TIPS in a FIRE portfolio?

[boringinvestor]

Currently approaching 40 and FIRE - living off of taxable portfolio income for the most part.

Although I'm "retired" I'm curious, given the length of my investment horizon (40+ years) whether TIPS would make sense? I don't want to take undue risk by putting a higher allocation into stocks than necessary, but given my horizon should I just stick to stocks to beat inflation as opposed to long term TIPS? Especially since this is in a taxable account, it seems stocks would make more sense.

I'm in a bit of an "in-between state" as it relates to portfolio construction. Curious what folks think.

[expatFIRE]

What is your current portfolio and your target SWR?

I’m similar age with about 35 to 40% bonds, and may downshift this year. SWR may be around 3% or less. At a low enough SWR, historically a higher bond allocation has survived for 40+ years. For higher SWR of 3.5% or so, then I’d plan to be closer to 25% bonds.

I’ve been maxing Series I bonds for over a decade but it’s only about 10% of the total bond allocation. The main fund is Vanguard Total Bond with some Intermediate Muni Bond, Intermediate Treasuries, and cash.

I don’t currently have access to TIPS in 401k but I likely plan to add TIPS when I separate from the company. My current thoughts are to have my bond allocation 50/50 between nominal bonds and inflation protected bonds (I bonds, TIPS, etc.). Once I add TIPS then I may consider an allocation to Long-Term Treasuries.

[EddyB]

I have TIPS for a specific span of years when there's a meaningful chance I will have a large cost denominated in US dollars. I am happy to have them for that purpose, but otherwise have been mostly indifferent to them.

[dbr]

The first thing is to find a collection of data or a model that shows there is any convincing difference in what one holds in bonds for a reasonable withdrawal rate, a reasonable allocation to stocks, and given a length of retirement. Mostly there seems to be no convincing result available, but maybe someone has one. Even a convincing dependence on stock/bond allocation does not exist exsept at the extremes. The problem can be complicated by considering pensions, annuities, and SS, again with no clear advice that one is or isn't better off because income is annuitized rather than derived from investments of similar implied wealth. The form in which risk appears might be different in different configurations.

For convincing dependence what does exist is a strong relationship to withdrawal rate and a huge dependends on when one retires.

[Varsh]

I am looking at a similar situation. I am evaluating my TIPs/Nominals. My current allocation is 60/40. My mix is 20 Fxaix S&P 500, 15% VXUS, 20% SCHD, 5% AVUV (formerly IJR), i have tilted to value. Bonds / FI = 10% MM, 10% I bonds, 10% STT (VGSH), 10% IT - SCHR.

Now, I am working on the allocations on the FI side, to add in TIPS. Ideas I have is to go 50/50, using a combo of I bonds, SCHP, VTIP, and cash, like MM, or treasuries. I have not really drafted the plan or strategized, so your discussion will be helpful for me too.

[NiceUnparticularMan]

My understanding is if anything, sequence of (real) returns risk is a bigger, not smaller, problem for early-retirement scenarios (at least once you have controlled for needing a lower withdrawal rate due to longer expected remaining longevity). And if your planned withdrawals are at least mostly in real terms, then logically IP bonds are a better choice for moderating sequence of real returns risk.

So personally, I would not think early retirees needed to worry less about SO(R)RR, or would benefit less from using specifically IP bonds to moderate SO(R)RR.

I'd only hold nominal bonds if you think as risky assets they would improve the efficiency of your risky portfolio. I'm a bit skeptical about that proposition myself, although people have made cases for things like global bond and LT Treasuries. Even so, that should be put on the risky side, and should likely only be pretty small--like if you were going to have, say, 60% in stocks, you might instead put 54% in stocks and 6% in either global bonds or LT Treasures or both. Something like that.

[NiceUnparticularMan]

The first thing is to find a collection of data or a model that shows there is any convincing difference in what one holds in bonds for a reasonable withdrawal rate, a reasonable allocation to stocks, and given a length of retirement. Mostly there seems to be no convincing result available, but maybe someone has one.

