Investment firm sees ‘higher and spikier’ inflation looming.
By David Enna, Tipswatch.com
AllianceBernstein, a global investment firm with about $725 billion in assets under management, is now advising its clients to replace the traditional 60% stocks / 40% bonds portfolio with a 60/30/10 model, with the 10% being allocated to inflation protection.
The strategy grew out of an April 2 report by two senior bond experts at the firm — Serena Zhou and AJ Rivers — who made the case that inflation protection in the form of Treasury Inflation-Protected Securities is now a “unique opportunity.”
As inflation recedes from recent cyclical highs, many investors are selling their holdings of inflation-protected securities. The result? Explicit inflation protection has become unusually cheap. Investors needing to boost their strategic allocations to inflation strategies may wish to take advantage of this opportunity—securing inexpensive “flood” insurance ahead of higher structural inflation over the coming decade.
The authors theorize that global economies are moving toward an era of “higher and spikier” inflation, triggered by three powerful forces:
- Deglobalization, which leads to potential labor shortages, higher labor costs, and potential supply shortages.
- Aging demographics, which also shrinks the labor pool.
- Climate change, which could drive energy, transportation, insurance, food and other costs higher in the future.
The authors point out that in the last three years, U.S. consumers lost 16% of their purchasing power. While inflation seems to be easing in 2024, the dangers remain:
(W)e think it’s more likely that 2% becomes a lower bound for inflation, rather than a central-bank target. Indeed, it’s highly likely we’ve already entered this new regime … Yet even marginally higher inflation represents a key risk. For example, if inflation persists at just 2.8%, an unprotected investor will have lost 35% of purchasing power 15 years from today.
The authors note: “That’s why, in our view, the wisest defense against unexpected inflation is to maintain a strategic allocation to an active inflation strategy that includes explicit inflation protection in the form of TIPS.”
The price of protection
In the 27-year history of TIPS, the authors note, these securities have yielded an average of 90 basis points below GDP growth. Today, with real yields well above 2% across the TIPS maturity spectrum, TIPS have yields close to or above GDP growth predictions for the next decade.
In other words, TIPS are abnormally cheap today relative to long-term averages; they’re also cheap if inflation surprises to the upside in the near future; and they’re cheap given our expectations for higher long-term inflation over the next decade.
The investment strategy
The authors suggest that investors should increase allocations to inflation protection.
In our analysis, a 10% allocation to inflation protection—for example, shifting from a typical 60/40 portfolio to a 60/30/10 allocation—may meaningfully improve risk-adjusted potential return under the new inflation regime.
Will that shift reduce investment returns? The authors theorize that it won’t and in fact could enhance returns. They suggest concentrating on shorter average duration to reduce interest-rate risk while retaining inflation protection. They conclude:
In our view, the right active inflation strategy should help investors beat inflation without sacrificing return. Between the low price of getting inflation protection today and the high cost of not having such insurance tomorrow, we believe the time is right to beat the inflationary tide.
The authors, unfortunately, then revert to “global investment firm” advice by suggesting backing up the TIPS holdings with high-yield bonds and emerging market debt. I am not a fan of that advice. Keep your bond allocation in safe investments and take risk elsewhere.
Thoughts
The AllianceBernstein authors raised an interesting point about real yields currently matching or potentially exceeding future GDP growth, which makes TIPS look like an under-priced investment. At the same time, investor interest is waning.
“Investors have been selling inflation protection in the mistaken belief that it’s no longer needed,” Rivers and Zhou wrote. Total net assets in this category have declined in each quarter from mid-2022 through March. In an interview with Barrons, Rivers noted that investors shouldn’t try to time inflation protection. From that article:
By buying TIPS “you’re getting a real yield of 2% plus any inflation accretion,” says Serena Zhou, portfolio manager for Fixed Income US Multi-Sector at AllianceBernstein. “If there are any unexpected inflation hikes, you are immunized from those spikes.”
Although my personal portfolio has only a 35% allocation to stocks, I have tried to achieve a 15% asset allocation in inflation protection. So my target would be more like 35% in stocks, 50% in bonds, CDs & cash, and 15% in I Bonds and individual TIPS held to maturity.
Over most of the past 13 years, attempting to build an inflation-protected allocation has been frustrating, with real yields often well below zero. That made I Bonds look super attractive with a fixed rate of only 0.0%. Today, the situation is reversed. Real yields are attractive. They could go higher, but today’s real yields are historically attractive.
