Would TIPS behave any differently than nominal bonds in high inflation?

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tcrez
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Would TIPS behave any differently than nominal bonds in high inflation?

Post by tcrez »

When looking at total return, TIPS and nominal bonds (longer duration) have been very closely correlated in their entire history of around 20 years. TIPS did a bit better in 2022 when inflation took off, but were still hit badly by rising interest rates. Real yields on TIPS went from -2% to +2%.

Anyone know what likely would happened in the 70s of high inflation?

Also, can you roll forward 1 month tips to avoid any duration risk?
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Re: Would TIPS behave any differently than nominal bonds in high inflation?

Post by jebmke »

I don't think a one month TIPs bond buys you any inflation protection.
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Re: Would TIPS behave any differently than nominal bonds in high inflation?

Post by retired@50 »

tcrez wrote: Mon May 13, 2024 9:59 am
Also, can you roll forward 1 month tips to avoid any duration risk?
According to treasurydirect.gov TIPS are sold in 5, 10, and 30 year terms.

If you want a 1 month TIPS bond (or other short term TIPS), you'd have to buy it on the secondary market, which means you'd be paying market price at the time of purchase.

https://www.treasurydirect.gov/marketab ... ties/tips/

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Re: Would TIPS behave any differently than nominal bonds in high inflation?

Post by toddthebod »

tcrez wrote: Mon May 13, 2024 9:59 am When looking at total return, TIPS and nominal bonds (longer duration) have been very closely correlated in their entire history of around 20 years. TIPS did a bit better in 2022 when inflation took off, but were still hit badly by rising interest rates. Real yields on TIPS went from -2% to +2%.

Anyone know what likely would happened in the 70s of high inflation?

Also, can you roll forward 1 month tips to avoid any duration risk?
So far, what we've learned in the almost 30 years of existence of TIPS is that the interest rates move pretty much in tandem with nominal rates, so all interest rate, duration, and reinvestment risk will be similar. What we saw in 2022, though, was that in a period of high inflation, the nominal yields on TIPS will be much better.

As to your second question, the inflation adjustment on TIPS is known about two months in advance.
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Re: Would TIPS behave any differently than nominal bonds in high inflation?

Post by jebmke »

retired@50 wrote: Mon May 13, 2024 10:07 am
tcrez wrote: Mon May 13, 2024 9:59 am
Also, can you roll forward 1 month tips to avoid any duration risk?
According to treasurydirect.gov TIPS are sold in 5, 10, and 30 year terms.

If you want a 1 month TIPS bond (or other short term TIPS), you'd have to buy it on the secondary market, which means you'd be paying market price at the time of purchase.

https://www.treasurydirect.gov/marketab ... ties/tips/

Regards,
and typically TIPS have maturity dates such that there are times when getting one month may not be possible. The real yield on July 15 is zero right now so the nominal yield is baked I think.
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tcrez
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Re: Would TIPS behave any differently than nominal bonds in high inflation?

Post by tcrez »

toddthebod wrote: Mon May 13, 2024 10:10 am
tcrez wrote: Mon May 13, 2024 9:59 am When looking at total return, TIPS and nominal bonds (longer duration) have been very closely correlated in their entire history of around 20 years. TIPS did a bit better in 2022 when inflation took off, but were still hit badly by rising interest rates. Real yields on TIPS went from -2% to +2%.

Anyone know what likely would happened in the 70s of high inflation?

Also, can you roll forward 1 month tips to avoid any duration risk?
So far, what we've learned in the almost 30 years of existence of TIPS is that the interest rates move pretty much in tandem with nominal rates, so all interest rate, duration, and reinvestment risk will be similar. What we saw in 2022, though, was that in a period of high inflation, the nominal yields on TIPS will be much better.

As to your second question, the inflation adjustment on TIPS is known about two months in advance.
A total return chart has the long duration TIPS ETF or LTPZ returned -30% since the start of 2021 while a similar duration nominal treasury ETF or TLT returned -38%.

So TIPS did better, but not enough to counter the hit from rising rates.
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Re: Would TIPS behave any differently than nominal bonds in high inflation?

Post by toddthebod »

tcrez wrote: Mon May 13, 2024 10:22 am
toddthebod wrote: Mon May 13, 2024 10:10 am
tcrez wrote: Mon May 13, 2024 9:59 am When looking at total return, TIPS and nominal bonds (longer duration) have been very closely correlated in their entire history of around 20 years. TIPS did a bit better in 2022 when inflation took off, but were still hit badly by rising interest rates. Real yields on TIPS went from -2% to +2%.

Anyone know what likely would happened in the 70s of high inflation?

Also, can you roll forward 1 month tips to avoid any duration risk?
So far, what we've learned in the almost 30 years of existence of TIPS is that the interest rates move pretty much in tandem with nominal rates, so all interest rate, duration, and reinvestment risk will be similar. What we saw in 2022, though, was that in a period of high inflation, the nominal yields on TIPS will be much better.

As to your second question, the inflation adjustment on TIPS is known about two months in advance.
A total return chart has the long duration TIPS ETF or LTPZ returned -30% since the start of 2021 while a similar duration nominal treasury ETF or TLT returned -38%.

So TIPS did better, but not enough to counter the hit from rising rates.
Right. That's what I said.
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Re: Would TIPS behave any differently than nominal bonds in high inflation?

Post by TimeIsYourFriend »

Pick your poison if you don't/can't duration-match bond selling. If the duration is too long, then you face losses due to rising rates. If the duration is too short, then you face the risk of lower yields when you go to re-invest.
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Re: Would TIPS behave any differently than nominal bonds in high inflation?

Post by watchnerd »

tcrez wrote: Mon May 13, 2024 9:59 am Also, can you roll forward 1 month tips to avoid any duration risk?
Why not just hold 1 month T-bills instead of buying nearly maturing TIPS on the secondary market?
Last edited by watchnerd on Mon May 13, 2024 11:22 am, edited 2 times in total.
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Re: Would TIPS behave any differently than nominal bonds in high inflation?

