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Hi folks

I've become aware recently that the yield on TIPS is now at or above 2% across the curve; some commentators have called this a gift to retirees / near retirees.

As I understand it, purchasers earn 2% on top of the annual CPI for the duration of the bond (e.g. 5, 10, 20, 30 yr) - which is appealing in that it reduces / eliminates inflation risk (to the extent that CPI is a good proxy for real inflation experienced by retirees. In contrast, although I could buy an individual 10 year bond yielding 4.5% today, which sounds attractive, if inflation remains a persistant problem over the next decade the real yield could be less than the TIPS 2% or even negative. One post I read made a comparison of TIPS at 2% to an annuity - which has occasionally been the subject of discusion here and on the Brk board - and said that TIPS were more attractive because the annuity does not provide inflation protection without an expensive rider that is usually not worth it.

Im hoping to learn how the retirement gurus who visit this Board think about TIPS given current yields, and how TIPS might fit in to an overall retirement oriented portfolio in terms of displacing other kinds of assets one might hold.

When Jim calculates expected returns on various equities (eg Brk) he often expresses it in terms of inflation + X%. And the x% is always far greater than 2%, reflecting the equity risk premium. I get that comparing stocks (even unkillable companies like Brk) to US government treasuries doesnt really make sense - its apples to oranges - so I dont see TIPS displacing equities in my portfolio.

On the other hand, bond ETFs / mutual funds have been crushed over the last couple of years, and like many others I've become increasingly concerned that the inverse correlation of stocks and bonds, the premise of the 60/40 portfolio and the basis of target retirement date funds is a thing of the past. Or at least a past when we had declining / low interest rates. I wish I had come to this conclsuion earlier. And perhaps my post will top tick the yield on the 10 year. But my gut (and now apprently Jamie Dimon) says we go higher.

Given that background, do folks think that building a TIPS ladder at these levels is a better solution for a retirement portfolio than other kind of bond holdings? Im curious about the % of ones portfolio one might assign to this, and how to think about the ladder construction.

For what its worth I'm mid / late 50s, ~ 5-7 years away from retirement

thanks

I guess I can't see buying bonds as a real income investment nowadays. There's way too much capital floating around out there for anything like a decent return at anything like a decent level of real risk.

(And, I've groused about bond funds elsewhere. Bottom line: I don't trust their holdings to be/do what they claim under stress)

It's hard for me to imagine a scenario where -- after some lag measured in a few months -- plain Treasuries won't keep up with inflation. So a plain Treasuries ladder (12, 24, 36 month) seems to me the safest way to keep most capital preservation, mostly.

The ladder won't grow in value, and because of the lag will probably slip a bit. But in retirement it's an asset pool to draw down while you're waiting for the equity market to recover from whatever swoon it's having at the moment. For example, we all were pretty much certain the Covid market swoon was going to be self-limited - but it would have been extremely painful to have to sell...well, anything, pretty much - to pay the grocery and utility bills in mid 2020.

Getting back to TIPS: ten years is a long time. And, I kind of don't trust the definition of "inflation" to stay constant. Our leaders will move the goalposts as much as they feel they can get away with, not because it's in the public interest to have that changed.

With retirement 5-7 year out, I'd probably have maybe kind of 20% in a bond ladder. Or maybe 25%. Depends on how much cash/cash equivalents you have set aside for equity buying opportunities (which, in a post-paycheck market meltdown, becomes grocery-buying opportunities)

--sutton

iBonds another decent choice, although not as attractive as a couple of years ago. Unfortunately they're limited to $10/K per SSN per year, and I have no idea how you'd do it inside of a 401(K) or similar

iBonds another decent choice, although not as attractive as a couple of years ago. Unfortunately they're limited to $10/K per SSN per year, and I have no idea how you'd do it inside of a 401(K) or similar

I remember trying to figure out I bonds when they were in the 9%s. Don't all the issues get the same rate, set semiannually, and you want to try to get a highest fixed rate? The fixed component is .9%, which is the highest it has been since 2008.

Given that background, do folks think that building a TIPS ladder at these levels is a better solution for a retirement portfolio than other kind of bond holdings? Im curious about the % of ones portfolio one might assign to this, and how to think about the ladder construction.

