Who should buy Treasury Inflation-Protected Securities?

1969 menu

Here’s a 1969 menu from a restaurant in my hometown, Rockford IL. It’s a reminder about why we need protection from inflation. Click on the image to see it larger.

I was updating my TIPS Q&A page today and I realized that I never really answered this question: Who should buy TIPS? So here we go …

First off, I want to state loudly that TIPS are for preserving wealth, not building wealth. If you are in the early stages of investing and far from your long-term needs for buying a house or for paying for college or especially for retirement, TIPS aren’t going to be a great investment. That’s especially true when yields are less than 1% over inflation. You probably won’t build enough wealth to meet your goals.

(There was a time, in the late 1990s when the stock market was bubbling, that TIPS paid nearly 4% above inflation. That was a screaming buy, no matter your situation, as a long-term buy-and-hold investment, or even as a speculation. Those days are long past.)

So who should buy TIPS?

If you are nearing retirement, or in retirement, and have an adequate nest egg, then TIPS make sense as part of your investment portfolio – especially if you buy and hold them to maturity. That strategy is risk-free, and you can protect a part of your savings from the dangers of unexpected inflation.

I think of TIPS as a way of punting money into the future. You will need it then. With TIPS paying a positive yield, you can preserve the current value against the threat of inflation. If you buy and hold to maturity, you have a lot of certainty – X dollars coming on X date.

But even then, I think TIPS, I Bonds and bank CDs should make up no more than 30% of your portfolio. Put the rest in stock and bond index funds, whatever matches your risk tolerance. In the past, I have suggested something like:

  • 10% Highest risk: International, small cap stock index funds
  • 30% Higher risk: U.S. stock index funds
  • 35% Lower risk: Broadly diversified bond funds, municipal bonds
  • 25% No risk: TIPS, I Bonds, insured bank CDs, Treasuries held to maturity

I Bonds are a special case, since there is a limit on purchases of $10,000 per person per year. If you want to build a large stake, you need to start early. I think I Bonds could work well for almost any investor. They are flexible enough to be a 1-year savings account, or a 30-year investment, with taxes deferred.

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9 Responses to Who should buy Treasury Inflation-Protected Securities?

  1. JJ says:

    This puzzles me. If a retiree has an “adequate” nest egg, why should he limit his TIPS/I-Bond exposure to 30 percent? Unless he wishes to leave money to charity or heirs, why should he risk one penny of his portfolio for unneeded growth — or even care about diversification — if his “adequate” stake can keep pace with inflation in risk-free instruments?

    Yes, the U.S. government might conceivably go broke, but wouldn’t the bond and equity markets follow suit if that happened anyway?

    Thanks again for your stellar work here..

    • JJ says:

      I hear what tipswatch is saying about risk. But isn’t there risk either way you go? I seems the risk my wife and I will outlive our nest egg at 90 is much smaller than the risk tipswatch is taking with his earlier retirement years.

      My worst case scenario has my wife and/or me I living on Social Security (like tens of millions of other Americans) at a time in life when we’ll be inactive and spending dramatically less anyway. Plus, in the unlikely event we see that scenario unfolding, we’ll have years to taper our expenditures to avoid it.

      If we assume tipswatch now has a nest egg adequate to get him to 90, I worry that his strategy to live larger in his 90s might well have him living smaller in his 80s or sooner.

      • tipswatch says:

        Just to clarify, I am some years away from retirement, and so I am still building the nest egg. I can afford to take more risk, but I actually my strategy is fairly low-risk. In my current strategy, the super-safe investments and low-risk bonds will somewhat offset a decline in the stock market in the case of a serious decline. My strategy does call for me not to run out of money at death, though. I am not willing to take that risk.

      • JJ says:

        tipswatch wrote:

        “Just to clarify, I am some years away from retirement, and so I am still building the nest egg. I can afford to take more risk, but I actually my strategy is fairly low-risk. In my current strategy, the super-safe investments and low-risk bonds will somewhat offset a decline in the stock market in the case of a serious decline. My strategy does call for me not to run out of money at death, though. I am not willing to take that risk.”

        TW is right that TIPS are a lousy way to grow a portfolio. We diverge only on the question of whether growth and the risk that goes with it are prudent for “heir-less” retirees with nest eggs already adequate to get them to age 90. For me at least, the risk associated with living to 95 is far outweighed by the risk that a more aggressive portfolio might tank in my 60s or 70s. That would put a big crimp in my lifestyle in my more active years and greatly compromise my standing in my 90s anyway.

        Thanks for the discussion and for the great website, TW.

  2. tipswatch says:

    JJ, I’d worry about a 4% withdrawal rate, growing with inflation, with an all-TIPS portfolio. Professor Zvi Bodie, who wrote ‘Worry-Free Investing,’ does endorse the 100% TIPS portfolio, and he has a lot of fans. But I’d also worry about taxes. A large hunk of your TIPS and all your I Bonds would be taxable, meaning a constant drain on your return. With the I Bond real return at zero and TIPS barely above zero, taxes create a negative real return, and that means you lose ground to inflation.

    • Joe says:

      But… following up in this question, if your goal is to spend all your money and have nothing left over, and more importantly, if you can attain this goal with a small return over inflation, the question still is, why take the risk of the stock market when you don’t have to?

      • tipswatch says:

        Joe, it will be tough to time your death for the moment your money runs out. So there will need to be some money left over. What if your money ran out when you were 90, and you live to 95? Still, if you have a very large nest egg and can be certain the money won’t run out, there’s nothing wrong with avoiding risk. You should also try to find a way to avoid taxes, maybe with municipal bonds? I am 59 years old and consider my risk tolerance 40% in the stock market, a lot lower than experts recommend. But I don’t need to take any more risk. Set your risk level equal to your comfort level.

      • JJ says:

        I found no reply link below tipswatch’s latest, so I hope he can sort out the thread a bit. I’ll post mine here as well to try to maintain continuity…

        I hear what tipswatch is saying about risk. But isn’t there risk either way you go? I seems the risk my wife and I will outlive our nest egg at 90 is much smaller than the risk tipswatch is taking with his earlier retirement years.

        My worst case scenario has my wife and/or me I living on Social Security (like tens of millions of other Americans) at a time in life when we’ll be inactive and spending dramatically less anyway. Plus, in the unlikely event we see that scenario unfolding, we’ll have years to taper our expenditures to avoid it.

        If we assume tipswatch now has a nest egg adequate to get him to 90, I worry that his strategy to live larger in his 90s might well have him living smaller in his 80s or sooner.

  3. Ed says:

    Stocks??? Please consider the following.
    ONE
    http://www.showrealhist.com/yTRIAL.html
    http://www.showrealhist.com/RHandRD.html
    TWO
    The Real Dow history is very instructive, but it is rarely shown! Holy cow — do you suppose that ‘NOT trustworthy’ is in control? Holy cow!

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