My allocation is an outlier. For most people approaching or in retirement, this 60 / 30 / 10 recommendation from AllianceBernstein passes the “common sense” test. Placing 10% of your portfolio in TIPS and I Bonds is a quality recommendation for the cautious investor.
• Now is an ideal time to build a TIPS ladder
• Confused by TIPS? Read my Q&A on TIPS
• TIPS in depth: Understand the language
• TIPS on the secondary market: Things to consider
• Upcoming schedule of TIPS auctions
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Feel free to post comments or questions below. If it is your first-ever comment, it will have to wait for moderation. After that, your comments will automatically appear.Please stay on topic and avoid political tirades.
David Enna is a financial journalist, not a financial adviser. He is not selling or profiting from any investment discussed. I Bonds and TIPS are not “get rich” investments; they are best used for capital preservation and inflation protection. They can be purchased through the Treasury or other providers without fees, commissions or carrying charges. Please do your own research before investing.
Treasury Inflation-Protected Securities 
What about now that real yields are below 2% again?
Ever since October 2023, I have been recommending urgency in building TIPS ladders at attractive yield levels. Maybe things are getting more urgent? We can’t be sure. Real yields at this point are still reasonable for a TIPS ladder, with yields at 1.50%+ for years 2033 to 2035 and then above 2.0% for years 2040 to 2055. A quick look at Tipsladder.com shows the ability to build a 30-year ladder with a guaranteed withdrawal rate of 4.55%.
The most important element in this equation is time frame. Obviously the tips did close to nothing for a 10% allocation over the last 3 years for your whole portfolio.”The authors point out that in the last three years, U.S. consumers lost 16% of their purchasing power”. What did it insure, just small cash position?
gg80108 seems to have a good point. Not sure how much good 10% is going to do. Also I don’t see putting my whole portfolio into a tips ladder.
Jay and GG, you raise good points. My investing theory for I Bonds and especially TIPS is to ensure an inflation-protected cash flow in the future. When real yields were zero or below zero, it was hard to build a 15% allocation in inflation protection, especially when other assets were rising so quickly — almost bubbly.
My goal was 15%, but now I finally am in the range of 15% to 20%. Our overall asset allocation target is 35% stocks, 60% bonds and 5% cash. So we remain exposed to stock market gains (or losses) and the rest of our bond portfolio is in still in nominal bonds, which protect against deflation.
At the end of the year we will rebalance to try to get the stock allocation back somewhere close to 35%. It’s a painful thing to do, but good times won’t continue forever. I Bonds and TIPS offer very predictable, low-risk returns with the added bonus of inflation protection.
Thank you. Off the top of my head my current allocation is 50/50 with about 4% of that in cash currently, and that includes a Siciak Security delay bond ladder that’s mostly in TIPs which is to last the next three years. After that once tge bind madder us depleted the allocation will be 70/30, but I plan to tweak it to 60/40 within that time. About a quarter of the bond allocation is in TIPs ETFs. I may increase that allocation.
I consider I Bonds an insurance policy (with the added benefit of a tangible payback). Whichever way the market goes, I feel I am a winner — inflation or deflation.
For 25 years (and counting), they have given me a lot of comfort, especially during the turbulent Great Financial Crisis. As kooky as things are these days, I think they will continue to do so.
The purchase limit is the big drawback on Ibonds.
I am pretty sure everyone reading this board is aware that TIPs have both duration and deflation risk if you are a forced seller. But it seems many investors in 2022 didn’t. What this means is you must consider the amount and duration you can afford to risk when allocating money to this category. People who may need the money in the near future should invest less and with a shorter duration. David can invest in a long duration ladder because he is in a financial position to do so.
This is why IBonds are more attractive for many people than TIPs even though their real yield is lower. IBonds have neither duration nor deflation risk. Unfortunately the limits on the amount you can invest make them much less useful to most investors. (They really are our only stablecoin investment though). Not that they are perfect but then we shouldn’t let the perfect be the enemy of the good. So before cashing in those lower fixed rate IBonds remember, if inflation rates reach high single or double digits you are not really going to care that your fixed rate is 0%.
Good points. I consider I Bonds to be the most “risk-free” investment for the longer term, especially if used as a source for future spending. T-bills are the risk-free investment for the shorter term, and have a higher yield in the short term. But T-bills go away after a year at most, while today’s I Bonds will yield 1.3% over inflation for years into the future.