For what its worth I'm mid / late 50s, ~ 5-7 years away from retirement



I pretty much agree with sutton about TIPS vs straightforward Treasuries. Unless you have some particular reason to worry about inflation, I would just go ahead and buy a small amount of treasuries; on the other hand, TIPS would do the job fine, too. I don't think any of us can really outguess the market about whether inflation is going higher or lower, so I would tend to be agnostic about TIPS vs treasuries too.

On the other hand, apart from how long it is until retirement, I would say it is also important to consider how much a person has in savings, in relation to the annual income they expect/desire/require in retirement. For instance, if you were to say that you expected to continue getting $200,000 a year and had $5 million saved already, then I would say you can comfortably withdraw about 5 years' worth of revenue (say $1,000,000, or 20% of your portfolio, like the 20-25% you mention), and then, with the help of any other pension funds you might have plus dividends from your stock holdings, you are safe to get through a 8-10 year slump in the stock market. But if you had $10 million in savings, by the same logic, you would only require 10% in your fixed income (treasuries) portfolio, and you would be better to keep the rest in stocks that will probably provide a better long term return.

It is possible to make the case that stocks are very highly valued right now, and that a higher percentage of fixed income (like 30-40%) may actually not cost you anything, in terms of expected return compared to stocks. With S&P 500 stocks paying an earnings yield of 4.1% right now, and with 1-y treasuries at 5.5% (as they say, the 'income' is back in 'fixed income'), it might be prudent to have treasuries, not just to provide income to get through a stock slump, but to have cash available to take advantage of that stock slump. In that case, you want enough cash and treasuries to provide for income AND investment opportunities. I think this makes sense, but I haven't pulled the trigger on this strategy myself.

You also mentioned the question of annuities. The big disadvantage of annuities is their very high cost, in comparison to the expected return. I think you really have to think of them more as an insurance policy (that you expect to lose money on) than an investment. The idea is to be able to cut off the tail of your life expectancy, say above the age of 85, where you have a fairly high probability of already having left the scene, but for which you would normally have to still have funds available, just in case. So you attribute a small percentage of your total investments to that annuity, a cheap one because of the advanced age, and can confidently plan for drawing down your assets from, say, the age of 65 to 85, allowing you to make much higher annual distributions to yourself than if you had to have funds available just in case you lived to 100 or more.

JMHO, regards, DTB

I really appreciate the different perspectives and points you've each made - about outsmarting the market with regard to inflation, plain treasuries vs TIPS, about the risk of moving goalposts, about savings and how to weather an extended equities slump, and annuities. Lots to consider.

Sutton wrote:

"It's hard for me to imagine a scenario where -- after some lag measured in a few months -- plain Treasuries won't keep up with inflation. So a plain Treasuries ladder (12, 24, 36 month) seems to me the safest way to keep most capital preservation, mostly".

and

"With retirement 5-7 year out, I'd probably have maybe kind of 20% in a bond ladder. Or maybe 25%. Depends on how much cash/cash equivalents you have set aside for equity buying opportunities (which, in a post-paycheck market meltdown, becomes grocery-buying opportunities)"

In terms of what Ive actually been doing - over the past year Ive been purchasing and rolling inidividual 6 month treasuries. The last time I spread it out to 3,6,12 months. With yields on the 2 year above 5% I'll now consider extending duration the next time one of the short term notes come due.

That said, a 10 year bond feeels like a bigger committment and bet on rates and inflation than a 10 year 2% TIPS does. I realize you dont lose principal if you hold to maturity, and maybe 4.5% on a 10 year is good enough. But I guess I've been thinking that the appeal of a 10 year TIPS is that, if held to maturity you can consider it safe as cash, with a small yield regardless of inflation. And that brings me back to thinking about what the purpose of that bucket is anyway.

Sutton again
"But in retirement it's an asset pool to draw down while you're waiting for the equity market to recover from whatever swoon it's having at the moment"

In the face of an extended sell off in equities - and once you've exhausted your cash/MMF and tneed to tap your bond holdings, is there any obvious answer to which would hold up better or - a 10 year conventional bond or a 10 year TIPS. Just seeing what has happened to prices on 10 year bonds this past year makes me realize that they are far from a risk free asset / couunter cyclical equity hedge...