So a completely convincing empirical result using actual TIPS data isn't going to exist because TIPS have not been around nearly long enough.

In contrast, academic studies using either models or synthetic returns have been supporting the utility of IP bonds for a long time, including since before they existed. Just to give you a little flavor, this is not directly a retirement study, more a general efficient portfolio study, but I think the applications for retirement savers specifically given SO(R)RR is pretty obvious:

https://www.tandfonline.com/doi/abs/10. ... 60.n1.2592

From the abstract:

In the study reported here, we set out to examine whether and how the availability of indexed bonds might affect investors' asset allocation decisions. We used historical yields on conventional U.S. T-bonds and an inflation-forecasting model to create a series of hypothetical indexed bond returns. We found that the real (inflation-adjusted) returns on indexed bonds are less volatile than the returns on otherwise similar conventional bonds. Moreover, the correlation with stock returns is much lower for the indexed bonds. An examination of asset allocation among stocks, indexed bonds, conventional Treasuries, and a riskless asset suggests that substantial weight should be given to indexed bonds in an efficient portfolio. These conclusions are generally supported by analysis of the history of actual returns on U.S. Treasury Inflation-Indexed Securities (commonly known as TIPS) for February 1997 through July 2003.
. . .
Naturally, the risk-reduction benefits of indexed bonds must be weighed against the possibility of a relatively low expected return. Interest rates on conventional bonds can be viewed as the sum of expected inflation, a real riskless rate of return, and a premium for inflation risk. If the inflation risk premium is positive, indexed bonds will have lower expected returns than conventional bonds. The pricing of TIPS traded in the market in the past few years suggests that the inflation risk premium may be close to zero or even negative, however, perhaps as a result of the lower liquidity of the indexed bonds. Because of these considerations, our base computations assume an inflation risk premium of zero, but we also consider alternative scenarios in which the risk premium is 50 bps or 100 bps. . . . Interestingly, using real returns, we found no role for conventional bonds unless the inflation risk premium exceeds 55 bps.
. . .
We also analyzed actual indexed bond data for 1997 through July 2003 to see whether the initial U.S. experience has been anything like our model-based predictions. The recent data confirm the suggestion of substantial diversification benefits to be had from adding TIPS. The volatility of TIPS returns has, in fact, been much lower than that observed in our historical simulation. Using the recent data to estimate risks and correlations, we again found that an efficient portfolio should give considerable weight to indexed bonds. This conclusion held for a wide range of scenarios for expected returns.

Indexed bonds dominated the efficient “tangency” portfolio in the absence of any inflation risk premium, and even with a risk premium of 50 bps, the allocation to indexed bonds exceeded that of conventional bonds.

OK, so long story short--studies like this tend to support the proposition that as long as the unexpected inflation risk premium appears to be close to zero, then 100% IP bonds seems like a good idea.

In the end, I think this comes down to appropriate default rules. Logically, an appropriate default rule starts with matching the nature of liabilities and the nature of assets. If your liabilities are themselves mostly or entirely inflation-linked, then it would seem like your matching assets should be mostly or entirely inflation-linked, barring some compelling reason to do something else.

What studies like the above indicate is that as long as TIPS do not have a high unexpected inflation insurance premium over comparable nominal bonds, then it is very unlikely there will be such a compelling reason not to stick with that default rule.

Nonetheless, a lot of people here still seem to think that even if their liabilities are mostly or entirely inflation-linked, they should either have very little in IP bonds or at most half in IP bonds. I really don't see the logic for such a default rule, and I don't know of any compelling reason to think it will work better in practice specifically for retirement savers.

[dbr]

The first thing is to find a collection of data or a model that shows there is any convincing difference in what one holds in bonds for a reasonable withdrawal rate, a reasonable allocation to stocks, and given a length of retirement. Mostly there seems to be no convincing result available, but maybe someone has one.

So a completely convincing empirical result using actual TIPS data isn't going to exist because TIPS have not been around nearly long enough.

