Are Treasury Inflation-Protected Securities now an unsafe or unwise investment? Is the Treasury market at the start of a long bear market? Will stocks greatly outperform bonds over the next 10 years?
Burton Malkiel, author of ‘A Random Walk Down Wall Street,’ wrote an intriguing piece for the Wall Street Journal on March 22, titled ‘What Does the Prudent Investor Do Now?‘
Malkiel makes the case that as the economy continues to improve, investments in bonds – especially Treasuries – are going to make investors weep. One of his key points:
Bonds are the worst asset class for investors. Usually thought of as the safest of investments, they are anything but safe today. At a yield of 2.25%, the 10-year U.S. Treasury note is a sure loser.
While Malkiel doesn’t specifically mention TIPS, he does point out that super-low rates on today’s Treasuries mean that investors will get negative real returns (less than the inflation rate). In the case of TIPS, most buyers today are guaranteeing themselves rates less than inflation, since the base rate is currently negative all the way up to 10-year issues.
As an alternative, Malkiel suggests investments in low-cost stock mutual funds (he feels that stocks are still a bit undervalued) and real estate (which could be nearing the end of a massive bear market).
Back to being ‘prudent’ … Malkiel makes a sensible, conservative investing argument: Stocks will outperform Treasuries in the next 10 years. Yes, that could very likely happen, as Treasuries are probably ending an amazing 30-year run of lower rates.
But the argument should never be stocks vs. bonds. The argument should be risk investments vs. super-safe investments. I have never argued that anyone hold 100% of their portfolio in TIPS or Treasuries. That would not make sense.
Every investor should decide, how much risk do I want to take? … and allocate assets to match that risk. An investor interested in capital preservation – nearing retirement with a sizable nest egg – could come up with something like:
- 10% Highest risk: International, small cap stocks
- 40% Higher risk: Large-cap dividend paying stocks
- 25% Lower risk: Broadly diversified bond funds, municipal bonds
- 25% No risk: TIPS, I Bonds, insured bank CDs, Treasuries held to maturity
My contention is that you can change the asset allocations, but you can’t change what’s in them. No matter how safe you think stocks are, you can’t put them into your ‘No Risk’ category. There are only a few ‘No Risk’ investments (money market funds, by the way, don’t qualify).
With the No Risk category, the investor is looking to preserve capital, no matter what happens. Stocks and bond mutual funds (including TIPS funds) can’t fill that role. In recent years, buying and holding TIPS to maturity has been an excellent way to fill this need. Today’s low rates make TIPS less attractive. I Bonds remain the best choice for this category, up to your purchase limit.
The Treasury ‘bear’ market. There are lots of news articles out this weekend pointing out that the Treasury market has taken a hit in 2012, for example: ‘Bonds limp to end worst quarter since 2010.’ And of course, stocks have done very well in the last three months.
So I want to close today with this chart, which compares the performance of the SPY ETF (S&P 500), the TIP ETF (overall TIPS market) and the TLT ETF (long-term Treasuries):
TIPS are a different animal, because of the inflation adjustment to principal. It appears that investors are fleeing longer-term Treasuries, but not TIPS.
And that also means that TIPS remain ‘unattractive’ for near-term buy-and-hold purchases.