Post by tcrez »

watchnerd wrote: Mon May 13, 2024 11:20 am
tcrez wrote: Mon May 13, 2024 9:59 am Also, can you roll forward 1 month tips to avoid any duration risk?
Why not just hold 1 month T-bills instead?
To counter unexpected inflation.

If there aren’t 1 month TIPS then maybe 3-6 month TIPS then?
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Re: Would TIPS behave any differently than nominal bonds in high inflation?

Post by watchnerd »

tcrez wrote: Mon May 13, 2024 11:22 am
watchnerd wrote: Mon May 13, 2024 11:20 am
tcrez wrote: Mon May 13, 2024 9:59 am Also, can you roll forward 1 month tips to avoid any duration risk?
Why not just hold 1 month T-bills instead?
To counter unexpected inflation.

If there aren’t 1 month TIPS then maybe 3-6 month TIPS then?
T-bills also respond quickly to rate hikes.

The spread on a nearly maturing TIPS is going to be wicked to drum up sellers instead of them just waiting for maturity.

Why would I sell you a 3-6 month TIPS on the secondary market if it's about to mature? Unless you're willing to pay way more than me just holding on.
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Re: Would TIPS behave any differently than nominal bonds in high inflation?

Post by tcrez »

watchnerd wrote: Mon May 13, 2024 11:24 am
tcrez wrote: Mon May 13, 2024 11:22 am
watchnerd wrote: Mon May 13, 2024 11:20 am
tcrez wrote: Mon May 13, 2024 9:59 am Also, can you roll forward 1 month tips to avoid any duration risk?
Why not just hold 1 month T-bills instead?
To counter unexpected inflation.

If there aren’t 1 month TIPS then maybe 3-6 month TIPS then?
T-bills also respond quickly to rate hikes.

The spread on a nearly maturing TIPS is going to be wicked to drum up sellers instead of them just waiting for maturity.

Why would I sell you a 3-6 month TIPS on the secondary market if it's about to mature? Unless you're willing to pay way more than me just holding on.
When inflation in the US was 9%, rates were still something like 3%. So I’d much rather have collected the inflation rate than tbt T-bill rate. That has flipped now, but wasn’t the case 2021-2022.

Why should 3-6 month TIPS be overpriced?
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Re: Would TIPS behave any differently than nominal bonds in high inflation?

Post by watchnerd »

tcrez wrote: Mon May 13, 2024 11:29 am
watchnerd wrote: Mon May 13, 2024 11:24 am
tcrez wrote: Mon May 13, 2024 11:22 am
watchnerd wrote: Mon May 13, 2024 11:20 am
tcrez wrote: Mon May 13, 2024 9:59 am Also, can you roll forward 1 month tips to avoid any duration risk?
Why not just hold 1 month T-bills instead?
To counter unexpected inflation.

If there aren’t 1 month TIPS then maybe 3-6 month TIPS then?
T-bills also respond quickly to rate hikes.

The spread on a nearly maturing TIPS is going to be wicked to drum up sellers instead of them just waiting for maturity.

Why would I sell you a 3-6 month TIPS on the secondary market if it's about to mature? Unless you're willing to pay way more than me just holding on.
When inflation in the US was 9%, rates were still something like 3%. So I’d much rather have collected the inflation rate than tbt T-bill rate. That has flipped now, but wasn’t the case 2021-2022.

Why should 3-6 month TIPS be overpriced?
CUSIP: 912828WU0

Matures: 7/15/24

YTM: -0.173%

CUSIP: 912828YL8

Matures: 10/15/24

YTM: 1.7%

Why would you buy these?

The first one has negative real yield.

The second one has slightly less real yield than current 3 month T-bill (1.7% vs 1.89%, assuming current 3.5% CPI inflation).
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Re: Would TIPS behave any differently than nominal bonds in high inflation?

Post by Elysium »

tcrez wrote: Mon May 13, 2024 9:59 am When looking at total return, TIPS and nominal bonds (longer duration) have been very closely correlated in their entire history of around 20 years. TIPS did a bit better in 2022 when inflation took off, but were still hit badly by rising interest rates. Real yields on TIPS went from -2% to +2%.

Anyone know what likely would happened in the 70s of high inflation?

Also, can you roll forward 1 month tips to avoid any duration risk?
I have some to compare from my own investments in TIPS, Short Bonds, MMF, and Stable Vale funds in different accounts. Beginning 2021 to 2024, the best performers is in this order -> SV, MMF, Short Bonds, TIPS. TBM is next, Long Bonds on the extreme end. You get the idea, TIPS funds did better than nominals, but not as well as T-Bills, MMF, SV, or Short Bonds. Although Short TIPS fund did better. Take your pick, if you want guarantees then only duration matched individual TIPS would do, for short spikes of inflation if holding funds then better to have T-Bills, MMF, or Short TIPS.

If you are asking about collecting higher yield alone, then it's a different question, in that case holding a TIPS fund will yield better in high inflation. But I don't get the point of it, as I am used to looking at total return. If you spend yield and not re-invest it affects the end value and then it's all a wash at end. So what's the point of that.
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Re: Would TIPS behave any differently than nominal bonds in high inflation?

Post by rockstar »

The history is all there. TIPS went to negative yields and sold for more than par. You only have to go back a couple of years for this info. So you were actually incentivized to sell then.
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Re: Would TIPS behave any differently than nominal bonds in high inflation?

Post by watchnerd »

rockstar wrote: Mon May 13, 2024 11:47 am The history is all there. TIPS went to negative yields and sold for more than par. You only have to go back a couple of years for this info. So you were actually incentivized to sell then.
Looks like 2 months TIPS are giving negative YTM right now on the secondary market.

i.e. you have to pay people extra to ditch them prematurely
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Re: Would TIPS behave any differently than nominal bonds in high inflation?

Post by exodusing »

tcrez wrote: Mon May 13, 2024 11:22 am
watchnerd wrote: Mon May 13, 2024 11:20 am
tcrez wrote: Mon May 13, 2024 9:59 am Also, can you roll forward 1 month tips to avoid any duration risk?
Why not just hold 1 month T-bills instead?
To counter unexpected inflation.

