Why use anything but TIPS?

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Orangutan
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Why use anything but TIPS?

Post by Orangutan »

My first post to this forum was “Why use anything but Treasuries”. Now I am asking the same thing, but for TIPS.

I run 1/2 Intermediate-Term Treasuries, half TIPS.

Yeah, I get that TIPS have historically made the line more squiggly and they temporarily sink a bit when stocks do - but they’re still doing their job as the bond portion of a portfolio. Whether inflation is transitory or not, it’s still made me reassess my fixed income strategy. Why am I exposing half of my fixed income to a huge risk? Why would I not want something in real terms? Also, I-Bonds are cool.

Thank you in advance.
skierincolorado
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Re: Why use anything but TIPS?

Post by skierincolorado »

Orangutan wrote: Wed Oct 13, 2021 8:08 am My first post to this forum was “Why use anything but Treasuries”. Now I am asking the same thing, but for TIPS.

I run 1/2 Intermediate-Term Treasuries, half TIPS.

Yeah, I get that TIPS have historically made the line more squiggly and they temporarily sink a bit when stocks do - but they’re still doing their job as the bond portion of a portfolio. Whether inflation is transitory or not, it’s still made me reassess my fixed income strategy. Why am I exposing half of my fixed income to a huge risk? Why would I not want something in real terms? Also, I-Bonds are cool.

Thank you in advance.
I agree. I don’t think I’d go 100% tips, but I think they should be more used like 50/50.
mrpotatoheadsays
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Re: Why use anything but TIPS?

Post by mrpotatoheadsays »

"If you believe inflation will be higher in the future than the market is predicting, TIPS are a way to place that bet. In contrast, if you think inflation will be lower than expected, Treasury bonds are the answer.

For those like me who have absolutely no idea, you split your bond portfolio equally between the two. The only caveat today is that TIPS start with a negative yield, and if you’re like me, that’s a hard pill to swallow." - Rob Berger, June 1, 2021

Paul Merriman recommends:
Intermediate-term Treasury bonds (50%)
Short-term Treasury bonds (30%)
Short-term TIPS (20%)

I am using:
Intermediate-term Treasury bonds (30%)
Intermediate-term TIPS (20%)
Short-term Treasury bonds (30%)
Short-term TIPS (20%)
Whakamole
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Re: Why use anything but TIPS?

Post by Whakamole »

The negative yield is a hard pill to swallow, but it's worth it.

I would only touch TIPS now if you think inflation will stay high. The new approach is to have a target average of 2% - if that's the case, inflation would have to be zero for some time. That may hurt the price of TIPS.
dbr
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Re: Why use anything but TIPS?

Post by dbr »

It might be difficult to find a convincing argument for why not use anything but TIPS for the fixed income portion of one's holdings.

Current negative real rates are not different between TIPS and nominal bonds. The yield premium for TIPS has historically been very small.

The rest is just esoteria that does not determine decision making.

You might be interested in reading the pros and cons for TIPS in Larry Swedroe's bond book. I would post a copy of that here except that it might be a copyright violation and anyway you should probably read the whole book to answer your questions. Note there is a link to Amazon at the top of these pages which gets BH some support.
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Re: Why use anything but TIPS?

Post by Ramjet »

100% FI in TIPS makes a lot more sense to me, some thoughts:

1) TIPS will cover actual inflation, Nominal Bond rates take into account estimated inflation. I thought Bogleheads "don't know nuthin"

2) But TIPS make up a small segment of overall bonds. Who cares? There is essentially no credit risk, they are backed by the full faith of the U.S. Government

3) Bogleheads hate bets, e.g., don't buy individual stocks, invest in the total market. How do Bogleheads reconcile that Nominal Bonds are a "bet" on inflation. We turn a blind eye when it is convenient

4) TIPS aren't as liquid as Nominal Bonds. Ok. They are close. Solution, have a year or two of expenses in cash or a CD
Last edited by Ramjet on Wed Oct 13, 2021 10:17 am, edited 1 time in total.
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G21
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Re: Why use anything but TIPS?

Post by G21 »

What specific Tips are most favorable to buy now?
Any Tip funds recommended?
dbr
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Re: Why use anything but TIPS?

Post by dbr »

Ramjet wrote: Wed Oct 13, 2021 10:11 am 100% FI in TIPS makes a lot more sense to me, some thoughts:

1) TIPS will cover actual inflation, Nominal Bond rates take into account estimated inflation. I thought Bogleheads "don't know nuthin"

2) But TIPS make up a small segment of overall bonds. Who cares? There is essentially no credit risk, they are backed by the full faith of the U.S. Government

3) Bogleheads hate bets, e.g., don't buy individual stocks, invest in the total market. How do Bogleheads reconcile that Nominal Bonds are a "bet" on inflation. We turn a blind eye when it is convenient

4) TIPS aren't s liquid as Nominal Bonds. Ok. They are close. Solution, have a year or two of expenses in cash or a CD
I agree with this.
dbr
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Re: Why use anything but TIPS?

Post by dbr »

G21 wrote: Wed Oct 13, 2021 10:14 am What specific Tips are most favorable to buy now?
Any Tip funds recommended?
Don't try to time what is "most favorable to buy now" Generally the choice is what duration suits your needs and also the possibility of just going to Treasury direct and for some reason or another buying particular issues.

For the long term investor in stocks and bonds any low cost intermediate duration TIPS fund is fine. Vanguard offers VIPSX/VAIPX. Is there a particular circumstance that dictates a concern for something else or a different fund company. If you want to get lost in choices you can think about short, intermediate, or long funds or ETFs from any variety of fund companies.
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Orangutan
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Re: Why use anything but TIPS?

Post by Orangutan »

dbr wrote: Wed Oct 13, 2021 10:25 am
G21 wrote: Wed Oct 13, 2021 10:14 am What specific Tips are most favorable to buy now?
Any Tip funds recommended?
Don't try to time what is "most favorable to buy now" Generally the choice is what duration suits your needs and also the possibility of just going to Treasury direct and for some reason or another buying particular issues.

For the long term investor in stocks and bonds any low cost intermediate duration TIPS fund is fine. Vanguard offers VIPSX/VAIPX. Is there a particular circumstance that dictates a concern for something else or a different fund company. If you want to get lost in choices you can think about short, intermediate, or long funds or ETFs from any variety of fund companies.
What do you think about mixing in some ST TIPS to knock down that duration a bit and make the line less squiggly? Maybe 80/20 VAIPX to VTAPX.
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Re: Why use anything but TIPS?

Post by Dude2 »

FIPDX is kind of the Total Bond Market Index Fund for TIPS. You get exposure to long, medium, and short. I think it's the ideal fund if it is convenient to buy it, i.e. you have a Fidelity account.

TIPS are the answer to bonds from a theoretical standpoint. No default risk. No inflation risk. There is still term risk, and the best we can do with that is to match duration to need.

In the real world, market forces could price TIPS in such a way that they deviate from the ideal, perfect bond. There could be liquidity effects. Also, the conspiracy theory guy will tell you that if unexpected inflation "takes off", if I were the government, the first thing I would do would be to buy back as many TIPS as I could. This would mean that I didn't really have the control I thought I had over inflation, lesson learned, and then I'd stop selling them. We can't assume that TIPS are a forever concept in the investment world.

Only I Bonds are pure.
A Liability Matching Portfolio where we express our future needs in real terms is also where TIPS shine.

As dbr said, this business of negative real yields is felt across all bonds.

If we want to take risk in stocks and have safety in bonds, then yes TIPS all the way.
Then ’tis like the breath of an unfee’d lawyer.
mrpotatoheadsays
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Re: Why use anything but TIPS?

Post by mrpotatoheadsays »

G21 wrote: Wed Oct 13, 2021 10:14 am Any Tip funds recommended?
mrpotatoheadsays wrote: Wed Oct 13, 2021 8:57 am Intermediate-term Treasury bonds (30%)
Intermediate-term TIPS (20%)
Short-term Treasury bonds (30%)
Short-term TIPS (20%)
Vanguard Intmdt-Term Trs Idx Admiral VSIGX
Vanguard Inflation-Protected Secs Adm VAIPX
Vanguard Short-Term Treasury Idx Admiral VSBSX
Vanguard Shrt-Term Infl-Prot Sec Idx Adm VTAPX
dbr
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Re: Why use anything but TIPS?