In contrast, academic studies using either models or synthetic returns have been supporting the utility of IP bonds for a long time, including since before they existed. Just to give you a little flavor, this is not directly a retirement study, more a general efficient portfolio study, but I think the applications for retirement savers specifically given SO(R)RR is pretty obvious:

https://www.tandfonline.com/doi/abs/10. ... 60.n1.2592

Thanks for the info.

By the way, you are talking to a person who started retirement at 50/50 TIPS/Treasuries, never could understand why not 100% TIPS, and has put their money where their mouth is now at 100% TIPS. For me intermediate duration TIPS funds are close enough whatever the precise theoretical configuration might be. It would have made sense for me to be 100% TIPS from they day they came out. That would be less than half my investing lifetime, though, maybe 25 out of 60 years.

[aristotelian]

TIPS have the same long term expected return as nominal Treasuries. Unless you have an extremely large bond allocation, I don't see them making a major difference in your safe withdrawal rate.

TIPS have been in existence just since 1997 so there isn't going to be any data available to backtest to determine a historical SWR.

[dbr]

TIPS have the same long term expected return as nominal Treasuries. Unless you have an extremely large bond allocation, I don't see them making a major difference in your safe withdrawal rate.

TIPS have been in existence just since 1997 so there isn't going to be any data available to backtest to determine a historical SWR.

The conclusion between the above likely fact and the apparent very small risk premium is that one might as well hold TIPS if one wants credit risk free holding and likes relating to real spending and real returns. One would not take exception to choosing other options.

[NiceUnparticularMan]

By the way, you are talking to a person who started retirement at 50/50 TIPS/Treasuries, never could understand why not 100% TIPS, and has put their money where their mouth is now at 100% TIPS. For me intermediate duration TIPS funds are close enough whatever the precise theoretical configuration might be. It would have made sense for me to be 100% TIPS from they day they came out. That would be less than half my investing lifetime, though, maybe 25 out of 60 years.

Yeah, the bottom line is it hasn't been very consequential yet in the actual (short) history of really easily investable TIPS. So no one on the spectrum of 0% TIPS through 50% TIPS to 100% TIPS has been significantly prejudiced--yet.

At some point, though, this could really matter for retirees (at least retirees looking to cut it somewhat close in terms of planned withdrawals). And in fact, while hopefully not, last year could have been the beginning of it mattering in the next long period. If last year was just a bump in the road, no. If it was the beginning of a new era in USD inflation history, maybe yes.

Point being no one needs to be too concerned looking backward, but looking forward, it is as good a time as any to being looking seriously at this issue.

[NiceUnparticularMan]

TIPS have the same long term expected return as nominal Treasuries. Unless you have an extremely large bond allocation, I don't see them making a major difference in your safe withdrawal rate.

So of course due sequence of (real) returns risk and how that affects "safe" withdrawal rates, your second proposition doesn't follow from the first. Meaning two assets could have similar long-term expected returns but one could do a lot more to moderate SO(R)RR than the other. Indeed, that is really the only good reason for retirees not to be 100% stocks in the first place, that despite having a favorably high expected return they also have a lot of SO(R)RR.

TIPS have been in existence just since 1997 so there isn't going to be any data available to backtest to determine a historical SWR.

Indeed, but the sorts of half-synthetic, half-empirical study I linked suggest that IP bonds should be more efficient at moderating SO(R)RR. This is not a surprise, it makes sense for basic logical reasons. And so this sort of study, while not completely decisive, at least confirms there is no obvious reason to think otherwise.

[chrisdds98]

I FIREd at 43 and about 80% of my bonds are TIPS. longterm inflation expectations are quite low (2.5% or so) and inflation is a big risk for a fixed income portfolio so why not?

I wish someone would come up with a long TIPS fund with a decent expense ratio... 20 basis points seems steep for managing a dozen bonds

[NiceUnparticularMan]

I wish someone would come up with a long TIPS fund with a decent expense ratio... 20 basis points seems steep for managing a dozen bonds

Yeah, this seems to point to the general unpopularity of TIPS for longer-term real liability matching, which is odd. Like, there are cheap ST TIPS funds, cheap broader market TIPS funds, but as you point out no cheap longer-term TIPS funds.