If there aren’t 1 month TIPS then maybe 3-6 month TIPS then?
It appears that inflation is easier to predict over the very short run than much longer time frames.

Short TIPS would have to be purchased in the secondary market, although that shouldn't be a problem. If you're just going to roll over your TIPS, a fund is likely much easier.
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Re: Would TIPS behave any differently than nominal bonds in high inflation?

Post by rockstar »

watchnerd wrote: Mon May 13, 2024 11:51 am
rockstar wrote: Mon May 13, 2024 11:47 am The history is all there. TIPS went to negative yields and sold for more than par. You only have to go back a couple of years for this info. So you were actually incentivized to sell then.
Looks like 2 months TIPS are giving negative YTM right now on the secondary market.

i.e. you have to pay people extra to ditch them prematurely
If you watch TIPS, they always go negative right before they mature. But the July 15s are still selling above par. You can see the YTM for Oct 15s also dropping.

I’m talking about TIPS going negative with still 5+ years out. This happened a couple of years ago.

I’m sure Kevin M has more to say about TIPS YTM dropping ahead of maturity. I haven’t dug much into it, but I’m aware that it happens.
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Re: Would TIPS behave any differently than nominal bonds in high inflation?

Post by watchnerd »

rockstar wrote: Mon May 13, 2024 12:02 pm
watchnerd wrote: Mon May 13, 2024 11:51 am
rockstar wrote: Mon May 13, 2024 11:47 am The history is all there. TIPS went to negative yields and sold for more than par. You only have to go back a couple of years for this info. So you were actually incentivized to sell then.
Looks like 2 months TIPS are giving negative YTM right now on the secondary market.

i.e. you have to pay people extra to ditch them prematurely
If you watch TIPS, they always go negative right before they mature. But the July 15s are still selling above par. You can see the YTM for Oct 15s also dropping.
Of course, that makes market sense -- unless desperate for liquidity, why would anyone sell soon-maturing TIPS if they couldn't make a profit?

Which is why OP's idea to buy <3 months TIPS seems odd -- one is going to pay a premium for doing so.
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Re: Would TIPS behave any differently than nominal bonds in high inflation?

Post by er999 »

That is the whole point of buying an individual long dated tips vs a nominal treasury— protection from unexpected inflation. You might get different results with a tips fund as if there is unexpected inflation rates will likely rise to combat it leading to a fall in the fund’s value that may not be offset by the inflation protection rise (like happened in 2022)
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Re: Would TIPS behave any differently than nominal bonds in high inflation?

Post by rockstar »

watchnerd wrote: Mon May 13, 2024 12:07 pm
rockstar wrote: Mon May 13, 2024 12:02 pm
watchnerd wrote: Mon May 13, 2024 11:51 am
rockstar wrote: Mon May 13, 2024 11:47 am The history is all there. TIPS went to negative yields and sold for more than par. You only have to go back a couple of years for this info. So you were actually incentivized to sell then.
Looks like 2 months TIPS are giving negative YTM right now on the secondary market.

i.e. you have to pay people extra to ditch them prematurely
If you watch TIPS, they always go negative right before they mature. But the July 15s are still selling above par. You can see the YTM for Oct 15s also dropping.
Of course, that makes market sense -- unless desperate for liquidity, why would anyone sell soon-maturing TIPS if they couldn't make a profit?

Which is why OP's idea to buy <3 months TIPS seems odd -- one is going to pay a premium for doing so.
I wouldn’t. I’d buy t bills for those maturities. I bought my April TIPS last month. They’ll eventually get down to less than 3 months. I’d start with at least 6 month TIPS. You also have the seasonality stuff going on too, where you’ll get negative CPI.
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Re: Would TIPS behave any differently than nominal bonds in high inflation?

Post by Northern Flicker »

er999 wrote: That is the whole point of buying an individual long dated tips vs a nominal treasury— protection from unexpected inflation. You might get different results with a tips fund as if there is unexpected inflation rates will likely rise to combat it leading to a fall in the fund’s value that may not be offset by the inflation protection rise (like happened in 2022)
An individual long-dated TIPS will fall in market value if real rates rise just like a TIPS fund will. A broker will report the market value/NAV in your statement.
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Re: Would TIPS behave any differently than nominal bonds in high inflation?

Post by aristotelian »

Absolutely, the whole point of TIPS are to protect against inflation. They will outperform nominal Treasuries when inflation is higher than expenses. Nominal Treasuries will outperform TIPS when inflation is lower than expected.
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Re: Would TIPS behave any differently than nominal bonds in high inflation?

Post by rockstar »

aristotelian wrote: Mon May 13, 2024 12:34 pm Absolutely, the whole point of TIPS are to protect against inflation. They will outperform nominal Treasuries when inflation is higher than expenses. Nominal Treasuries will outperform TIPS when inflation is lower than expected.
And the expected is the breakeven. So either you agree with it or not. The 10 year last I checked was 2.3%. So if you think the Fed will be successful in bringing it back down to 2% or lower, then you win with 10 year nominals. If inflation is greater than 2.3%, then you win with TIPS.
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Re: Would TIPS behave any differently than nominal bonds in high inflation?

Post by er999 »

Northern Flicker wrote: Mon May 13, 2024 12:32 pm
er999 wrote: That is the whole point of buying an individual long dated tips vs a nominal treasury— protection from unexpected inflation. You might get different results with a tips fund as if there is unexpected inflation rates will likely rise to combat it leading to a fall in the fund’s value that may not be offset by the inflation protection rise (like happened in 2022)
An individual long-dated TIPS will fall in market value if real rates rise just like a TIPS fund will. A broker will report the market value/NAV in your statement.
Sure, you still have the loss and could have gotten a better deal if you bought that individual tips after the drop in price. However you still have the original deal you purchased — the real return of the bond if held to maturity that you knew at the time of purchase. Not so much with a tips fund.
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Re: Would TIPS behave any differently than nominal bonds in high inflation?