Post by dbr »

Orangutan wrote: Wed Oct 13, 2021 10:30 am
dbr wrote: Wed Oct 13, 2021 10:25 am
G21 wrote: Wed Oct 13, 2021 10:14 am What specific Tips are most favorable to buy now?
Any Tip funds recommended?
Don't try to time what is "most favorable to buy now" Generally the choice is what duration suits your needs and also the possibility of just going to Treasury direct and for some reason or another buying particular issues.

For the long term investor in stocks and bonds any low cost intermediate duration TIPS fund is fine. Vanguard offers VIPSX/VAIPX. Is there a particular circumstance that dictates a concern for something else or a different fund company. If you want to get lost in choices you can think about short, intermediate, or long funds or ETFs from any variety of fund companies.
What do you think about mixing in some ST TIPS to knock down that duration a bit and make the line less squiggly? Maybe 80/20 VAIPX to VTAPX.
Well there is always "Why not X?" and "Why not Y?" I don't know why not, but it hardly seems worth the bother.

It might be a harder "why not" to answer is why not go longer? I don't know that either.

Maybe someone else can come up with something more definitive.
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Re: Why use anything but TIPS?

Post by Ramjet »

Dude2 wrote: Wed Oct 13, 2021 10:39 am FIPDX is kind of the Total Bond Market Index Fund for TIPS
Thanks, I didn't know about this fund

Avg. duration about 5.5 years
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Re: Why use anything but TIPS?

Post by HappyJack »

dbr wrote: Wed Oct 13, 2021 10:16 am
Ramjet wrote: Wed Oct 13, 2021 10:11 am 100% FI in TIPS makes a lot more sense to me, some thoughts:

1) TIPS will cover actual inflation, Nominal Bond rates take into account estimated inflation. I thought Bogleheads "don't know nuthin"

2) But TIPS make up a small segment of overall bonds. Who cares? There is essentially no credit risk, they are backed by the full faith of the U.S. Government

3) Bogleheads hate bets, e.g., don't buy individual stocks, invest in the total market. How do Bogleheads reconcile that Nominal Bonds are a "bet" on inflation. We turn a blind eye when it is convenient

4) TIPS aren't s liquid as Nominal Bonds. Ok. They are close. Solution, have a year or two of expenses in cash or a CD
I agree with this.
+1 and duration match
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Re: Why use anything but TIPS?

Post by calqueuelater »

"If you believe inflation will be higher in the future than the market is predicting, TIPS are a way to place that bet. In contrast, if you think inflation will be lower than expected, Treasury bonds are the answer."

Because I realize I don't know what will happen, I'm half Treasuries and half TIPS.
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Re: Why use anything but TIPS?

Post by nisiprius »

I don't really know why not.

First, let me brush something aside. An awful lot of these these discussions are actually devoted to "which is going to make more money, nominal bonds or TIPS," which I consider to be unknown and unimportant.

Second, let me acknowledge--as a great big TIPS fan who bought my first TIPS in 1998--that for some reason, probably less liquidity, TIPS have had some quirky additional fluctuations, and the result is that since inception VIPSX has had more volatility and a lower Sharpe ratio--lower risk-adjusted return--than the Vanguard Total Bond Fund.

IMHO it's a fair knock on TIPS to say that they have had corporate-like volatility rather than nominal Treasury-like volatility.

People will mention the 10% dip TIPS took in 2008-2009 more often then they will mention the fact that it was preceded by a peculiar 10% upward jump they took about a year before the dip. So these are the words of someone willing to forgive an inamorata, but... I don't feel the 2008-2009 dip in TIPS is comparable to the similar dip in corporates. But one mustn't overlook the subsequent outperformance of corporates.

Source

Image

I am not suggesting anybody else do this. But just for the record: our household currently has just about twice as much in the TIPS fund, VIPSX, as in the nominal bond fund, VBTLX.

And we have roughly as much in Series I savings bonds as in the nominal bond fund. They were mostly bought back when the "fixed rate" was around 3% and you could buy $30,000/year per person.

I don't think it makes an awful lot of difference. I think it's perfectly reasonable to hold mostly, or all TIPS as ones' fixed income holding.

Although Scott Burns once proposed a "Margarita Portfolio" of one-third each Total Stock, Total International Stock, and Inflation-Protected Securities, it's very hard to sell how serious he was about it. But it does show that at least one respectable guru-type once suggested that all bonds be TIPS.

I haven't read the book myself but I think David Swensen suggested half nominal, half TIPS, but I don't know the reasoning behind it.
Last edited by nisiprius on Wed Oct 13, 2021 11:27 am, edited 2 times in total.
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Re: Why use anything but TIPS?

Post by NiceUnparticularMan »

There are many possible purposes an investment in non-equities can serve. TIPS can be a good solution for many purposes, but not necessarily all of them.

The most obvious point is TIPS are not a good hedge against disinflation/deflation scenarios. Since we have seen a couple recent pretty severe disinflationary economic crises, this is a fairly important point to keep in mind.

Note, though, there is a fairly common sort of erroneous reasoning that goes something like this: TIPS can hedge against unexpectedly high inflation, nominal Treasuries (or other high-quality nominal USD-denominated bonds) can hedge against unexpectedly low inflation, so if you hold some of each, you are hedged against both scenarios.

That tempting logic is wrong, of course. All that you are doing in cases like that is cancelling out the other hedge.

That doesn't mean such a portfolio is a bad idea, though. In particular, you might worry if you have a lot of nominal USD bonds that you have a net negative exposure to unexpectedly high inflation. So, you might swap to/add TIPS to bring you closer to neutral. But again, that doesn't mean you are then hedged against both. It just means you have undone some or all of your negative exposure to unexpectedly high inflation, at the cost of undoing some or all of your positive exposure to unexpectedly low inflation.

Or you might want a net hedge against unexpectedly high inflation, in which case you should have more TIPS than nominal, up to all TIPS. And the reverse if you want a net hedge against unexpectedly low inflation, aka disinflation/deflation.

I think the other thing to keep in mind about TIPS is their relationship to inflation is very predictable, but that is for both good and ill. Specifically, there is pretty much always going to be a 1 to 1 correlation between unexpectedly high inflation (as measured by CPI) and the increase in TIPS returns--no less, but also no more.

And what this means is TIPS are good for things like future liability matching when your future liabilities are also inflation-linked. They are also good for offsetting the effects of unexpectedly high inflation on nominal bonds, as discussed above--as long as you have enough.

But small allocations to TIPS won't be able to protect an entire portfolio against unexpectedly high inflation, really just themselves.

In summary, TIPS are nice because they are very predictable in terms of what they will, and will not, do, in response to inflation. But there are indeed things they will not do, so obviously if you want something to fulfill those other purposes, you cannot use only TIPS.
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Re: Why use anything but TIPS?

Post by secondopinion »

Ramjet wrote: Wed Oct 13, 2021 10:11 am 100% FI in TIPS makes a lot more sense to me, some thoughts:

1) TIPS will cover actual inflation, Nominal Bond rates take into account estimated inflation. I thought Bogleheads "don't know nuthin"

2) But TIPS make up a small segment of overall bonds. Who cares? There is essentially no credit risk, they are backed by the full faith of the U.S. Government

3) Bogleheads hate bets, e.g., don't buy individual stocks, invest in the total market. How do Bogleheads reconcile that Nominal Bonds are a "bet" on inflation. We turn a blind eye when it is convenient

4) TIPS aren't as liquid as Nominal Bonds. Ok. They are close. Solution, have a year or two of expenses in cash or a CD
On 1, we do not need to know anything; the market has priced it in.

On 3, what other asset besides nominal bonds protect against below expected inflation when almost everything else is at least somewhat inflation-hedged? If no one knows anything, then why not?
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Re: Why use anything but TIPS?

Post by willthrill81 »

TIPS remove the impact of unexpected inflation from the funds used to buy them and do so for very little, potentially even zero, cost. As such, they seem like close to a no-brainer to me. I've heard very esoteric arguments against this (e.g., 'not all expenses track CPI and some are nominal, so some nominal bonds make sense'), but the reality is that inflation risk has likely been the single biggest risk historically to bonds, and TIPS (and I bonds) remove the risk of unexpected inflation as noted above.

So I agree that 100% TIPS for one's fixed income is certainly logical.
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Re: Why use anything but TIPS?

