see the solution in money market or bonds. Especially while quantitative easing is going on. I have 0 interest in cybercurrencies. Historically commodities do well during inflationary times but I do not see a shortage in raw materials. Instead see shortages in labor, shipping, and computer chips. Also in the past consumer staples seemed to keep up with in inflation. But I see erosion in the ability for the large consumer product companies (Heinz, Proctor and Gamble, Kellogg) to command premium pricing. I see consumers increasing willing to consider substitutes, a diverse marketplace of products and consumers, and pricing power by large retail and grocery chains.

I could go on with what I don't like but the topic at hand is what I am thinking about: REITS. Specifically Vanguard Real Estate Index Fund Admiral Shares (VGSLX) because I have most of my assets at Vanguard.

I am thinking about initially moving 10% of my bonds into VGSLX with a possible future max of 20%. My allocation is about 80% stocks, 20% bonds. I would make these changes in my tax deferred IRA account.

Can you think of anything I am missing or have not considered?

Thank you in advance for your advice.
You already have a lot of stocks; adding REITs instead of bonds is just asking for more risk. Go with TIPS and short duration bonds. Because interest rates often follow inflation, short duration bonds do actually okay in most cases.
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Re: REITS (VGSLX) revisited again as inflation hedge in IRA

Post by fisher0815 »

JSnyder wrote: Mon Sep 13, 2021 7:45 am The reason is bonds are not keeping up with inflation so their being power is eroding every year.
Historical bonds provided a good protection against inflation. Check out this article:
https://portfoliocharts.com/2017/05/12/ ... -investor/
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arcticpineapplecorp.
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Re: REITS (VGSLX) revisited again as inflation hedge in IRA

Post by arcticpineapplecorp. »

JSnyder wrote: Sun Sep 12, 2021 8:38 pm I am more afraid of inflation then I am a market decline.

Can you think of anything I am missing or have not considered?
if it's only a small part of your portfolio (10%) it might not be a major mistake if things don't go according to plan. 20% is a little more significant of a tilt, however.

if inflation is 5% then your cash is losing 5% of it's purchasing power.

but if we have a market decline, REITS could go down with the market.

So look at the last two significant declines (2020 and 2008) and compare bonds to REITS:

2008:
https://www.portfoliovisualizer.com/bac ... ion2_2=100

took you 4 years to recover from your losses.

And your losses were -61.94% drawdown, worst year -37.05% for REIT index fund.

Bond's max drawdown was -3.99% and worst year was +4.05%.

ask yourself if that drawdown...if that worst year...if 4 years to recover from losses was somehow worse than losing 5% of the money in cash?

you can run the same experiment with last year's decline...since you say you're more afraid of inflation than a market decline:

https://www.portfoliovisualizer.com/bac ... ion2_2=100

you wouldn't have recovered until March of this year with REITS. So how patient are you? Would you be ok with having lost 25% on your REITS last year and had to wait a year to break even? Was that worse than 5% inflation?

only you can answer these questions, but I think people often think they can handle downturns better than they really can.

sure it's only those losses above on 10% or 20% of your portfolio, not the whole portfolio, but if you're stock heavy already, you will have no where to hide in the next down turn (possibly). Bonds help you there. Just look at the bond performance on the charts for yourself.
It's hard to accept the truth when the lies were exactly what you wanted to hear. Investing is simple, but not easy. Buy, hold & rebalance low cost index funds & manage taxable events.
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arcticpineapplecorp.
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Re: REITS (VGSLX) revisited again as inflation hedge in IRA

Post by arcticpineapplecorp. »

one other thought. you should develop a plan to meet your goals and accept the risk you have the need, ability and willingness to take. What you're doing is shifting your plan based on short term events and market forces/changes. If you wish to change based on external events, you'll be changing your portfolio all the time. So get a plan

The final thing to consider: is it possible your porfolio overall will be fine against inflation so why are you changing parts of your portfolio, when the whole portfolio might do just fine?