Post by alluringreality »

tcrez wrote: Mon May 13, 2024 9:59 am Anyone know what likely would happened in the 70s of high inflation?
Various sources have attempted to estimate TIPS performance. For example the Global Asset Allocation book has a chart for Real Returns 1973-1981 that includes an entry for TIPS synthetic series from Global Financial Data. The book does not indicate additional details regarding the item, so I have to make guesses at their intent based on other attempts at estimates. Personally I think it's difficult to guess at what might happen with near-term TIPS rates if inflation expectations became embedded, especially with the relatively limited issue compared to nominals. Series I savings bonds are currently guaranteed to offer at least 0% real, but the limits are not inflation adjusted, so the buying limits can essentially erode over time.
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Re: Would TIPS behave any differently than nominal bonds in high inflation?

Post by avalpert1 »

They might, it would depend on how the market's price they want to pay for future inflation protection goes - if people are willing to pay more for it than they will pay more for TIPS driving down yields (independent of the yield movement on nominals and inflation expectations).
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Re: Would TIPS behave any differently than nominal bonds in high inflation?

Post by Northern Flicker »

1970's inflation was US inflation that significantly outpaced global inflation. Recent inflation has been robust global where the US inflation was not more severe. In fact, the dollar strengthened in recent years.

Historically, stocks have been the best inflation hedge, but you need int'l diversification for protection when US inflation being significantly more robust than global inflation. Other assets should be held to provide adequate short term and, if needed medium term, liquidity as needed in light of the high volatility of stocks.

Vanguard uses short TIPS to provide a good source of liquidity when stocks and intermediate bonds are repricing due to rising rates and inflation. This is a good strategy, but cash also can fulfill that role.

https://www.portfoliovisualizer.com/bac ... 7jdRSEeTnX
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Re: Would TIPS behave any differently than nominal bonds in high inflation?

Post by Northern Flicker »

Inflation was sticky in the 1970's. I believe that this suggests that had TIPS existed, breakevens likely would have been a pretty good predictor of future inflation, and TIPS with term exposure would have performed somewhat better than nominal treasuries, but still would have been hit significantly by rising rates.
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Re: Would TIPS behave any differently than nominal bonds in high inflation?

Post by avalpert1 »

Northern Flicker wrote: Mon May 13, 2024 1:20 pm Historically, stocks have been the best inflation hedge,
Not really, real returns have historically been lower in times of higher inflation than in times of low inflation.
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Re: Would TIPS behave any differently than nominal bonds in high inflation?

Post by gavinsiu »

Here are my observation, keep in mind that my knowledge of bonds are somewhat limited.
  • The pricing of the bonds will factor in the expected inflation. If inflation is stable, the long term return should be above inflation and nominal bonds will have a slight real return because TIPS is essentially an insurance against inflation. Should inflation is unexpected, TIPS will win out.
  • TIPS's cpi adjustment is semi-annual, so you can't use TIPS to protect against short term inflation risk. You can't really buy a 1 month TIPS for example, if you want to buy something a month later. It would be helpful if you were using it for income. If you hold a nominal bond, then at the end of the year, your 10K bond is now worth less after inflation. If you hold a TIPS, it is adjusted for inflation so that your income rises as well.
  • If inflation persist, then I would think Stock return would eventually rise, but not in the short term because companies can't adjust for the change in the short term. Over the long terms, stocks return will return a higher real return than TIPS, if you are just saving for retirement in 30-40 years, you should probably invest more in stock than TIPS. If you are retire and need income, then TIPS might be a better bet.
  • TIPS is probably the closest thing to a certain inflation hedge. If the cpi rises, so just Tips correspondingly. Stocks may be a long term inflation hedge but the relationship with inflation is less certain. The same is also true for stuff like Gold. It might work or it might not.
  • How would TIPS do in the 70's? I have no idea. My guess is that they do better than nominal because there was a lot of unpredictable inflation.
  • One good use for TIPS that if you can estimate how much money you would actually need in retirement, you can probably build a TIPS ladder that pays the income you need. This would be better than using nominal since if inflation shoots up, you are still good. If you get deflation, then you get your original principle back plus some extra return from the deflation.
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Re: Would TIPS behave any differently than nominal bonds in high inflation?

Post by rockstar »

avalpert1 wrote: Mon May 13, 2024 1:30 pm
Northern Flicker wrote: Mon May 13, 2024 1:20 pm Historically, stocks have been the best inflation hedge,
Not really, real returns have historically been lower in times of higher inflation than in times of low inflation.
If you’re bored, go and read the old Berkshire letters about inflation. They’re pretty basic, but they’re interesting. Corporate taxation rates definitely have an impact, and they’re much lower today than back then.
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Re: Would TIPS behave any differently than nominal bonds in high inflation?

Post by watchnerd »

gavinsiu wrote: Mon May 13, 2024 2:18 pm Here are my observation, keep in mind that my knowledge of bonds are somewhat limited.
  • The pricing of the bonds will factor in the expected inflation. If inflation is stable, the long term return should be above inflation and nominal bonds will have a slight real return because TIPS is essentially an insurance against inflation. Should inflation is unexpected, TIPS will win out.
This is not necessarily true.

During ZIRP, there were times when both nominals and TIPS were giving negative real yields relative to the inflation vs interest rates at that time.
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Re: Would TIPS behave any differently than nominal bonds in high inflation?

Post by Northern Flicker »

avalpert1 wrote: Mon May 13, 2024 1:30 pm
Northern Flicker wrote: Mon May 13, 2024 1:20 pm Historically, stocks have been the best inflation hedge,
Not really, real returns have historically been lower in times of higher inflation than in times of low inflation.
The part of my post you did not quote back is salient:
Other assets should be held to provide adequate short term and, if needed medium term, liquidity as needed in light of the high volatility of stocks.
Over medium and longer terms stocks have outpaced inflation. Over short time periods you need a good source of liquidity when stocks experience volatility. One of those scenarios is when stocks reprice due to increases in interest rates.
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Re: Would TIPS behave any differently than nominal bonds in high inflation?