Post by willthrill81 »

secondopinion wrote: Wed Oct 13, 2021 11:26 am
Ramjet wrote: Wed Oct 13, 2021 10:11 am 100% FI in TIPS makes a lot more sense to me, some thoughts:

1) TIPS will cover actual inflation, Nominal Bond rates take into account estimated inflation. I thought Bogleheads "don't know nuthin"

2) But TIPS make up a small segment of overall bonds. Who cares? There is essentially no credit risk, they are backed by the full faith of the U.S. Government

3) Bogleheads hate bets, e.g., don't buy individual stocks, invest in the total market. How do Bogleheads reconcile that Nominal Bonds are a "bet" on inflation. We turn a blind eye when it is convenient

4) TIPS aren't as liquid as Nominal Bonds. Ok. They are close. Solution, have a year or two of expenses in cash or a CD
On 1, we do not need to know anything; the market has priced it in.

On 3, what other asset besides nominal bonds protect against below expected inflation when almost everything else is at least somewhat inflation-hedged? If no one knows anything, then why not?
If you buy TIPS, you remove the impact of inflation, whatever transpires, from the funds used to buy the TIPS. You know precisely what the real return of your TIPS will be when you buy them. Yes, you might come out ahead with nominal bonds if inflation is below what the market expected, but you might lose. Unless you are paid a premium for taking on the risk of unexpected inflation, there is little or no logical reason to take on that risk. The cost of the unexpected inflation 'insurance' provided by TIPS has been arguably close to zero for a long time now, so investors buying nominal bonds when they could buy TIPS are just taking on additional risk, a risk that has historically been a very substantial risk for nominal bonds, for very little or no compensation.
“Good and ill have not changed since yesteryear; nor are they one thing among Elves and Dwarves and another among Men.” J.R.R. Tolkien, The Lord of the Rings
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Re: Why use anything but TIPS?

Post by NiceUnparticularMan »

Oh, one other thought: I think there are certain sorts of non-marketable investments that could potentially substitute for TIPS such that you might need little or none of them even if you would otherwise find them attractive. I am thinking primarily of Social Security, stable value funds, and the TSP G Fund. Social Security is sort of a given, but I think it is always worth keeping it in mind when thinking about inflation hedges. Stable value funds and the TSP G Fund are only available in certain accounts to certain employees, but they tend to have attributes that make them approximately as suitable as an alternative unexpected inflation hedge.
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Re: Why use anything but TIPS?

Post by secondopinion »

NiceUnparticularMan wrote: Wed Oct 13, 2021 11:25 am There are many possible purposes an investment in non-equities can serve. TIPS can be a good solution for many purposes, but not necessarily all of them.

The most obvious point is TIPS are not a good hedge against disinflation/deflation scenarios. Since we have seen a couple recent pretty severe disinflationary economic crises, this is a fairly important point to keep in mind.

Note, though, there is a fairly common sort of erroneous reasoning that goes something like this: TIPS can hedge against unexpectedly high inflation, nominal Treasuries (or other high-quality nominal USD-denominated bonds) can hedge against unexpectedly low inflation, so if you hold some of each, you are hedged against both scenarios.

That tempting logic is wrong, of course. All that you are doing in cases like that is cancelling out the other hedge.


That doesn't mean such a portfolio is a bad idea, though. In particular, you might worry if you have a lot of nominal USD bonds that you have a net negative exposure to unexpectedly high inflation. So, you might swap to/add TIPS to bring you closer to neutral. But again, that doesn't mean you are then hedged against both. It just means you have undone some or all of your negative exposure to unexpectedly high inflation, at the cost of undoing some or all of your positive exposure to unexpectedly low inflation.

Or you might want a net hedge against unexpectedly high inflation, in which case you should have more TIPS than nominal, up to all TIPS. And the reverse if you want a net hedge against unexpectedly low inflation, aka disinflation/deflation.

I think the other thing to keep in mind about TIPS is their relationship to inflation is very predictable, but that is for both good and ill. Specifically, there is pretty much always going to be a 1 to 1 correlation between unexpectedly high inflation (as measured by CPI) and the increase in TIPS returns--no less, but also no more.

And what this means is TIPS are good for things like future liability matching when your future liabilities are also inflation-linked. They are also good for offsetting the effects of unexpectedly high inflation on nominal bonds, as discussed above--as long as you have enough.

But small allocations to TIPS won't be able to protect an entire portfolio against unexpectedly high inflation, really just themselves.

In summary, TIPS are nice because they are very predictable in terms of what they will, and will not, do, in response to inflation. But there are indeed things they will not do, so obviously if you want something to fulfill those other purposes, you cannot use only TIPS.
The logic is not wrong; you are taking a half inflation-hedged position, and you still will lose/gain some from unexpected inflation/deflation. The only way to "cancel out" nominal bonds is to carry fixed-rate debt.

When most other assets are somewhat inflation-hedged, why are we so concerned in taking a position? Not to mention, many people have mortgages so holding nominal bonds hedges out taking an actual inflation position by holding fixed rate debt.
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Re: Why use anything but TIPS?

Post by dbr »

willthrill81 wrote: Wed Oct 13, 2021 11:29 am TIPS remove the impact of unexpected inflation from the funds used to buy them and do so for very little, potentially even zero, cost. As such, they seem like close to a no-brainer to me. I've heard very esoteric arguments against this (e.g., 'not all expenses track CPI and some are nominal, so some nominal bonds make sense'), but the reality is that inflation risk has likely been the single biggest risk historically to bonds, and TIPS (and I bonds) remove the risk of unexpected inflation as noted above.

So I agree that 100% TIPS for one's fixed income is certainly logical.
I would only add that TIPS remove the impact of inflation expected or not and even if it is negative. If the object is to not have an effect of inflation on the investment, it would seem obvious to hold TIPS.

The discussion happens when one fails to set aside, as pointed out by nisiprius, that one is buying them to make more money than something else rather than to have an investment in real terms, period. One would imagine having everything invested in real terms would be an objective. My personal biggest retirement problem is having part of the income not in real terms, namely a fixed pension. That causes all sorts of grief and contortions to manage and much thankfullness that inflation has been minimal. By contortions I mean that portfolio withdrawals have to increase faster than inflation to offset loss of pension purchasing power. That was never anticipated in the SWR literature. Of course in reality a little bit more sophisticated model like any retirement planner just throws it all in the wash. 100% TIPS puts a minimum on this but does not offset it.
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Re: Why use anything but TIPS?

Post by NiceUnparticularMan »

willthrill81 wrote: Wed Oct 13, 2021 11:33 am If you buy TIPS, you remove the impact of inflation, whatever transpires, from the funds used to buy the TIPS. You know precisely what the real return of your TIPS will be when you buy them. Yes, you might come out ahead with nominal bonds if inflation is below what the market expected, but you might lose. Unless you are paid a premium for taking on the risk of unexpected inflation, there is little or no logical reason to take on that risk. The cost of the unexpected inflation 'insurance' provided by TIPS has been arguably close to zero for a long time now, so investors buying nominal bonds when they could buy TIPS are just taking on additional risk, a risk that has historically been a very substantial risk for nominal bonds, for very little or no compensation.
Just to be clear, though, unexpectedly low inflation represents a type of risk too.

Of course if all you were doing is providing against your future consumption, not trying to build wealth through risky investments, then this might not be a risk you care about. But if, like many people, you have invested some of your capital in risky investments in order to try to build wealth, then often those investments are themselves going to be negatively impacted by, or at least negatively correlated in some way with, unexpectedly low inflation scenarios.

This is really the source of a lot of the benefit to historic investments in combinations of both stocks and nominal bonds--often, at least, nominal bonds were benefiting at least relatively from disinflation/deflation scenarios that were hurting stocks.

With TIPS, you are giving up this possibly beneficial positive relationship to unexpectedly low inflation as exhibited by nominal bonds.
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Re: Why use anything but TIPS?

Post by RJC »

For those who have access to Federal G funds. Is that the same as TIPS?
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Re: Why use anything but TIPS?

Post by Whakamole »

Ramjet wrote: Wed Oct 13, 2021 11:08 am
Dude2 wrote: Wed Oct 13, 2021 10:39 am FIPDX is kind of the Total Bond Market Index Fund for TIPS
Thanks, I didn't know about this fund

Avg. duration about 5.5 years
I have all my TIPS allocation in this fund. Between this and I-bonds, half my fixed income investments are inflation adjusted.
RJC wrote: Wed Oct 13, 2021 11:43 am For those who have access to Federal G funds. Is that the same as TIPS?
Not the same.
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Re: Why use anything but TIPS?