This reminds me of all the older folks who stretch for yield, selling safe low yielding bonds for dividend stocks or high yield bonds, etc. When if they looked over their total return they'd see respectable above inflation returns (because stocks got you there). So what was the need for change? There wasn't one. But that didn't stop lots of people from looking at parts of their portfolio in isolation rather than the portfolio's performance as a whole. Think about it.
It's hard to accept the truth when the lies were exactly what you wanted to hear. Investing is simple, but not easy. Buy, hold & rebalance low cost index funds & manage taxable events.
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Re: REITS (VGSLX) revisited again as inflation hedge in IRA

Post by asif408 »

If your biggest fear is inflation, you should read Bill Bernstein's Deep Risk book. He takes a deep dive into inflation risk, and his conclusion is there are several ways to deal with high expected inflation:

1) International equity exposure
2) Tilt to value stocks
3) Tilt to stocks of commodity producers (and importantly not commodity futures funds, with the issue of contango)
4) TIPS and I-bonds
5) Fixed rate mortgage

In your case, I would encourage you to increase you exposure to international value stocks in developed and emerging markets, add more exposure to the stocks of commodity producers (which you can do indirectly right now by tilting to international value stocks or by buying sector funds in commodity producers like oil and metals) and sprinkle in some TIPS and I-bonds. The nice thing about TIPS and I-bonds is that they protect again both inflation and deflation (in the case of TIPS, as long as they are held to maturity, and with I-bonds, the yield can never go below 0).

One last note: REITs may do ok during the next inflation spell, and have worked during some periods of high inflation, but always look at the valuation of an asset before investing. Historically, assets that are highly valued at the beginning of an inflationary period have almost universally not done so well going forward, no matter their historical performance or reputation. With that said, right now, international value equities are not highly valued based on a number of valuation metrics; with US REITs that is not the case, with their dividend yields under 3%. If we do see inflation in the near future, I would expect international value stocks and/or the stocks of commodity producers will be a better inflation hedge than REITs simply based on current valuations.
NiceUnparticularMan
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Joined: Sat Mar 11, 2017 7:51 am

Re: REITS (VGSLX) revisited again as inflation hedge in IRA

Post by NiceUnparticularMan »

My two cents is you need to carefully distinguish between expected inflation and unexpected inflation, and then between assets that protect themselves from unexpected inflation and assets which might respond strongly enough to offset other parts of your portfolio which are responding poorly.

With respect to the first distinction, if you are PREDICTING higher inflation is coming, why are not the markets doing the same thing, and already pricing marketed securities accordingly? I for one am never comfortable with the thought I know better.

But unexpected inflation does happen. It is just important to me to understand it is not the same as predictable inflation.

With respect to the second distinction, there is a long list of common assets that surely will, or at least likely will, protect themselves from unexpected USD inflation. Social Security and TIPS will. A fixed-rate mortgage, to the extent you think of it in these terms, will. Ex-U.S. stocks and value-tilted stocks at least likely will (relatively speaking, of course--they could be down but might be down less relative to U.S. neutral-to-growth stocks). Diversified direct real estate or REITs likely will (at least in the longer term, and again in relative terms).

But none of those are likely to do much more than that, meaning they are not likely to respond positively enough to unexpected inflation to offset other parts of your portfolio (I note neutral-to-growth U.S. stocks MIGHT, but they might also go the other way, and historically the odds are more against than for).

With that background in mind, I think you have some choices.

You can just be neutral to the possibility of unexpected inflation (high or low), which means you can just do a fairly normal mix of U.S. and ex-U.S. stocks, roughly half and half nominal bonds and TIPs, and there you go.

Note if USD inflation is unexpectedly low for some period, you will then likely "underperform" someone who is weighted mostly to nominal U.S. bonds and neutral-to-growth U.S. stocks--which has more or less happened in recent years. But I think properly understood, that sort of portfolio is really a bet on unexpectedly low USD inflation, a bet which has happened to pay off in recent years.

Or you can see the risks as asymmetric and hedge one way or the other. Again, using mostly nominal USD bonds and neutral-to-growth U.S. stocks is already a bet on unexpectedly low inflation. Using instead mostly things from the list above can mildly tilt you toward a bet on unexpectedly high inflation.

Finally, you can start with a mostly nominal USD bond and U.S. neutral-to-growth stock portfolio, then try to offset that bet on unexpectedly low inflation with something like a significant allocation to diversified commodities futures, which have a much stronger response to unexpected inflation (but at a cost, although there are now funds trying to minimize the contango issue).

I don't think a lot of people favor this last approach. But if you are the type of person who really puts a premium on not investing outside the U.S., using "total market" funds for both stocks and bonds, and so on, but ALSO are worried about the implied bet on unexpectedly low USD inflation that such a portfolio is making . . . it could be something to consider as a hedge to that bet.
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