Post by Northern Flicker »

er999 wrote: Mon May 13, 2024 12:57 pm
Northern Flicker wrote: Mon May 13, 2024 12:32 pm
er999 wrote: That is the whole point of buying an individual long dated tips vs a nominal treasury— protection from unexpected inflation. You might get different results with a tips fund as if there is unexpected inflation rates will likely rise to combat it leading to a fall in the fund’s value that may not be offset by the inflation protection rise (like happened in 2022)
An individual long-dated TIPS will fall in market value if real rates rise just like a TIPS fund will. A broker will report the market value/NAV in your statement.
Sure, you still have the loss and could have gotten a better deal if you bought that individual tips after the drop in price. However you still have the original deal you purchased — the real return of the bond if held to maturity that you knew at the time of purchase. Not so much with a tips fund.
You also have the original deal you bought into with the TIPS fund after rates rise.
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Re: Would TIPS behave any differently than nominal bonds in high inflation?

Post by exodusing »

gavinsiu wrote: Mon May 13, 2024 2:18 pm
  • TIPS's cpi adjustment is semi-annual, so you can't use TIPS to protect against short term inflation risk. You can't really buy a 1 month TIPS for example, if you want to buy something a month later. It would be helpful if you were using it for income. If you hold a nominal bond, then at the end of the year, your 10K bond is now worth less after inflation. If you hold a TIPS, it is adjusted for inflation so that your income rises as well.
  • If inflation persist, then I would think Stock return would eventually rise, but not in the short term because companies can't adjust for the change in the short term. Over the long terms, stocks return will return a higher real return than TIPS, if you are just saving for retirement in 30-40 years, you should probably invest more in stock than TIPS. If you are retire and need income, then TIPS might be a better bet.
  • TIPS's cpi adjustment is daily. https://eyebonds.info/tips/help.html explains.
  • Companies can change prices immediately. How the market will react is hard to know in advance, including because multiple factors affect market pricing. While we expect stocks to have a risk premium and return more than TIPS, there are no assurances, no matter how long you hold. The risk premium is for bearing risk. Otherwise you (large institution) could short 30 year TIPS and buy equities (or some version of this strategy) and make a guaranteed profit.
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Re: Would TIPS behave any differently than nominal bonds in high inflation?

Post by KlangFool »

gavinsiu wrote: Mon May 13, 2024 2:18 pm Here are my observation, keep in mind that my knowledge of bonds are somewhat limited.

The pricing of the bonds will factor in the expected inflation. If inflation is stable, the long term return should be above inflation and nominal bonds will have a slight real return because TIPS is essentially an insurance against inflation. Should inflation is unexpected, TIPS will win out.

gavinsiu,

1) Should inflation is unexpected high, TIPS will win out.

2) Should inflation is unexpected low, nominal bond will win out.

3) If inflation matches expectation, they are about the same.

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Re: Would TIPS behave any differently than nominal bonds in high inflation?

Post by avalpert1 »

Northern Flicker wrote: Mon May 13, 2024 6:41 pm
avalpert1 wrote: Mon May 13, 2024 1:30 pm
Northern Flicker wrote: Mon May 13, 2024 1:20 pm Historically, stocks have been the best inflation hedge,
Not really, real returns have historically been lower in times of higher inflation than in times of low inflation.
The part of my post you did not quote back is salient:
Other assets should be held to provide adequate short term and, if needed medium term, liquidity as needed in light of the high volatility of stocks.
Over medium and longer terms stocks have outpaced inflation. Over short time periods you need a good source of liquidity when stocks experience volatility. One of those scenarios is when stocks reprice due to increases in interest rates.
While liquidity may indeed be a salient point for some purposes it is irrelevant to the question of whether equities are a hedge for inflation - that actual historical record demonstrates that they do not act as a hedge to inflation. The equity risk premium may help you get real returns over the long run, but real returns decrease in times of high inflation acting as the opposite of a hedge.
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Re: Would TIPS behave any differently than nominal bonds in high inflation?

Post by Northern Flicker »

Inflation swaps and shorting debt (such as being a mortgagee) are the only pure hedges to inflation if you use the literal definition of hedge. Stocks and real estate are the best defense against inflation over medium and longer terms. Rolling commodities do a good job over short timeframes, but there are no guarantees.

A decrease in real return is not a sufficient condition to invalidate being a hedge to inflation. Any asset that maintains a positive real return is hedging some of the effect of inflation.
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Re: Would TIPS behave any differently than nominal bonds in high inflation?

Post by nisiprius »

Let's do all of our thinking in real dollars, and consider a TIPS and a nominal bond. The bedrock consideration is that TIPS react only to one source of risk: interest rates; while nominal bonds react to two: interest rates and inflation rate.

The only way that can't matter is if interest rates and inflation rates move in perfect lockstep, so the two sources of risk are really only one.

A bond pays out coupon interest, and the coupon interest from a TIPS is level (in real dollars) while that from a nominal bond fluctuates, almost always declining. So the coupon interest payment of the two bonds differs.

Every bond also has a principal value, which is visible to the market but won't be paid until maturity. During the life of the bond, the market value of a bond depends on other available bonds it is competing with, but eventually it will mature and pay out the principal. The market value is anchored to the principal value, at first with a lot of scope for fluctuation, then less and less as the anchor line is continuously shortened. The market value fluctuates around, or fluctuates with respect to, the principal value. And, again, that principal value is level (in real dollars!) for a TIPS; it has a stable principal value. The nominal bond has a fluctuating principal, varying with inflation rate. In other words, prior to maturity the TIPS has only one source of fluctuation (interest rates) while the nominal bond has two (interest rates and inflation rate).

It sure seems clear that the two will behave differently.

The only way their market value could behave exactly the same would be if interest rates exactly tracked the inflation rate. No, not even then: would still be divergence due to the effect of TIPS having level coupon payments while nominal bonds have fluctuating and declining payments.

It can be argued that market forces will make interest rates tend to track inflation, but this is a very imprecise thing with all kinds of friction and multi-year lags. (I experienced that personally in the 1970s and early 1980s).