Post by Ramjet »

secondopinion wrote: Wed Oct 13, 2021 11:26 am
Ramjet wrote: Wed Oct 13, 2021 10:11 am 100% FI in TIPS makes a lot more sense to me, some thoughts:

1) TIPS will cover actual inflation, Nominal Bond rates take into account estimated inflation. I thought Bogleheads "don't know nuthin"

2) But TIPS make up a small segment of overall bonds. Who cares? There is essentially no credit risk, they are backed by the full faith of the U.S. Government

3) Bogleheads hate bets, e.g., don't buy individual stocks, invest in the total market. How do Bogleheads reconcile that Nominal Bonds are a "bet" on inflation. We turn a blind eye when it is convenient

4) TIPS aren't as liquid as Nominal Bonds. Ok. They are close. Solution, have a year or two of expenses in cash or a CD
On 1, we do not need to know anything; the market has priced it in.
Why choose an estimate over something that will give you actual returns. All it is is unnecessary risk

On 3, what other asset besides nominal bonds protect against below expected inflation when almost everything else is at least somewhat inflation-hedged? If no one knows anything, then why not?

I don't subscribe to "nobody knows nuthin'", I think it gives people a reason to go into autopilot and turn their brain off. TIPS also protect against deflation. They come with a deflation floor that protects your principal value.
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dbr
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Re: Why use anything but TIPS?

Post by dbr »

Ramjet wrote: Wed Oct 13, 2021 11:46 am
I don't subscribe to "nobody knows nuthin'", I think it gives people a reason to go into autopilot and turn their brain off. TIPS also protect against deflation. They come with a deflation floor that protects your principal value.
Doesn't "inflation protection" imply that the nominal value should go up with inflation and down with deflation, that is inflation positive or negative has no effect on real value. If one wants the value to go up with positive inflation but not go down with negative inflation, that is an unreasonable ask. The deflation floor is kind of an unearned benefit.
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Re: Why use anything but TIPS?

Post by NiceUnparticularMan »

secondopinion wrote: Wed Oct 13, 2021 11:37 am
NiceUnparticularMan wrote: Wed Oct 13, 2021 11:25 am There are many possible purposes an investment in non-equities can serve. TIPS can be a good solution for many purposes, but not necessarily all of them.

The most obvious point is TIPS are not a good hedge against disinflation/deflation scenarios. Since we have seen a couple recent pretty severe disinflationary economic crises, this is a fairly important point to keep in mind.

Note, though, there is a fairly common sort of erroneous reasoning that goes something like this: TIPS can hedge against unexpectedly high inflation, nominal Treasuries (or other high-quality nominal USD-denominated bonds) can hedge against unexpectedly low inflation, so if you hold some of each, you are hedged against both scenarios.

That tempting logic is wrong, of course. All that you are doing in cases like that is cancelling out the other hedge.


That doesn't mean such a portfolio is a bad idea, though. In particular, you might worry if you have a lot of nominal USD bonds that you have a net negative exposure to unexpectedly high inflation. So, you might swap to/add TIPS to bring you closer to neutral. But again, that doesn't mean you are then hedged against both. It just means you have undone some or all of your negative exposure to unexpectedly high inflation, at the cost of undoing some or all of your positive exposure to unexpectedly low inflation.

Or you might want a net hedge against unexpectedly high inflation, in which case you should have more TIPS than nominal, up to all TIPS. And the reverse if you want a net hedge against unexpectedly low inflation, aka disinflation/deflation.

I think the other thing to keep in mind about TIPS is their relationship to inflation is very predictable, but that is for both good and ill. Specifically, there is pretty much always going to be a 1 to 1 correlation between unexpectedly high inflation (as measured by CPI) and the increase in TIPS returns--no less, but also no more.

And what this means is TIPS are good for things like future liability matching when your future liabilities are also inflation-linked. They are also good for offsetting the effects of unexpectedly high inflation on nominal bonds, as discussed above--as long as you have enough.

But small allocations to TIPS won't be able to protect an entire portfolio against unexpectedly high inflation, really just themselves.

In summary, TIPS are nice because they are very predictable in terms of what they will, and will not, do, in response to inflation. But there are indeed things they will not do, so obviously if you want something to fulfill those other purposes, you cannot use only TIPS.
The logic is not wrong; you are taking a half inflation-hedged position, and you still will lose/gain some from unexpected inflation/deflation. The only way to "cancel out" nominal bonds is to carry fixed-rate debt.
I am not sure why you are claiming this--perhaps it is a terminology issue. Because if you hold enough TIPS, their response to unexpectedly high inflation will in fact cancel out the negative effect that unexpectedly high inflation will have on a given amount of nominal bonds.
When most other assets are somewhat inflation-hedged, why are we so concerned in taking a position?
I think this is just pointing to the issue all this has to be evaluated in the context of an overall portfolio. Historically, at least, some people have had half or more of their financial wealth in nominal bonds. On the one hand, those people had a large hedge against the sorts of disinflation/deflation scenarios that have often been bad for stocks. On the other hand, those people had a large exposure to unexpectedly high inflation. People will say the stocks are enough to deal with that, but that depends on the amount of stocks, and there are also unexpectedly high inflation scenarios that can be bad for stocks--what I tend to call "stagflation" scenarios.

So, worrying about the degree of exposure one has to unexpectedly low or high inflation, and using higher or lower allocations to TIPS to adjust that exposure, is not an inherently unreasonable thing to do.
Not to mention, many people have mortgages so holding nominal bonds hedges out taking an actual inflation position by holding fixed rate debt.
Right, any fixed-rate debt, including mortgages, possibly student loans, and so on can help offset the effects of unexpectedly high inflation on nominal bonds. But, of course, many people seek to minimize the amount of such debt they are carrying at some point or another. So, something like an increasing allocation to TIPS as you are decreasing your fixed-rate debt might be a reasonable strategy for controlling your net exposure to unexpected inflation effects.
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Re: Why use anything but TIPS?

Post by NiceUnparticularMan »

dbr wrote: Wed Oct 13, 2021 11:39 amI would only add that TIPS remove the impact of inflation expected or not and even if it is negative. If the object is to not have an effect of inflation on the investment, it would seem obvious to hold TIPS.
So this gets to an important issue, which is defining your baseline.

The return on TIPS will likely be lower than you expect in nominal terms if inflation is lower than expected at the time you bought the TIPS.

Now, you might say you don't care, if what you are using TIPS to pay for is also less expensive as a result. This is why TIPS are a good way to match future liabilities that are themselves inflation-linked.

But nominally-denominated liabilities do exist. The most common form is debt, as we were just discussing. If, say, you have fixed-rate mortgage payments to make, and if you are trying to invest in a way that will make sure you can always make those payments, then TIPS could fail in this purpose if inflation is unexpectedly low.

Of course you might have other options, like refinancing and such, but that all depends on other circumstances not necessarily within your control.

None of this is meant to be alarmist about TIPS, nor to suggest that it might well be reasonable to end up 100% TIPS with your bonds. But it all does depend on the total context of what you are trying to do.
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Re: Why use anything but TIPS?

Post by dbr »

NiceUnparticularMan wrote: Wed Oct 13, 2021 12:00 pm
dbr wrote: Wed Oct 13, 2021 11:39 amI would only add that TIPS remove the impact of inflation expected or not and even if it is negative. If the object is to not have an effect of inflation on the investment, it would seem obvious to hold TIPS.
So this gets to an important issue, which is defining your baseline.

The return on TIPS will likely be lower than you expect in nominal terms if inflation is lower than expected at the time you bought the TIPS.

Now, you might say you don't care, if what you are using TIPS to pay for is also less expensive as a result. This is why TIPS are a good way to match future liabilities that are themselves inflation-linked.

But nominally-denominated liabilities do exist. The most common form is debt, as we were just discussing. If, say, you have fixed-rate mortgage payments to make, and if you are trying to invest in a way that will make sure you can always make those payments, then TIPS could fail in this purpose if inflation is unexpectedly low.

Of course you might have other options, like refinancing and such, but that all depends on other circumstances not necessarily within your control.

None of this is meant to be alarmist about TIPS, nor to suggest that it might well be reasonable to end up 100% TIPS with your bonds. But it all does depend on the total context of what you are trying to do.
Nice. Thank you.
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Re: Why use anything but TIPS?

