Alex Frakt wrote:The problem is that [nominal bonds] may take a few years to catch up to an inflation spike. This makes TIPS preferable when you need to live off the income, but doesn't really come into the picture if you are 10+ years away from retirement.
Alex, just out of curiosity, is there anything you don't find particularly persuasive about holding TIPS as a non-correlated asset in a portfolio? Just as you have indicated that investors who are in the accumulation phase need not be too concerned with the yield on nominal bonds (thus implying that their value comes not from their yield but from their non-correlation with equities in the portfolio), would it not be worthwhile to hold a real-return asset that is itself not fully correlated with nominal bonds, and which also happens to be less correlated with equities than nominal bonds are?
It would seem that this aspect of holding TIPS could be of even greater relative value for younger investors, as a real-return asset could boost portfolio returns over time (particularly in the event of shocks to expected inflation). I would think that the expected value derived from rebalancing between the nominal and real return bond allocations (as well as with the equity allocation) would exceed the predicted difference in the yields of the different types of treasuries (the "insurance premium" that folks keep alluding to).
First, I was not "implying that [nominal bonds] value comes not from their yield but from their non-correlation with equities in the portfolio" if by that you mean the value comes only
from that non-correlation. I was actually answering a different question - whether nominals offer inflation protection - which I hope was clear from the sentence preceding the one you quoted:
Nominal bonds work fine for long-term inflation protection with real annual returns since 1926 of around 2 1/4% (which is around 50bp greater than the current TIPS real yield).
Obviously instruments with a 2 1/4% real return have a value over and above any derived from a rebalancing bonus due to its low correlation with another asset class. So while bonds do offer low correlations with equities, they also offer real growth. But the most important reason for holding bonds is risk reduction. And by risk reduction I don't just mean some academic measure of volatility, I mean protection against all the black and white swan weirdness that can and does occur in the equity markets.
Which brings us back to your question on the value of using TIPS to slice and dice your bond holdings. If I wanted to S&D bonds, I would be looking for asset classes with risk profiles that complemented each other. It seems to me that Intermediate investment grade corporates and short or limited term nominal Treasuries provides a better risk/return mix than TIPS + anything else in the majority of possible economic scenarios.
But once again, I'm not opposed to the use of TIPS. They are an extremely valuable tool for certain situations: in particular for wealth preservation. For example, for anyone who has enough assets to swing it, putting enough in TIPS that you can live off the real yield and investing the rest in equities makes perfect sense. And even in those cases where I think the use of TIPS is less than optimal, they are never really a bad choice.