The point about TIPS is not that they will make more money, it is that they will be more predictable and more stable (in real terms! always in real terms!) in the face of varying inflation, because they are reacting to one less source of risk. TIPS react only to interest rate changes. nominal bonds react to both interest rates changes and inflation changes.
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Re: Would TIPS behave any differently than nominal bonds in high inflation?

Post by gavinsiu »

exodusing wrote: Mon May 13, 2024 7:10 pm
[*]TIPS's cpi adjustment is daily. https://eyebonds.info/tips/help.html explains.
[*]Companies can change prices immediately. How the market will react is hard to know in advance, including because multiple factors affect market pricing. While we expect stocks to have a risk premium and return more than TIPS, there are no assurances, no matter how long you hold. The risk premium is for bearing risk. Otherwise you (large institution) could short 30 year TIPS and buy equities (or some version of this strategy) and make a guaranteed profit.
[/list]
Thanks, I was never about to figure out when cpi adjustment were made. I just saw one of the article saying semiannually.

Yes, I know that this is not guarantee, but I was under the impression that as inflation becomes ingrained, the company would adjust eventually to higher inflation. I feel that if you are starting from scratch and is saving for retirement which would be measured in decades, you should probably hold stocks than TIPS.
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Re: Would TIPS behave any differently than nominal bonds in high inflation?

Post by gavinsiu »

nisiprius wrote: Tue May 14, 2024 6:46 am Let's do all of our thinking in real dollars, and consider a TIPS and a nominal bond. The bedrock consideration is that TIPS react only to one source of risk: interest rates; while nominal bonds react to two: interest rates and inflation rate.

The only way that can't matter is if interest rates and inflation rates move in perfect lockstep, so the two sources of risk are really only one.

A bond pays out coupon interest, and the coupon interest from a TIPS is level (in real dollars) while that from a nominal bond fluctuates, almost always declining. So the coupon interest payment of the two bonds differs.

Every bond also has a principal value, which is visible to the market but won't be paid until maturity. During the life of the bond, the market value of a bond depends on other available bonds it is competing with, but eventually it will mature and pay out the principal. The market value is anchored to the principal value, at first with a lot of scope for fluctuation, then less and less as the anchor line is continuously shortened. The market value fluctuates around, or fluctuates with respect to, the principal value. And, again, that principal value is level (in real dollars!) for a TIPS; it has a stable principal value. The nominal bond has a fluctuating principal, varying with inflation rate. In other words, prior to maturity the TIPS has only one source of fluctuation (interest rates) while the nominal bond has two (interest rates and inflation rate).

It sure seems clear that the two will behave differently.

The only way their market value could behave exactly the same would be if interest rates exactly tracked the inflation rate. No, not even then: would still be divergence due to the effect of TIPS having level coupon payments while nominal bonds have fluctuating and declining payments.

It can be argued that market forces will make interest rates tend to track inflation, but this is a very imprecise thing with all kinds of friction and multi-year lags. (I experienced that personally in the 1970s and early 1980s).

The point about TIPS is not that they will make more money, it is that they will be more predictable and more stable (in real terms! always in real terms!) in the face of varying inflation, because they are reacting to one less source of risk. TIPS react only to interest rate changes. nominal bonds react to both interest rates changes and inflation changes.
That's a good way to look at it. This brings me back to the original question, which was how TIPS behave differently in high inflation. Suppose you have sudden inflation. A nominal bond would be affected by both, so at some point, the inflation could exceed the coupon, resulting in a loss. For a TIPS, the inflation component would go up with the inflation, so you always have a real return.

However, one common strategy to combat inflation is to raise interest rate. This will cause the value of both nominal bonds and TIPS to drop. If you hold to maturity, you would get value of the bond back, but if you sell then you incurred a loss. What would be the strategy to use TIPS?

I would think the easiest would be to use a collapsing TIPS ladder. As each rung is redeemed. You get the bond value back despite the drop in value. What if you use a rolling TIPS ladder? I imagine that you could live off the coupon interest while reinvesting? Would the same strategy for a TIPS fund?
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Re: Would TIPS behave any differently than nominal bonds in high inflation?

Post by Northern Flicker »

nisiprius wrote: The only way that can't matter is if interest rates and inflation rates move in perfect lockstep, so the two sources of risk are really only one.
Duration-matched treasuries and TIPS will behave more or less the same way if realized inflation matches the a priori breakeven inflation rate closely.

Inflation risk and term risk do in fact have a moderately high short-term correlation, but the longer the holding period, the more impact there usually will be on the difference in performance from inflation rather than interest rates.

Here is a backtest of total market treasury and TIPS portfolios with similar durations:

https://www.portfoliovisualizer.com/bac ... O2txrLPuM4
Last edited by Northern Flicker on Tue May 14, 2024 10:35 pm, edited 1 time in total.
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Re: Would TIPS behave any differently than nominal bonds in high inflation?

Post by #Cruncher »

rockstar wrote: Mon May 13, 2024 12:02 pm...
If you watch TIPS, they always go negative right before they mature. ...
Not so. Sometimes they are priced below par and sometimes above. To see this we only have to look at the last two TIPS to mature -- the Jan 15 2024 and April 15 2024. For example, one month before maturity the first one sold at 99.5 with a yield-to-maturity (YTM) of over 7% while the second one sold at 100.125 with a negative YTM. [*]

At this time the index ratios at maturity were known for both bonds. In effect they had become nominal bonds, and the market was pricing them as such. Row 21 at the bottom of the table below shows they were priced so as to have about the same nominal return.