Post by willthrill81 »

dbr wrote: Wed Oct 13, 2021 11:39 am
willthrill81 wrote: Wed Oct 13, 2021 11:29 am TIPS remove the impact of unexpected inflation from the funds used to buy them and do so for very little, potentially even zero, cost. As such, they seem like close to a no-brainer to me. I've heard very esoteric arguments against this (e.g., 'not all expenses track CPI and some are nominal, so some nominal bonds make sense'), but the reality is that inflation risk has likely been the single biggest risk historically to bonds, and TIPS (and I bonds) remove the risk of unexpected inflation as noted above.

So I agree that 100% TIPS for one's fixed income is certainly logical.
I would only add that TIPS remove the impact of inflation expected or not and even if it is negative. If the object is to not have an effect of inflation on the investment, it would seem obvious to hold TIPS.
Exactly.
dbr wrote: Wed Oct 13, 2021 11:39 am The discussion happens when one fails to set aside, as pointed out by nisiprius, that one is buying them to make more money than something else rather than to have an investment in real terms, period. One would imagine having everything invested in real terms would be an objective. My personal biggest retirement problem is having part of the income not in real terms, namely a fixed pension. That causes all sorts of grief and contortions to manage and much thankfullness that inflation has been minimal. By contortions I mean that portfolio withdrawals have to increase faster than inflation to offset loss of pension purchasing power. That was never anticipated in the SWR literature. Of course in reality a little bit more sophisticated model like any retirement planner just throws it all in the wash. 100% TIPS puts a minimum on this but does not offset it.
Yes, that is indeed a problem that is rarely addressed; I haven't even seen it mentioned on this forum in years. This problem also extends to SPIAs, though a SPIA with a 2% or 3% COLA will obviously put less pressure on one's remaining assets to fund constant inflation-adjusted spending.
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Re: Why use anything but TIPS?

Post by willthrill81 »

NiceUnparticularMan wrote: Wed Oct 13, 2021 11:42 am
willthrill81 wrote: Wed Oct 13, 2021 11:33 am If you buy TIPS, you remove the impact of inflation, whatever transpires, from the funds used to buy the TIPS. You know precisely what the real return of your TIPS will be when you buy them. Yes, you might come out ahead with nominal bonds if inflation is below what the market expected, but you might lose. Unless you are paid a premium for taking on the risk of unexpected inflation, there is little or no logical reason to take on that risk. The cost of the unexpected inflation 'insurance' provided by TIPS has been arguably close to zero for a long time now, so investors buying nominal bonds when they could buy TIPS are just taking on additional risk, a risk that has historically been a very substantial risk for nominal bonds, for very little or no compensation.
Just to be clear, though, unexpectedly low inflation represents a type of risk too.

Of course if all you were doing is providing against your future consumption, not trying to build wealth through risky investments, then this might not be a risk you care about. But if, like many people, you have invested some of your capital in risky investments in order to try to build wealth, then often those investments are themselves going to be negatively impacted by, or at least negatively correlated in some way with, unexpectedly low inflation scenarios.

This is really the source of a lot of the benefit to historic investments in combinations of both stocks and nominal bonds--often, at least, nominal bonds were benefiting at least relatively from disinflation/deflation scenarios that were hurting stocks.

With TIPS, you are giving up this possibly beneficial positive relationship to unexpectedly low inflation as exhibited by nominal bonds.
I don't follow this argument. Historically, high inflation hasn't been great for assets like stocks, at least not in the short- or mid-term. And if high inflation leads to high interest rates, it hasn't been historically kind to real estate either (as an investment). It was comparatively much harder to sell a home back when mortgage interest rates were above 10% than it is now.
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Re: Why use anything but TIPS?

Post by NiceUnparticularMan »

willthrill81 wrote: Wed Oct 13, 2021 1:01 pm
NiceUnparticularMan wrote: Wed Oct 13, 2021 11:42 am
willthrill81 wrote: Wed Oct 13, 2021 11:33 am If you buy TIPS, you remove the impact of inflation, whatever transpires, from the funds used to buy the TIPS. You know precisely what the real return of your TIPS will be when you buy them. Yes, you might come out ahead with nominal bonds if inflation is below what the market expected, but you might lose. Unless you are paid a premium for taking on the risk of unexpected inflation, there is little or no logical reason to take on that risk. The cost of the unexpected inflation 'insurance' provided by TIPS has been arguably close to zero for a long time now, so investors buying nominal bonds when they could buy TIPS are just taking on additional risk, a risk that has historically been a very substantial risk for nominal bonds, for very little or no compensation.
Just to be clear, though, unexpectedly low inflation represents a type of risk too.

Of course if all you were doing is providing against your future consumption, not trying to build wealth through risky investments, then this might not be a risk you care about. But if, like many people, you have invested some of your capital in risky investments in order to try to build wealth, then often those investments are themselves going to be negatively impacted by, or at least negatively correlated in some way with, unexpectedly low inflation scenarios.

This is really the source of a lot of the benefit to historic investments in combinations of both stocks and nominal bonds--often, at least, nominal bonds were benefiting at least relatively from disinflation/deflation scenarios that were hurting stocks.

With TIPS, you are giving up this possibly beneficial positive relationship to unexpectedly low inflation as exhibited by nominal bonds.
I don't follow this argument. Historically, high inflation hasn't been great for assets like stocks, at least not in the short- or mid-term. And if high inflation leads to high interest rates, it hasn't been historically kind to real estate either (as an investment). It was comparatively much harder to sell a home back when mortgage interest rates were above 10% than it is now.
Well, as a general rule, unexpected bad things are bad for stocks.

That can include unexpectedly high inflation scenarios, but it can also include unexpectedly low inflation scenarios. What often really matters is why that is happening.

Unexpectedly high inflation, for example, can be caused by a critical supply shortage. This can disrupt various business plans and reduce the returns on existing capital investments.

Unexpectedly low inflation, for example, can be caused by a consumer demand shock. This can also disrupt various business plans and reduce the returns on existing capital investments.

We in fact have seen a couple recent economic crises which were disinflationary/deflationary in nature, and stocks did take a big hit. But, at least in the U.S., these times stocks bounced back relatively quickly. So as long as you didn't panic sell, you probably did OK, and maybe better than OK if you were buying (either as usual from income or through rebalancing or something).

But stocks have not always bounced back quickly throughout history in disinflationary/deflationary scenarios. And in those scenarios, higher-quality bonds often (as long as the crisis was not too severe) ended up serving as a useful hedge.

TIPS, though, will track unexpectedly low inflation down. There is a floor in the sense they cannot go negative. But they won't experience the same increase in value that nominal bonds can experience in such scenarios.
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Re: Why use anything but TIPS?

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NiceUnparticularMan wrote: Wed Oct 13, 2021 1:18 pm
willthrill81 wrote: Wed Oct 13, 2021 1:01 pm
NiceUnparticularMan wrote: Wed Oct 13, 2021 11:42 am
willthrill81 wrote: Wed Oct 13, 2021 11:33 am If you buy TIPS, you remove the impact of inflation, whatever transpires, from the funds used to buy the TIPS. You know precisely what the real return of your TIPS will be when you buy them. Yes, you might come out ahead with nominal bonds if inflation is below what the market expected, but you might lose. Unless you are paid a premium for taking on the risk of unexpected inflation, there is little or no logical reason to take on that risk. The cost of the unexpected inflation 'insurance' provided by TIPS has been arguably close to zero for a long time now, so investors buying nominal bonds when they could buy TIPS are just taking on additional risk, a risk that has historically been a very substantial risk for nominal bonds, for very little or no compensation.
Just to be clear, though, unexpectedly low inflation represents a type of risk too.

Of course if all you were doing is providing against your future consumption, not trying to build wealth through risky investments, then this might not be a risk you care about. But if, like many people, you have invested some of your capital in risky investments in order to try to build wealth, then often those investments are themselves going to be negatively impacted by, or at least negatively correlated in some way with, unexpectedly low inflation scenarios.

This is really the source of a lot of the benefit to historic investments in combinations of both stocks and nominal bonds--often, at least, nominal bonds were benefiting at least relatively from disinflation/deflation scenarios that were hurting stocks.

With TIPS, you are giving up this possibly beneficial positive relationship to unexpectedly low inflation as exhibited by nominal bonds.
I don't follow this argument. Historically, high inflation hasn't been great for assets like stocks, at least not in the short- or mid-term. And if high inflation leads to high interest rates, it hasn't been historically kind to real estate either (as an investment). It was comparatively much harder to sell a home back when mortgage interest rates were above 10% than it is now.
Well, as a general rule, unexpected bad things are bad for stocks.

That can include unexpectedly high inflation scenarios, but it can also include unexpectedly low inflation scenarios. What often really matters is why that is happening.