And indeed a total lack of competition--LTPZ is the only TIPS ETF longer than a market TIPS fund I know of, and it is at best a modestly-sized fund. DFA has a mutual fund, and that is about it. In contrast, there are way more longer-term nominal Treasury ETFs.

So for whatever reason, this is apparently a very low-demand part of the retail fund market with no real competition. Oh well.

[secondopinion]

The first thing is to find a collection of data or a model that shows there is any convincing difference in what one holds in bonds for a reasonable withdrawal rate, a reasonable allocation to stocks, and given a length of retirement. Mostly there seems to be no convincing result available, but maybe someone has one.

So a completely convincing empirical result using actual TIPS data isn't going to exist because TIPS have not been around nearly long enough.

In contrast, academic studies using either models or synthetic returns have been supporting the utility of IP bonds for a long time, including since before they existed. Just to give you a little flavor, this is not directly a retirement study, more a general efficient portfolio study, but I think the applications for retirement savers specifically given SO(R)RR is pretty obvious:

https://www.tandfonline.com/doi/abs/10. ... 60.n1.2592

From the abstract:

In the study reported here, we set out to examine whether and how the availability of indexed bonds might affect investors' asset allocation decisions. We used historical yields on conventional U.S. T-bonds and an inflation-forecasting model to create a series of hypothetical indexed bond returns. We found that the real (inflation-adjusted) returns on indexed bonds are less volatile than the returns on otherwise similar conventional bonds. Moreover, the correlation with stock returns is much lower for the indexed bonds. An examination of asset allocation among stocks, indexed bonds, conventional Treasuries, and a riskless asset suggests that substantial weight should be given to indexed bonds in an efficient portfolio. These conclusions are generally supported by analysis of the history of actual returns on U.S. Treasury Inflation-Indexed Securities (commonly known as TIPS) for February 1997 through July 2003.
. . .
Naturally, the risk-reduction benefits of indexed bonds must be weighed against the possibility of a relatively low expected return. Interest rates on conventional bonds can be viewed as the sum of expected inflation, a real riskless rate of return, and a premium for inflation risk. If the inflation risk premium is positive, indexed bonds will have lower expected returns than conventional bonds. The pricing of TIPS traded in the market in the past few years suggests that the inflation risk premium may be close to zero or even negative, however, perhaps as a result of the lower liquidity of the indexed bonds. Because of these considerations, our base computations assume an inflation risk premium of zero, but we also consider alternative scenarios in which the risk premium is 50 bps or 100 bps. . . . Interestingly, using real returns, we found no role for conventional bonds unless the inflation risk premium exceeds 55 bps.
. . .
We also analyzed actual indexed bond data for 1997 through July 2003 to see whether the initial U.S. experience has been anything like our model-based predictions. The recent data confirm the suggestion of substantial diversification benefits to be had from adding TIPS. The volatility of TIPS returns has, in fact, been much lower than that observed in our historical simulation. Using the recent data to estimate risks and correlations, we again found that an efficient portfolio should give considerable weight to indexed bonds. This conclusion held for a wide range of scenarios for expected returns.

Indexed bonds dominated the efficient “tangency” portfolio in the absence of any inflation risk premium, and even with a risk premium of 50 bps, the allocation to indexed bonds exceeded that of conventional bonds.

OK, so long story short--studies like this tend to support the proposition that as long as the unexpected inflation risk premium appears to be close to zero, then 100% IP bonds seems like a good idea.

In the end, I think this comes down to appropriate default rules. Logically, an appropriate default rule starts with matching the nature of liabilities and the nature of assets. If your liabilities are themselves mostly or entirely inflation-linked, then it would seem like your matching assets should be mostly or entirely inflation-linked, barring some compelling reason to do something else.