Code: Select all

Row                   Col A           Col B          Col C   Formula in Column B
  2              Price date  Fri 12/15/2023  Fri 3/15/2024
  3         Settlement date  Mon 12/18/2023  Mon 3/18/2024
  4           Maturity date       1/15/2024      4/15/2024
  5                  Coupon          0.625%         0.500%
  6                   Price         99.5000       100.1250 [*]
  7       Yield to maturity          7.213%        -1.130%  =YIELD(B3,B4,B5,B6,100,2,1)
  8  Previous interest date       7/15/2023     10/15/2023  =COUPPCD(B3,B4,2,1)
  9          Days in period             184            183  =B4-B8
 10  Days before settlement             156            155  =B3-B8
 11       Days after settle              28             28  =B4-B3
 12        Accrued interest          0.2649         0.2117  =100*(B5/2)*(B10/B9)

Code: Select all

 13               Real cost         99.7649       100.3367  =B6+B12
 14           Real proceeds        100.3125       100.2500  =100*(1+B5/2)
 15             Real return          7.213%        -1.130%  =2*(B14/B13-1)*(B$9/B$11)
 16  Index ratio settlement         1.31883        1.21987
 17    Index ratio maturity         1.31741        1.22640
 18                  Change          -0.11%          0.54%  =B17/B16-1
 19            Nominal cost        131.5730       122.3978  =B13*B16
 20        Nominal proceeds        132.1527       122.9466  =B14*B17
 21          Nominal return          5.791%         5.861%  =2*(B20/B19-1)*(B$9/B$11)
* Prices are "Sell Price" from TreasuryDirect's FedInvest Historical Prices.
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Re: Would TIPS behave any differently than nominal bonds in high inflation?

Post by AlwaysLearningMore »

#Cruncher wrote: Tue May 14, 2024 7:01 pm
rockstar wrote: Mon May 13, 2024 12:02 pm...
If you watch TIPS, they always go negative right before they mature. ...
Not so. Sometimes they are priced below par and sometimes above. To see this we only have to look at the last two TIPS to mature -- the Jan 15 2024 and April 15 2024. For example, one month before maturity the first one sold at 99.5 with a yield-to-maturity (YTM) of over 7% while the second one sold at 100.125 with a negative YTM. [*]

At this time the index ratios at maturity were known for both bonds. In effect they had become nominal bonds, and the market was pricing them as such. Row 21 at the bottom of the table below shows they were priced so as to have about the same nominal return.

Code: Select all

Row                   Col A           Col B          Col C   Formula in Column B
  2              Price date  Fri 12/15/2023  Fri 3/15/2024
  3         Settlement date  Mon 12/18/2023  Mon 3/18/2024
  4           Maturity date       1/15/2024      4/15/2024
  5                  Coupon          0.625%         0.500%
  6                   Price         99.5000       100.1250 [*]
  7       Yield to maturity          7.213%        -1.130%  =YIELD(B3,B4,B5,B6,100,2,1)
  8  Previous interest date       7/15/2023     10/15/2023  =COUPPCD(B3,B4,2,1)
  9          Days in period             184            183  =B4-B8
 10  Days before settlement             156            155  =B3-B8
 11       Days after settle              28             28  =B4-B3
 12        Accrued interest          0.2649         0.2117  =100*(B5/2)*(B10/B9)

Code: Select all

 13               Real cost         99.7649       100.3367  =B6+B12
 14           Real proceeds        100.3125       100.2500  =100*(1+B5/2)
 15             Real return          7.213%        -1.130%  =2*(B14/B13-1)*(B$9/B$11)
 16  Index ratio settlement         1.31883        1.21987
 17    Index ratio maturity         1.31741        1.22640
 18                  Change          -0.11%          0.54%  =B17/B16-1
 19            Nominal cost        131.5730       122.3978  =B13*B16
 20        Nominal proceeds        132.1527       122.9466  =B14*B17
 21          Nominal return          5.791%         5.861%  =2*(B20/B19-1)*(B$9/B$11)
* Prices are "Sell Price" from TreasuryDirect's FedInvest Historical Prices.
Just wanted to thank you for all of the work you do on behalf of BH.
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Re: Would TIPS behave any differently than nominal bonds in high inflation?

Post by rockstar »

#Cruncher wrote: Tue May 14, 2024 7:01 pm
rockstar wrote: Mon May 13, 2024 12:02 pm...
If you watch TIPS, they always go negative right before they mature. ...
Not so. Sometimes they are priced below par and sometimes above. To see this we only have to look at the last two TIPS to mature -- the Jan 15 2024 and April 15 2024. For example, one month before maturity the first one sold at 99.5 with a yield-to-maturity (YTM) of over 7% while the second one sold at 100.125 with a negative YTM. [*]

At this time the index ratios at maturity were known for both bonds. In effect they had become nominal bonds, and the market was pricing them as such. Row 21 at the bottom of the table below shows they were priced so as to have about the same nominal return.

Code: Select all

Row                   Col A           Col B          Col C   Formula in Column B
  2              Price date  Fri 12/15/2023  Fri 3/15/2024
  3         Settlement date  Mon 12/18/2023  Mon 3/18/2024
  4           Maturity date       1/15/2024      4/15/2024
  5                  Coupon          0.625%         0.500%
  6                   Price         99.5000       100.1250 [*]
  7       Yield to maturity          7.213%        -1.130%  =YIELD(B3,B4,B5,B6,100,2,1)
  8  Previous interest date       7/15/2023     10/15/2023  =COUPPCD(B3,B4,2,1)
  9          Days in period             184            183  =B4-B8
 10  Days before settlement             156            155  =B3-B8
 11       Days after settle              28             28  =B4-B3
 12        Accrued interest          0.2649         0.2117  =100*(B5/2)*(B10/B9)

Code: Select all

 13               Real cost         99.7649       100.3367  =B6+B12
 14           Real proceeds        100.3125       100.2500  =100*(1+B5/2)
 15             Real return          7.213%        -1.130%  =2*(B14/B13-1)*(B$9/B$11)
 16  Index ratio settlement         1.31883        1.21987
 17    Index ratio maturity         1.31741        1.22640
 18                  Change          -0.11%          0.54%  =B17/B16-1
 19            Nominal cost        131.5730       122.3978  =B13*B16
 20        Nominal proceeds        132.1527       122.9466  =B14*B17
 21          Nominal return          5.791%         5.861%  =2*(B20/B19-1)*(B$9/B$11)
* Prices are "Sell Price" from TreasuryDirect's FedInvest Historical Prices.
Good stuff. Thanks for correcting me.
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Re: Would TIPS behave any differently than nominal bonds in high inflation?