Unexpectedly high inflation, for example, can be caused by a critical supply shortage. This can disrupt various business plans and reduce the returns on existing capital investments.

Unexpectedly low inflation, for example, can be caused by a consumer demand shock. This can also disrupt various business plans and reduce the returns on existing capital investments.

We in fact have seen a couple recent economic crises which were disinflationary/deflationary in nature, and stocks did take a big hit. But, at least in the U.S., these times stocks bounced back relatively quickly. So as long as you didn't panic sell, you probably did OK, and maybe better than OK if you were buying (either as usual from income or through rebalancing or something).

But stocks have not always bounced back quickly throughout history in disinflationary/deflationary scenarios. And in those scenarios, higher-quality bonds often (as long as the crisis was not too severe) ended up serving as a useful hedge.
I just don't see consistent enough effects in order to make AA decisions over the possibility of 'inflation being too low'. Most of the time, low inflation has been favorable for stocks, though there are certainly exceptions (e.g., Japan for the last 30 years). I agree that deflation is bad for virtually everything except nominal bonds, but TIPS do have some protection against deflation as well in that buyers are guaranteed to receive at least their nominal purchase price.

But even then, consistent deflation of any meaningful quantity would likely lead to much bigger problems than one's own portfolio (e.g., huge problems for the economy, debtors and their creditors, the Treasury's debt obligations).
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Re: Why use anything but TIPS?

Post by nisiprius »

NiceUnparticularMan wrote: Wed Oct 13, 2021 11:34 am Oh, one other thought: I think there are certain sorts of non-marketable investments that could potentially substitute for TIPS such that you might need little or none of them even if you would otherwise find them attractive. I am thinking primarily of Social Security, stable value funds, and the TSP G Fund. Social Security is sort of a given, but I think it is always worth keeping it in mind when thinking about inflation hedges. Stable value funds and the TSP G Fund are only available in certain accounts to certain employees, but they tend to have attributes that make them approximately as suitable as an alternative unexpected inflation hedge.
Series I savings bonds are also a non-marketable investment. This may be part of the reason why you hear so little about them. In addition to having no inflation risk, they have no interest rate risk. (I have participated in some strange discussions in which financial sophisticates have tried to argue that they do too have interest rate risk because you should not value them at the number of dollars the Treasury will pay you any time you decide to redeem them, but at the number of dollars they would be worth in the market if they were marketable.)
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Re: Why use anything but TIPS?

Post by NiceUnparticularMan »

RJC wrote: Wed Oct 13, 2021 11:43 am For those who have access to Federal G funds. Is that the same as TIPS?
No, but it may be as good or better for some purposes.

Investments in the G Fund are guaranteed not to lose value, and they also get a yield equal to the weighted average yield of all Treasuries 4+ years to maturity. I think it ends up averaging around 12 years.

If inflation is higher than expected, and then expected to stay that way for some time, usually this means those yields will increase. So, generally speaking the G Fund should also track up with unexpectedly high inflation, at least as long as it is expected to be sustained for a while (if it is just expected to be a temporary blip, it might not do much).

However, unlike with normal nominal bonds, when long-term market rates increase, the market value of investments in the G Fund don't decrease. So, yields on the G Fund can track up with inflation/rates without market values tracking down. Which again is sorta like TIPS.

Conversely, though, investments in the G Fund will not lose market value when inflation and rates go down, unlike with TIPS. This is not necessarily a critical distinction if you just plan to hold individual TIPS to maturity, which is true of some people doing things like TIPS ladders and such. But, if you are invested in a TIPS fund from which you are planning to withdraw a relatively fixed amount, or at least want the option to take out money on demand, then TIPS lack this characteristic of the G Fund.

Conceptually, then, investments in the G Fund have on-demand liquidity like cash, expected returns like longer-term (~12 year) bonds, and persistent inflation insurance like TIPS. And once you understand all that they can be pretty useful in solving various problems for personal investors with lower allocations and/or lower offsetting downsides.

I note all this is only possible because the G Fund is not generally marketed.
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Re: Why use anything but TIPS?

Post by secondopinion »

NiceUnparticularMan wrote: Wed Oct 13, 2021 1:18 pm
willthrill81 wrote: Wed Oct 13, 2021 1:01 pm
NiceUnparticularMan wrote: Wed Oct 13, 2021 11:42 am
willthrill81 wrote: Wed Oct 13, 2021 11:33 am If you buy TIPS, you remove the impact of inflation, whatever transpires, from the funds used to buy the TIPS. You know precisely what the real return of your TIPS will be when you buy them. Yes, you might come out ahead with nominal bonds if inflation is below what the market expected, but you might lose. Unless you are paid a premium for taking on the risk of unexpected inflation, there is little or no logical reason to take on that risk. The cost of the unexpected inflation 'insurance' provided by TIPS has been arguably close to zero for a long time now, so investors buying nominal bonds when they could buy TIPS are just taking on additional risk, a risk that has historically been a very substantial risk for nominal bonds, for very little or no compensation.
Just to be clear, though, unexpectedly low inflation represents a type of risk too.

Of course if all you were doing is providing against your future consumption, not trying to build wealth through risky investments, then this might not be a risk you care about. But if, like many people, you have invested some of your capital in risky investments in order to try to build wealth, then often those investments are themselves going to be negatively impacted by, or at least negatively correlated in some way with, unexpectedly low inflation scenarios.

This is really the source of a lot of the benefit to historic investments in combinations of both stocks and nominal bonds--often, at least, nominal bonds were benefiting at least relatively from disinflation/deflation scenarios that were hurting stocks.

With TIPS, you are giving up this possibly beneficial positive relationship to unexpectedly low inflation as exhibited by nominal bonds.
I don't follow this argument. Historically, high inflation hasn't been great for assets like stocks, at least not in the short- or mid-term. And if high inflation leads to high interest rates, it hasn't been historically kind to real estate either (as an investment). It was comparatively much harder to sell a home back when mortgage interest rates were above 10% than it is now.
Well, as a general rule, unexpected bad things are bad for stocks.

That can include unexpectedly high inflation scenarios, but it can also include unexpectedly low inflation scenarios. What often really matters is why that is happening.

Unexpectedly high inflation, for example, can be caused by a critical supply shortage. This can disrupt various business plans and reduce the returns on existing capital investments.

Unexpectedly low inflation, for example, can be caused by a consumer demand shock. This can also disrupt various business plans and reduce the returns on existing capital investments.

We in fact have seen a couple recent economic crises which were disinflationary/deflationary in nature, and stocks did take a big hit. But, at least in the U.S., these times stocks bounced back relatively quickly. So as long as you didn't panic sell, you probably did OK, and maybe better than OK if you were buying (either as usual from income or through rebalancing or something).

But stocks have not always bounced back quickly throughout history in disinflationary/deflationary scenarios. And in those scenarios, higher-quality bonds often (as long as the crisis was not too severe) ended up serving as a useful hedge.

TIPS, though, will track unexpectedly low inflation down. There is a floor in the sense they cannot go negative. But they won't experience the same increase in value that nominal bonds can experience in such scenarios.
Right. Unexpected major low/high inflation is usually bad for stocks.

We also need to understand the business cycle. During good times, stocks do well, borrowing is cheap, spending is high, but inflation also starts to climb (bad for nominal bonds). To curb this, interest rates are increased to encourage saving and discourage borrowing too much (then nominal bonds are definitely hurt). However, this causes spending to retract, which is bad for stocks. Because general saving has increased, the inflation becomes less (or even negative); this is good of nominal bonds. To spur spending and discourage saving too much, rates have to be decreased (and this definitely improves nominal bonds).

So in the normal flow of things, nominal bonds (given high enough quality) go against business cycle, stocks follow the business cycle, and TIPS will disregard the cycle. That is part of the reason why TIPS seem to follow stocks more than nominal bonds.

Unexpected major low/high inflation has a plus or minus for nominal bonds, but let us not forget how they behave in the normal cases.
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Re: Why use anything but TIPS?

