As one of the world’s most boring investments, Treasury Inflation-Protected Securities generally don’t get a lot of press. But lately, TIPS are getting all sorts of play in the Wall Street Journal, both negative (mostly) and positive (somewhat).
Article No. 1 is ‘Looking for Inflation Protection? Take TIPS off Your List‘ by Brett Arends. It starts with the classic TIPS dismissal:
Would you buy an investment that was guaranteed
to lose money? That is the situation investors are embracing today in the market for Treasury inflation-protected securities, or TIPS.
Arends makes the case that TIPS, yielding negative to inflation well up the maturity ladder, are a horrible investment:
The effective interest rates on TIPS have collapsed to record lows. It is mathematically impossible now for investors to earn respectable returns from any of them, and in many cases they are a lock to lose money in real, inflation-adjusted terms.
Arends actually is making a perfectly reasonable case. TIPS are expensive, with yields
following traditional Treasuries down to pathetic lows, thanks to two years of Federal Reserve manipulation. (I have down on buying TIPS for the last 18 months.)
My criticism, though, is that Arends is singling out (and ridiculing) TIPS as an investment that is ‘guaranteed’ to produce a negative real yield. Yet Arends admits that TIPS, because of the inflation protection, are preferable to traditional Treasuries, which also yield well below current and likely future inflation. The same is true of bank CDs, short-term
bond funds and money market funds.
The only way to get a ‘real yield’ is to increase your risk level, meaning stocks or commodities or real estate. I think stocks, commodities and real estate are fine for your portfolio, but not for your ‘super safe’ allocation. TIPS might be flawed and expensive, but inflation protection still makes them today’s 2nd best super-safe investment, after I Bonds.
So that leads me to article No. 2, ‘A ‘Bucket List’ for Better Diversification‘ by Jason Zweig, who makes the case for a different sort of portfolio allocation. Zweig suggests that investors replace the traditional stock vs. bonds formula with one that puts investments in buckets tailored for economic conditions:
- Expansion, stocks and real estate (and possibly commodities)
- Inflation, TIPS and I Bonds (and possibly commodities)
- Recession, traditional bonds and bond funds
- Deflation, traditional Treasuries and insured bank CDs
Zweig ends up endorsing TIPS as an investment, despite their low yields.
How does differsification work in practice? If you own no TIPS, your inflation bucket is perilously empty, and you need to fill it. Otherwise you are gambling that the cost of living won’t rise higher or faster than most people expect—and that is an expensive bet to get wrong.
Investors are predicting an inflation rate over the next 10 years of roughly 2.5% annually, says Gemma Wright-Casparius, manager of the Vanguard Inflation-Protected Securities Fund. If inflation runs higher than that, TIPS will guard you against a loss of your purchasing power. If it doesn’t, you could lose money on your TIPS—but your other buckets should do well.
My personal style is to buy TIPS at auction and hold them to maturity, so there is no risk
of losing money. But at today’s prices TIPS aren’t attractive for that strategy. If you have TIPS maturing this year – like I do – you’re facing tough choices.