Post by exodusing »

gavinsiu wrote: Tue May 14, 2024 10:40 am
exodusing wrote: Mon May 13, 2024 7:10 pm
[*]TIPS's cpi adjustment is daily. https://eyebonds.info/tips/help.html explains.
[*]Companies can change prices immediately. How the market will react is hard to know in advance, including because multiple factors affect market pricing. While we expect stocks to have a risk premium and return more than TIPS, there are no assurances, no matter how long you hold. The risk premium is for bearing risk. Otherwise you (large institution) could short 30 year TIPS and buy equities (or some version of this strategy) and make a guaranteed profit.
[/list]
Thanks, I was never about to figure out when cpi adjustment were made. I just saw one of the article saying semiannually.

Yes, I know that this is not guarantee, but I was under the impression that as inflation becomes ingrained, the company would adjust eventually to higher inflation. I feel that if you are starting from scratch and is saving for retirement which would be measured in decades, you should probably hold stocks than TIPS.
The traditional reason for being very heavy stocks when young is that your human capital (your ability to earn money) is very high compared to your portfolio size. If your job is secure, it might be compared to a bond. You also have more time to make up for portfolio loses.

The reason not to go too high is that you can lose your job and need to sell to eat. There can easily be a common factor to both, making both more likely to happen at the same time. For example, a recession can lead to higher unemployment, lower stock prices and lower interest rates/higher bond prices.

The more people believe stocks are higher returning and safer, the more they bid up prices making stocks less returning and riskier.
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Re: Would TIPS behave any differently than nominal bonds in high inflation?

Post by gavinsiu »

exodusing wrote: Wed May 15, 2024 6:51 am The traditional reason for being very heavy stocks when young is that your human capital (your ability to earn money) is very high compared to your portfolio size. If your job is secure, it might be compared to a bond. You also have more time to make up for portfolio loses.

The reason not to go too high is that you can lose your job and need to sell to eat. There can easily be a common factor to both, making both more likely to happen at the same time. For example, a recession can lead to higher unemployment, lower stock prices and lower interest rates/higher bond prices.

The more people believe stocks are higher returning and safer, the more they bid up prices making stocks less returning and riskier.
Yes, that was sort of my experience. When the dotcom bubble burst, the first couple of years were a nightmare employment-wise. If I had been employed 100% of the time, I think this would have been a good opportunity to make up the portfolio loss and buy a lot of stock at lower prices. Unfortunately, not having working for part of the year resulting in reduction in contribution. I did however had sufficient emergency fund to survive without withdrawing the 100% stock portfolio. My job was fairly stable in 2008, so the crash had zero effect.

Interesting that you mentioned that the more people invest, the less return you get. I believe Ben Felix mentioned this in the podcast, but has this happened though? I feel that more people are in the stock market than before but the return hasn't fallen. Do you think that because people think it's safer they are willing to take a higher valuation?
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Re: Would TIPS behave any differently than nominal bonds in high inflation?

Post by rockstar »

exodusing wrote: Wed May 15, 2024 6:51 am
gavinsiu wrote: Tue May 14, 2024 10:40 am
exodusing wrote: Mon May 13, 2024 7:10 pm
[*]TIPS's cpi adjustment is daily. https://eyebonds.info/tips/help.html explains.
[*]Companies can change prices immediately. How the market will react is hard to know in advance, including because multiple factors affect market pricing. While we expect stocks to have a risk premium and return more than TIPS, there are no assurances, no matter how long you hold. The risk premium is for bearing risk. Otherwise you (large institution) could short 30 year TIPS and buy equities (or some version of this strategy) and make a guaranteed profit.
[/list]
Thanks, I was never about to figure out when cpi adjustment were made. I just saw one of the article saying semiannually.

Yes, I know that this is not guarantee, but I was under the impression that as inflation becomes ingrained, the company would adjust eventually to higher inflation. I feel that if you are starting from scratch and is saving for retirement which would be measured in decades, you should probably hold stocks than TIPS.
The traditional reason for being very heavy stocks when young is that your human capital (your ability to earn money) is very high compared to your portfolio size. If your job is secure, it might be compared to a bond. You also have more time to make up for portfolio loses.

The reason not to go too high is that you can lose your job and need to sell to eat. There can easily be a common factor to both, making both more likely to happen at the same time. For example, a recession can lead to higher unemployment, lower stock prices and lower interest rates/higher bond prices.

The more people believe stocks are higher returning and safer, the more they bid up prices making stocks less returning and riskier.
If you have safe assets to sell, then this shouldn’t be a problem. But think about what is advised. Put bonds in tax deferred. Put equities in taxable. Well, when things go south, you can’t really sell those bonds to pay the bills. There has to be tax inefficiency to have safe assets to sell. My workaround is building up an emergency fund in I Bonds. I can defer the taxes and have safe assets to sell. Also, 10% of my current portfolio is now 2x expenses, so I can now run with 90/10 with 10% of safe assets to sell. The idea of having longer maturity bonds at all is becoming less reasonable to me. What’s the point of reducing volatility in tax deferred?

Something I have been pondering lately. The bigger my portfolio gets the more years of safe assets.
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Re: Would TIPS behave any differently than nominal bonds in high inflation?

Post by watchnerd »

gavinsiu wrote: Wed May 15, 2024 10:23 am I feel that more people are in the stock market than before but the return hasn't fallen. Do you think that because people think it's safer they are willing to take a higher valuation?
Actually, the US stock market return has fallen quite dramatically.

US Stock Market last decades of 20th century (1972-1999): 13.50% CAGR

https://www.portfoliovisualizer.com/bac ... XX2q6M5ngf

US Stock Market in the first decades 21st century (2000-2024): 7.24% CAGR

https://www.portfoliovisualizer.com/bac ... eBnQJegVwX
Global stocks, IG/HY bonds, gold & digital assets at market weights 75% / 19% / 6% || LMP: TIPS ladder
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