What studies like the above indicate is that as long as TIPS do not have a high unexpected inflation insurance premium over comparable nominal bonds, then it is very unlikely there will be such a compelling reason not to stick with that default rule.

Nonetheless, a lot of people here still seem to think that even if their liabilities are mostly or entirely inflation-linked, they should either have very little in IP bonds or at most half in IP bonds. I really don't see the logic for such a default rule, and I don't know of any compelling reason to think it will work better in practice specifically for retirement savers.

I would agree that IP bonds are generally a good idea; however, I did think of something: companies borrow money with loans/bonds that are nominal rate or floating rate as a means to get leverage. With this in mind, is there any reason with investing in those loans/bonds as to "deleverage" their stock holdings? Maybe just a random thought.

[NiceUnparticularMan]

I would agree that IP bonds are generally a good idea; however, I did think of something: companies borrow money with loans/bonds that are nominal rate or floating rate as a means to get leverage. With this in mind, is there any reason with investing in those loans/bonds as to "deleverage" their stock holdings? Maybe just a random thought.

So generally speaking I think managing their own leverage/financing is actually part of what is efficient about the corporate form and something to embrace as a diversified stock owner. I note too that if, say, a company is buying a long-term capital asset, and financing that purchase with a loan/bond, while you can think of that as a form of leverage, I personally think it can be another form of matching assets to liabilities.

But yes, I suppose if you wanted more of a pure bet on the assets of the companies (tangible or intangible), you could buy their corporate bonds. I am not sure just any corporate bond fund would really work for that purpose, though, even if you bought diversified stock funds. I think you would have to confirm that was not leaving you with too few bonds for some companies, too many for others, and so on.

Indeed, my understanding is corporate bond funds typically include bonds issues by private corporations. So I would think those are automatically mismatched to stocks. And then there are corporate loans which are not securitized. And so on.

So in practice, this seems like a hard concept to implement. And personally, I don't really see the point.

[secondopinion]

I would agree that IP bonds are generally a good idea; however, I did think of something: companies borrow money with loans/bonds that are nominal rate or floating rate as a means to get leverage. With this in mind, is there any reason with investing in those loans/bonds as to "deleverage" their stock holdings? Maybe just a random thought.

So generally speaking I think managing their own leverage/financing is actually part of what is efficient about the corporate form and something to embrace as a diversified stock owner. I note too that if, say, a company is buying a long-term capital asset, and financing that purchase with a loan/bond, while you can think of that as a form of leverage, I personally think it can be another form of matching assets to liabilities.

But yes, I suppose if you wanted more of a pure bet on the assets of the companies (tangible or intangible), you could buy their corporate bonds. I am not sure just any corporate bond fund would really work for that purpose, though, even if you bought diversified stock funds. I think you would have to confirm that was not leaving you with too few bonds for some companies, too many for others, and so on.

Indeed, my understanding is corporate bond funds typically include bonds issues by private corporations. So I would think those are automatically mismatched to stocks. And then there are corporate loans which are not securitized. And so on.

So in practice, this seems like a hard concept to implement. And personally, I don't really see the point.

If we believe that public stocks are good enough to ignore private stocks, then I would think generalized corporate bonds would at least approximate the process.

[steadyosmosis]

Currently approaching 40 and FIRE - living off of taxable portfolio income for the most part.

Although I'm "retired" I'm curious, given the length of my investment horizon (40+ years) whether TIPS would make sense? I don't want to take undue risk by putting a higher allocation into stocks than necessary, but given my horizon should I just stick to stocks to beat inflation as opposed to long term TIPS? Especially since this is in a taxable account, it seems stocks would make more sense.

I'm in a bit of an "in-between state" as it relates to portfolio construction. Curious what folks think.

I retired early, and hold no TIPS, with a similar time horizon and ~60/40 portfolio.
My taxable, Roth, and HSA accounts are 100% equities.
Fixed income (mostly US bond index) is in tax-deferred accounts.

[NiceUnparticularMan]

If we believe that public stocks are good enough to ignore private stocks, then I would think generalized corporate bonds would at least approximate the process.