In the face of an extended sell off in equities - and once you've exhausted your cash/MMF and tneed to tap your bond holdings, is there any obvious answer to which would hold up better or - a 10 year conventional bond or a 10 year TIPS. Just seeing what has happened to prices on 10 year bonds this past year makes me realize that they are far from a risk free asset / couunter cyclical equity hedge...

I see no reason why TIPS or Treasuries would perform differently in an equity sell-off - both would drop along with stocks. The difference would be between TIPS/Treasuries with shorter and longer terms.

And I much prefer a shorter term than 10y for 3 reasons:

(i) The rates are about 1% higher, no doubt because the market thinks rates are headed lower (recession, or just inflation being whipped but with a soft landing);

(ii) Stocks are a better long-term bet, so in general I want to own stocks, not Treasuries. If I'm buying Treasuries, it's because I want to hedge my bets in case stocks plunge and I need cash to live off of, or even to buy more stocks at lower prices. Bonds with longer terms are a poorer hedge, because they will crash along with stocks.

(iii) Weakest argument, since it is probably pretentious of me to expect to outguess the market: I think rates are going higher, not lower, so I don't want to lock in 5% when rates go to 6-8-10%.

DTB

A few random comments

The comments that there is no point opting for the extra protection offered by TIPS mystifiy me...plain bonds are certificates of confiscation, sometimes.
If inflation rises, you can be more or less wiped out. Check the real total return on 10- or long-bonds in the inflationary years. Why take that risk if there is absolutely no advantage in doing so?
I agree that nobody knows what inflation will be. That is precisely the reason NOT to place a huge wager on it remaining low, which is what buying nominal return bonds entails.

From a portfolio construction point of view, inflation protected bonds are as different from ordinary nominal bonds as equities are from nominal bonds.

I agree that 2% real yield on TIPS sure is a whole lot better than it was for a long time.
But in the OP's situation, still earning and some years from even beginning retirement, I don't really see the point in his/her buying TIPS at this juncture.
On the assumption that the person already has some decent amount of savings, that maybe-TIPS money (the marginal saved dollar, the last one which will get spent) won't be needed for many many years.
Over that kind of longer time frame, the rate of return matters. Would you rather have a real total return on it of 7% or 2%?
For one or two years, or a few, a very humdrum 2% real rate of return on your money is no big deal. But for 15-40 years, I would care a lot.

TIPS can be a nice way to park money that you know you will need at a specific time in future in a way that you know with absolute certainty the ultimate buying power, if you have that situation for any reason. But parked money doesn't earn much.

I'm mostly and equities-and-cash person. The only situation I might see myself doing some real return bonds is if the market seemed pretty toppy and I wanted to liquidate some of my overpriced equities in favour of a ladder for maybe 2-4 years of expenses. Right now I simply have an above-average allocation to cash: the potential advantage to TIPS over cash is in proportion to the time frame I expect to hold it, times the likely upper bound on the amount of inflation likely to occur in that time frame, times the apparent yield difference. None of those seems large at the moment--I'm cool with 4.83% on my cash deposits at Interactive Brokers.

My assessment is that US monetary inflation is probably largely under control in the next couple of years. I check the New York Fed's "UIG", which is now under 3%. That's the fraction of inflation that seems to be best explained by economy-wide constant effects, after separating out product- and service-specific fluctuations.

Jim

The comments that there is no point opting for the extra protection offered by TIPS mystifiy me...plain bonds are certificates of confiscation, sometimes.
If inflation rises, you can be more or less wiped out. Check the real total return on 10- or long-bonds in the inflationary years. Why take that risk if there is absolutely no advantage in doing so?

Jim:

This makes perfect sense to me *if*:

1) I'm allowed to replace "TIPS" with "individual Treasury securities e.g. TIPS, Treasury bills, and iBonds", and

2) to replace "plain bonds" with "bond funds, including not only corporate but also US Treasury bond funds"

In other words, if I spend $10K for shares of Suttons Universal Conservative Kingdom Eternal Refuge Bond Fund (ticker: SUCKER), it's a good question how much of that $10K I'll ever see again.

But if I buy an individual 5% 6 month $10K T bill (CUSIP 1234567) today, I'll spend $9750 and am certain to get back $10,000 at the end of March.

It doesn't have to be a muliyear TIPS?

Otherwise: please (attempt to) educate me.

Thanks

--sutton

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