Post by NiceUnparticularMan »

willthrill81 wrote: Wed Oct 13, 2021 1:24 pm
NiceUnparticularMan wrote: Wed Oct 13, 2021 1:18 pm
willthrill81 wrote: Wed Oct 13, 2021 1:01 pm
NiceUnparticularMan wrote: Wed Oct 13, 2021 11:42 am
willthrill81 wrote: Wed Oct 13, 2021 11:33 am If you buy TIPS, you remove the impact of inflation, whatever transpires, from the funds used to buy the TIPS. You know precisely what the real return of your TIPS will be when you buy them. Yes, you might come out ahead with nominal bonds if inflation is below what the market expected, but you might lose. Unless you are paid a premium for taking on the risk of unexpected inflation, there is little or no logical reason to take on that risk. The cost of the unexpected inflation 'insurance' provided by TIPS has been arguably close to zero for a long time now, so investors buying nominal bonds when they could buy TIPS are just taking on additional risk, a risk that has historically been a very substantial risk for nominal bonds, for very little or no compensation.
Just to be clear, though, unexpectedly low inflation represents a type of risk too.

Of course if all you were doing is providing against your future consumption, not trying to build wealth through risky investments, then this might not be a risk you care about. But if, like many people, you have invested some of your capital in risky investments in order to try to build wealth, then often those investments are themselves going to be negatively impacted by, or at least negatively correlated in some way with, unexpectedly low inflation scenarios.

This is really the source of a lot of the benefit to historic investments in combinations of both stocks and nominal bonds--often, at least, nominal bonds were benefiting at least relatively from disinflation/deflation scenarios that were hurting stocks.

With TIPS, you are giving up this possibly beneficial positive relationship to unexpectedly low inflation as exhibited by nominal bonds.
I don't follow this argument. Historically, high inflation hasn't been great for assets like stocks, at least not in the short- or mid-term. And if high inflation leads to high interest rates, it hasn't been historically kind to real estate either (as an investment). It was comparatively much harder to sell a home back when mortgage interest rates were above 10% than it is now.
Well, as a general rule, unexpected bad things are bad for stocks.

That can include unexpectedly high inflation scenarios, but it can also include unexpectedly low inflation scenarios. What often really matters is why that is happening.

Unexpectedly high inflation, for example, can be caused by a critical supply shortage. This can disrupt various business plans and reduce the returns on existing capital investments.

Unexpectedly low inflation, for example, can be caused by a consumer demand shock. This can also disrupt various business plans and reduce the returns on existing capital investments.

We in fact have seen a couple recent economic crises which were disinflationary/deflationary in nature, and stocks did take a big hit. But, at least in the U.S., these times stocks bounced back relatively quickly. So as long as you didn't panic sell, you probably did OK, and maybe better than OK if you were buying (either as usual from income or through rebalancing or something).

But stocks have not always bounced back quickly throughout history in disinflationary/deflationary scenarios. And in those scenarios, higher-quality bonds often (as long as the crisis was not too severe) ended up serving as a useful hedge.
I just don't see consistent enough effects in order to make AA decisions over the possibility of 'inflation being too low'. Most of the time, low inflation has been favorable for stocks, though there are certainly exceptions (e.g., Japan for the last 30 years).
That to me seems like an "exception" well worth taking into account. But I gather some people won't believe it can happen in the U.S. unless and until it does happen--at which point it will be a little late to insure against the possibility.

But I note we also had a bad low inflation period which was bad for U.S. stocks during the Great Depression.
but TIPS do have some protection against deflation as well in that buyers are guaranteed to receive at least their nominal purchase price.
Again, this just puts a limit on how much value they can lose to unexpectedly low inflation. It does not mean they will have the same increase in value as nominal bonds in such a scenario.
But even then, consistent deflation of any meaningful quantity would likely lead to much bigger problems than one's own portfolio (e.g., huge problems for the economy, debtors and their creditors, the Treasury's debt obligations).
Well, Japan has survived, in some ways thrived by historic measures.

Individual Japanese investors, though, might not have done as well. And many more might have done a lot worse if they didn't at least have a lot of nominal Japanese bonds.
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Re: Why use anything but TIPS?

Post by RJC »

NiceUnparticularMan wrote: Wed Oct 13, 2021 1:37 pm
RJC wrote: Wed Oct 13, 2021 11:43 am For those who have access to Federal G funds. Is that the same as TIPS?
No, but it may be as good or better for some purposes.

Investments in the G Fund are guaranteed not to lose value, and they also get a yield equal to the weighted average yield of all Treasuries 4+ years to maturity. I think it ends up averaging around 12 years.

If inflation is higher than expected, and then expected to stay that way for some time, usually this means those yields will increase. So, generally speaking the G Fund should also track up with unexpectedly high inflation, at least as long as it is expected to be sustained for a while (if it is just expected to be a temporary blip, it might not do much).

However, unlike with normal nominal bonds, when long-term market rates increase, the market value of investments in the G Fund don't decrease. So, yields on the G Fund can track up with inflation/rates without market values tracking down. Which again is sorta like TIPS.

Conversely, though, investments in the G Fund will not lose market value when inflation and rates go down, unlike with TIPS. This is not necessarily a critical distinction if you just plan to hold individual TIPS to maturity, which is true of some people doing things like TIPS ladders and such. But, if you are invested in a TIPS fund from which you are planning to withdraw a relatively fixed amount, or at least want the option to take out money on demand, then TIPS lack this characteristic of the G Fund.

Conceptually, then, investments in the G Fund have on-demand liquidity like cash, expected returns like longer-term (~12 year) bonds, and persistent inflation insurance like TIPS. And once you understand all that they can be pretty useful in solving various problems for personal investors with lower allocations and/or lower offsetting downsides.

I note all this is only possible because the G Fund is not generally marketed.
Thank you for the explanation.
NiceUnparticularMan
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Re: Why use anything but TIPS?

Post by NiceUnparticularMan »

nisiprius wrote: Wed Oct 13, 2021 1:27 pm
NiceUnparticularMan wrote: Wed Oct 13, 2021 11:34 am Oh, one other thought: I think there are certain sorts of non-marketable investments that could potentially substitute for TIPS such that you might need little or none of them even if you would otherwise find them attractive. I am thinking primarily of Social Security, stable value funds, and the TSP G Fund. Social Security is sort of a given, but I think it is always worth keeping it in mind when thinking about inflation hedges. Stable value funds and the TSP G Fund are only available in certain accounts to certain employees, but they tend to have attributes that make them approximately as suitable as an alternative unexpected inflation hedge.
Series I savings bonds are also a non-marketable investment. This may be part of the reason why you hear so little about them. In addition to having no inflation risk, they have no interest rate risk. (I have participated in some strange discussions in which financial sophisticates have tried to argue that they do too have interest rate risk because you should not value them at the number of dollars the Treasury will pay you any time you decide to redeem them, but at the number of dollars they would be worth in the market if they were marketable.)
All correct. I will admit the scale of the available amounts has deterred me from ever using I Bonds, but I certainly can understand why some people see them as at least a first stop for bond shopping.
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Re: Why use anything but TIPS?

Post by NiceUnparticularMan »

secondopinion wrote: Wed Oct 13, 2021 1:42 pm
NiceUnparticularMan wrote: Wed Oct 13, 2021 1:18 pm
willthrill81 wrote: Wed Oct 13, 2021 1:01 pm
NiceUnparticularMan wrote: Wed Oct 13, 2021 11:42 am
willthrill81 wrote: Wed Oct 13, 2021 11:33 am If you buy TIPS, you remove the impact of inflation, whatever transpires, from the funds used to buy the TIPS. You know precisely what the real return of your TIPS will be when you buy them. Yes, you might come out ahead with nominal bonds if inflation is below what the market expected, but you might lose. Unless you are paid a premium for taking on the risk of unexpected inflation, there is little or no logical reason to take on that risk. The cost of the unexpected inflation 'insurance' provided by TIPS has been arguably close to zero for a long time now, so investors buying nominal bonds when they could buy TIPS are just taking on additional risk, a risk that has historically been a very substantial risk for nominal bonds, for very little or no compensation.
Just to be clear, though, unexpectedly low inflation represents a type of risk too.

Of course if all you were doing is providing against your future consumption, not trying to build wealth through risky investments, then this might not be a risk you care about. But if, like many people, you have invested some of your capital in risky investments in order to try to build wealth, then often those investments are themselves going to be negatively impacted by, or at least negatively correlated in some way with, unexpectedly low inflation scenarios.

This is really the source of a lot of the benefit to historic investments in combinations of both stocks and nominal bonds--often, at least, nominal bonds were benefiting at least relatively from disinflation/deflation scenarios that were hurting stocks.