Maybe?

Part of my point is financing is really a very business-specific decision, and I would not personally assuming public companies collectively resemble private companies collectively in terms of how they are financed.

I note in terms of equity investments, it is also arguably suboptimal that capital is invested in private companies, and I am not investing in those companies. But I really don't see anything useful to do about it, so oh well.

[chrisdds98]

Currently approaching 40 and FIRE - living off of taxable portfolio income for the most part.

Although I'm "retired" I'm curious, given the length of my investment horizon (40+ years) whether TIPS would make sense? I don't want to take undue risk by putting a higher allocation into stocks than necessary, but given my horizon should I just stick to stocks to beat inflation as opposed to long term TIPS? Especially since this is in a taxable account, it seems stocks would make more sense.

I'm in a bit of an "in-between state" as it relates to portfolio construction. Curious what folks think.

I retired early, and hold no TIPS, with a similar time horizon and ~60/40 portfolio.
My taxable, Roth, and HSA accounts are 100% equities.
Fixed income (mostly US bond index) is in tax-deferred accounts.

why don't you have TIPS? a long period of high inflation will wreck a nominal fixed income portfolio, right? what benefit do you get for taking this risk?

[KlangFool]

Currently approaching 40 and FIRE - living off of taxable portfolio income for the most part.

Although I'm "retired" I'm curious, given the length of my investment horizon (40+ years) whether TIPS would make sense? I don't want to take undue risk by putting a higher allocation into stocks than necessary, but given my horizon should I just stick to stocks to beat inflation as opposed to long term TIPS? Especially since this is in a taxable account, it seems stocks would make more sense.

I'm in a bit of an "in-between state" as it relates to portfolio construction. Curious what folks think.

The answer is highly dependent on the size of your portfolio. What is the size of your portfolio versus your annual expense? What is your SWR?

KlangFool

[steadyosmosis]

Currently approaching 40 and FIRE - living off of taxable portfolio income for the most part.

Although I'm "retired" I'm curious, given the length of my investment horizon (40+ years) whether TIPS would make sense? I don't want to take undue risk by putting a higher allocation into stocks than necessary, but given my horizon should I just stick to stocks to beat inflation as opposed to long term TIPS? Especially since this is in a taxable account, it seems stocks would make more sense.

I'm in a bit of an "in-between state" as it relates to portfolio construction. Curious what folks think.

I retired early, and hold no TIPS, with a similar time horizon and ~60/40 portfolio.
My taxable, Roth, and HSA accounts are 100% equities.
Fixed income (mostly US bond index) is in tax-deferred accounts.

why don't you have TIPS? I am not (yet) convinced I need them, but I do keep reading what others here write about them.
a long period of high inflation will wreck a nominal fixed income portfolio, right? I don't know for sure.
what benefit do you get for taking this risk? Well, I guess I just keep a simpler portfolio.

Replies in blue above. Good questions. Maybe someday I will add TIPS.

[9-5 Suited]

A few years from 40 and I'm FIRE but spouse still working (so I suppose a contested bit of terminology if I'm FIRE or a stay-at-home-husband, but we have the resources so I count it).

We have ~30% in fixed income. About half of the fixed income is in long-term bonds to match our long-term time horizon (per guidance from Vineviz). Those long-term fixed income assets are primarily in TIPS via LTPZ, since inflation over decades can absolutely wreck long-term nominal bonds. We do have some long-term nominals, but not a lot. Over a long time horizon, a long-term TIPS bond is as close to the risk free rate as you can get.

For the shorter-term fixed income, which often ends up being the primary source of any needed withdrawals above spouse's income, that is invested in mostly nominal instruments (short and intermediate duration treasuries, leaning toward intermediate). Not as worried about effects of inflation on our ability to live life over the next <10 years. We can adapt to it pretty easily if needed.

And of course, the 70% equity share with a small/value tilt and heavy international weighting is also expected to produce significant long-term inflation protection in its own right.