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.
Treasury Inflation-Protected Securities 
David, You wrote
“If you have TIPS maturing this year – like I do – you’re facing tough choices.”
I have nothing maturing, but I do have cash (after I-bonds for this CY) that I’d like to put in TIPS.
SO, I’ll be very interested in the evolution of your thinking/choosing!
I like how we agree. At 60 I would be way of buying a 30 year TIPS. I would think an immediate annuity with a guaranteed payout would be safer than a 30 year TIPS. I bonds and EE bonds would be safe enough as there is no interest rate risk and there is a put option on them after one year. The tail risk in the stock market is something not to be ignored either. 2 times in the past 12 years you saw a significant drop in asset value. Being retired in one’s 70s, it must not be a fun choice to choose between heat and cat food.
I have to say, it is a tough market to make money the last 12 years. Because of poor returns in the stock market, people in their 60s are still working and thus people in their 20s can’t find jobs. Also, because of increasing costs in health insurance and medicare premiums, people just continue to work becasue they don’t know what tomorrow will bring in terms of costs.
Joe, I agree that at the age of 32 you can safely buy a 30-year TIPS at 0.5% yield above inflation and then hold it to maturity and ignore its value on the secondary market. For someone 60 years old, though, that is a risky purchase, because that buyer is much more likely to need to sell that TIPS before maturity, possibly at a substantial loss. In normal times, a 30-year TIPS would be paying at least 2.5% above inflation. But who knows when we will see ‘normal’ times again.
Being 32, I can get a positive real yield on TIPS by buying the 30 tips at auction. I expect to get a little over .5% this month on the auction. With inflation running 1.9% last year, I would have received a nominal return of 2.4%. There is not one cd that will give you that much even if held for 10 years. I also max out I bonds and EE bonds(3.5% if held 20 years, with put option to cash out early if something better comes up). I keep TIPS, I bonds and EE bonds to 30% of my portfolio with stocks the other 70%. The main risk of TIPS is interest rate risk if you want to sell early. Since interest rates have fallen, I currently have a small fortune sitting in TIPS. I firmly see 10 year rates going down to 1%, so I am just going to hold on to my TIPS for now. And if I am wrong? I will just hold them to maturity. It doesn’t overly matter. I just make sure to invest my fixed allocation into the highest yielding safe investment I can find.
The problem with these WSJ articles and financial advisors is that they have no idea how the bond market works. They are in the business of selling ads, and these companies don’t make money when you buy TIPS from the government. So they write some article how you guarantee a real loss with TIPS which is not true this month with the 30 year auction. Lets look at the Vanguard S and P 500 fund since 2000. You will average a nominal yield with dividends of about 2.5% yearly on average. So for the last 12 years, the stock market has just about kept up with inflation. I think this is why one needs to diversify over a couple of different investments.
Everyone should establish their own risk capacity based upon their age, annualized net income and total net worth. By risk capacity, I mean the ability to recuperate from losses. For example, if your net worth is a million bucks and you can save 100K a year, it would only take you one year to recover a 10% loss of your net worth. On the other hand, if you are in your mid-sixties and can expect to draw down your net worth for your remaining life expectancy (plus whatever optimistic number of years past that you wish to choose), it doesn’t make much sense to have any risky assets. Investment advisers alway like to trot out the inflation bogeyman as a excuse for maintaining risky investments into retirement. However, the simple fact of the matter is that CD’s with variable terms should limit your inflation losses to between 1% and 2% per annum. Investment advisors like to use an 8% return from a balanced stock portfolio. Considering the performance of the market over the last 50 years, I find that number to be a bit of a stretch. The stock market quadrupled between 1960 and 1980 (20 years). Then, it quadrupled again between 1990 and 2000 (10 years). Since 2000, it’s been flopping around trying to revert to the mean (12 years and counting). In that period, it has endured two major crashes of well over 20%. That’s 10 to 20 years of inflation losses. Both of these crashes took around 5 years to recover. When you reach your mid-sixties, a 10 year time horizon coincides remarkly close to the average life expectancy of your cohort. That is, 50% won’t make it thru the next ten years. And, a smaller percentage won’t even make it to the next five years. So, waiting 5 years to recover from market crashes becomes increasingly unlikely.
Jimbo, a very, very helpful overview. Thank you very much. Joe
Joseph, I am close to your age. My personal allocation includes what I call ‘super-safe’ investments, the ones without risk that will hopefully also have some return. For me, right now, TIPS and I Bonds make up about 15% of my portfolio. Insured Bank CDs make up another 3% or so. I would like that super-safe number to be a little higher (25%), but today’s yields make purchases difficult. I don’t consider TIPS bond funds to be super-safe, although they are a conservative investment. If I owned a TIPS fund, it would be in my bond portfolio. In a previous posting, I suggested this allocation, just as an idea:
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
I like this break down a lot with one caveat. For my own personal comfort, I am probably going to go 30% on no risk. I am maxing out annually on Ibonds in my and my wifes treasury direct account. I like Jimbo’s point on cds. If you do a cd ladder over five years, you are going to get the beneit of higher rates, when they occur going forward. The caveat: I am avoiding longer term bond funds and bonds due to the interest rate risk. I think there will be a better time to get into these. This 32 year bull market in bonds cannot continue forever. Thanks.
Recommended portfolios by the financial mainstream are quoted. But the mainstream very seldom show these price histories, which have such compelling structure of overwhelming timing-dependence:
http://www.showrealhist.com/RHandRD.html
The mainstream are doing massive deception by omission. They are NOT TRUSTWORTHY.
I am continuing to buy IBonds. What percentage of one’s portfolio should be “inflation protection with guarentee of principal” such as IBonds? I am 62. Thanks.
Both authors of the cited articles avoid showing inflation-adjusted price histories of stocks and homes, which are VERY instructive:
http://www.showrealhist.com/RHandRD.html
They are serving the paid advertisers in the WSJ. They are NOT serving the readers of the WSJ.