With TIPS, you are giving up this possibly beneficial positive relationship to unexpectedly low inflation as exhibited by nominal bonds.
I don't follow this argument. Historically, high inflation hasn't been great for assets like stocks, at least not in the short- or mid-term. And if high inflation leads to high interest rates, it hasn't been historically kind to real estate either (as an investment). It was comparatively much harder to sell a home back when mortgage interest rates were above 10% than it is now.
Well, as a general rule, unexpected bad things are bad for stocks.

That can include unexpectedly high inflation scenarios, but it can also include unexpectedly low inflation scenarios. What often really matters is why that is happening.

Unexpectedly high inflation, for example, can be caused by a critical supply shortage. This can disrupt various business plans and reduce the returns on existing capital investments.

Unexpectedly low inflation, for example, can be caused by a consumer demand shock. This can also disrupt various business plans and reduce the returns on existing capital investments.

We in fact have seen a couple recent economic crises which were disinflationary/deflationary in nature, and stocks did take a big hit. But, at least in the U.S., these times stocks bounced back relatively quickly. So as long as you didn't panic sell, you probably did OK, and maybe better than OK if you were buying (either as usual from income or through rebalancing or something).

But stocks have not always bounced back quickly throughout history in disinflationary/deflationary scenarios. And in those scenarios, higher-quality bonds often (as long as the crisis was not too severe) ended up serving as a useful hedge.

TIPS, though, will track unexpectedly low inflation down. There is a floor in the sense they cannot go negative. But they won't experience the same increase in value that nominal bonds can experience in such scenarios.
Right. Unexpected major low/high inflation is usually bad for stocks.

We also need to understand the business cycle. During good times, stocks do well, borrowing is cheap, spending is high, but inflation also starts to climb (bad for nominal bonds). To curb this, interest rates are increased to encourage saving and discourage borrowing too much (then nominal bonds are definitely hurt). However, this causes spending to retract, which is bad for stocks. Because general saving has increased, the inflation becomes less (or even negative); this is good of nominal bonds. To spur spending and discourage saving too much, rates have to be decreased (and this definitely improves nominal bonds).

So in the normal flow of things, nominal bonds (given high enough quality) go against business cycle, stocks follow the business cycle, and TIPS will disregard the cycle. That is part of the reason why TIPS seem to follow stocks more than nominal bonds.

Unexpected major low/high inflation has a plus or minus for nominal bonds, but let us not forget how they behave in the normal cases.
Yeah, one interesting thing about TIPS is they make a very easy to understand asset on their own. Again, you might complain about the expected return you can get these days, but if you just want to provide against future real spending in a certain amount without having to worry too much about what happens between now and then, they are great for that.

But they are trickier to understand when doing overall portfolio design, in some ways trickier than nominal bonds for the reasons you just gave. That doesn't mean you shouldn't use them, maybe a lot of them, in overall portfolio design. But my two cents is they don't fit neatly into the traditional X:Y discussion of stocks and bonds (70:30, 60:40, 20:80, and such), because most of that is really based on observations about such portfolios containing nominal bonds.

So I do get a little worried for someone who might be thinking along the lines, "Well, I decided on a 70:30 portfolio, but now how much of that 30 should be in TIPS versus nominal?" Really I think people need to understand the differences between TIPS and nominal bonds, And once you start using TIPS you may not end up 70:30 anymore, and that's OK.
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Re: Why use anything but TIPS?

Post by Lalamimi »

Very timely topic for me. I have recently purchased VANGUARD SCOTTSDALE FDS LONG TERM TREASURY ETF and
SCHWAB STRATEGIC TR US TIPS ETF for TIPS (23% of Bonds), but see they are both just long term.
What would be a short term recommendation?
We also have (AGG) SHARES CORE US AGGREGATE BOND ETF, (BND) VANGUARD BD INDEX FDS TOTAL BND MRKT and FIDELITY U.S. BOND INDEX FUND (77%) for a total of 27% allocation to our portfolio, all in our IRAs.
tonyclifton
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Re: Why use anything but TIPS?

Post by tonyclifton »

To the original poster:

There is a lot of good info and perspectives in this thread. I'll add our own.

Our portfolio is currently 78% equities and 22% fixed income. The fixed income is 66% TIPS funds, 20% bond funds and 14% Cash. The 20% in bond funds are in a 457 plan that does not offer a TIPS fund and an HSA. The cash includes the emergency fund / sinking fund.

I found this book by the Finance Buff (Harry Site) to be helpful, "Explore TIPS: A Practical Guide to Investing in Treasury Inflation-Protected Securities."

As well as Larry Swedroe's, "The Only Guide to a Winning Bond Strategy You'll Ever Need: The Way Smart Money Preserves Wealth Today."

These books helped us arrive at a decision to use intermediate TIPS funds to help offset a pension that has a limited cost-of-living adjustment.

We are using low cost intermediate TIPS index fund (Vanguard Inflation-Protected Secs Adm, VAIPX) and intermediate Bond index funds (Vanguard Total Bond Market Index Fund Institutional Plus, VBPMX & FIDELITY U.S. BOND INDEX FUND, FXNAX).

At this time, we are also preferring TIPS funds to using I Bonds - mostly from a simplicity perspective vs a return perspective. This thread also has some helpful information to weigh options.

If we were to tinker, it would be to replace some of the intermediate term TIPS fund with long-term TIPS funds as the money in TIPS won't be accessed for approximately 20 to 30 years.
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Re: Why use anything but TIPS?

Post by BigJohn »

mrpotatoheadsays wrote: Wed Oct 13, 2021 8:57 am For those like me who have absolutely no idea, you split your bond portfolio equally between the two. The only caveat today is that TIPS start with a negative yield, and if you’re like me, that’s a hard pill to swallow." - Rob Berger, June 1, 2021
Why is this any harder to swallow than the nearly identical negative real yield on nominal Treasuries? Don’t be fooled by the stated nominal yield, with inflation expectation greater than that the real yield is still negative.

To the OP, I decided several years ago that I needed inflation insurance and moved to having 50% of my bond allocation in TIPS. Just like all insurance, I hoped I wouldn’t need it but am sure glad to have it right now.
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billthecat
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Re: Why use anything but TIPS?

Post by billthecat »

I don't buy TIPS because I don't understand them. It seems like you are betting that actual inflation will be higher than what folks generally expect, and I don't see why I would know better than the market.
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Re: Why use anything but TIPS?

Post by Dude2 »

billthecat wrote: Wed Oct 13, 2021 5:20 pm I don't buy TIPS because I don't understand them. It seems like you are betting that actual inflation will be higher than what folks generally expect, and I don't see why I would know better than the market.
When you purchase TIPS you remove inflation risk. If you want to take on more risk, as is stated in a post above, you should be compensated for that. Put another way, investing in nominal bonds is actually placing a bet that you will be rewarded for taking on inflation risk.
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Re: Why use anything but TIPS?

Post by willthrill81 »

BigJohn wrote: Wed Oct 13, 2021 5:17 pm
mrpotatoheadsays wrote: Wed Oct 13, 2021 8:57 am For those like me who have absolutely no idea, you split your bond portfolio equally between the two. The only caveat today is that TIPS start with a negative yield, and if you’re like me, that’s a hard pill to swallow." - Rob Berger, June 1, 2021
Why is this any harder to swallow than the nearly identical negative real yield on nominal Treasuries? Don’t be fooled by the stated nominal yield, with inflation expectation greater than that the real yield is still negative.
Correct. Far too many have a false hope that bonds paying a nominal 1.4% starting yield will somehow not have a negative return. It's possible, but the bond market as a whole is very clearly not expecting it.

The bull bond market from 1981-2012 lulled many into believing that bonds would somehow keep providing robustly positive real returns in spite of interest rates not having much further to fall without going negative.

From 1981-2012, intermediate-term Treasuries had a real return of 5.4%.

Since 2013, the real return has been .12%.

And the next decade is likely to see real returns closer to -1%.
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Re: Why use anything but TIPS?

Post by tonyclifton »

billthecat wrote: Wed Oct 13, 2021 5:20 pm I don't buy TIPS because I don't understand them. It seems like you are betting that actual inflation will be higher than what folks generally expect, and I don't see why I would know better than the market.
There is no bet. It is not a wager. If you wish to learn more about what they are the wiki has info and the two books mentioned up thread.

Saying TIPS are a bet is like saying Treasuries are a bet that the US Government won’t default. Better not!

One strong case, IMHO, against TIPS is that they haven’t been “tested” in a high inflationary period as they came into existence in 1997 and there hasn’t been a high inflationary period since then (thankfully).

If someone is seeking higher yields go for it elsewhere!
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