All of these gymnastics laddering etc sounds good but only if one has someone to take over the management of the portfolio if or when ones brain turns to mush. Mosts spouses will go to an advisor and they sell everything and start over. I made my portfolio as hands off as possible.
Possibly true. My wife is a former CPA and has worked in corporate finance. She’ll be fine. It’s my theory that you could provide some simple guidelines for the future, if that is a problem. However, after you are gone it’s not yours to worry about.
The only par my wife cares about is on her golf score card.
Dave like your portfolio allocation. Similar to mine. Do you sell stocks when the allocation gets bigger allocation just through growth or do you just let em ride. I put a couple of Annuities in my cash like bucket. My stocks have grown from 40% to 50%. I’m letting em ride.
We do rebalance, maybe once or twice a year, depending on when things get out of line. I wrote about that here: https://tipswatch.com/2024/03/10/attention-investors-is-it-time-to-rebalance/
I can never sell my big stock winners, they are hard to find.
For the life of me, I can’t figure out why they recommend investing only 25% of one’s bond allocation to TIPS. Every situation may be different, but I moved almost all of my bonds to a 29-year ladder (starts 2025). This will fund the majority of my anticipated retirement expenses ex-SSI (and serve as a pre-SSI bridge) and will therefore allow my equity withdrawal rate to be much, much lower. What better purpose could other bonds serve? Are they not meant to be funds “to be spent”?
You raise a good point, but this approach takes discipline to hold the TIPS to maturity no matter your future needs. I like to have some alternatives like a total bond fund to draw on for future RMDs, where needed, or for gifts to charity.
Do you fund all your 29-year ladder all at once or build it through out the years? For example, I have an $X amount maturing in 2027 and I would like to use that $X amount to buy either a 5-year TIPS or 10-year TIPS or spend half of that amount and the other half into another TIPS security for future use. Thanks.
I am just trying to figure what’s the best way to build the ladder.
Agree, why would anyone care about this company after reading this?
Either option is fine. I have set my ladder up with some nominal Treasurys and CDs to mature in early years, so I can buy future TIPS in the 2035 to 2039 gap period. The key factor today is that real yields — while declining a bit recently — are attractive across the board, so you can actually build out a decent ladder quickly.
Thanks for your quick reply. May I ask you why you would buy nominal Treasury and CDs and not TIPS? Say buy an extra $X amount of TIPS that matures in 10 years and buy another $X amount 10-year TIPS to ladder the 20th year gap.
I like nominal Treasurys and CDs for short-term purposes. That way I can set aside a certain nominal amount to invest in 2035 to 2039, filling the gaps in the TIPS ladder. Of course, my plans might change if yields head toward zero. I already do have additional amounts invested to mature in TIPS in 2032, 2033 and to a lesser extent, 2040.
p.s. I hold both
In evaluating where I stand in comparison to these allocation guidelines, would a short-term TIPS fund be lumped in with TIPS or with “Bonds”? Toss-up?
Yes, a short-term TIPS fund would be considered part of your TIPS allocation.
Thank you for this very informative website. I’ve been reading your posts for a couple of years now and have learned a lot. I wonder why they only recommend 10% in TIPS. With real yields above 2%, I plan to allocate around 25% to individual TIPS in a ladder. if I hold them to maturity and they were bought at a discount to face value, I don’t see the downside risk. I know it’s possible that real yields could rise but I’m happy with 2% return over inflation.
The allocation decision is highly personal, depending on your risk tolerance, stage of life, potential heirs, and net worth you are trying to protect. My wife and I combine our assets to determine the current allocation, but my wife’s IRA investments include zero TIPS, while mine are overloaded with TIPS. Add in the I Bonds and we get to 15%.
Re their advice “ concentrating on shorter average duration to reduce interest-rate risk while retaining inflation protection.” If this is a historic opportunity to buy tips now, you miss out staying short term.
They say “After all, inflation protection on 30-year TIPS and one-year TIPS is identical.” except for the 30 year tips you get the guaranteed real yield for 30 years, with the 1 year you get whatever the real yield will be next year when you need to re-invest the money.
They are correct that if rates go higher you will wish you waited, but if rates go lower you’ll miss out. If this is truly a historic opportunity, load up now.
I know David is more of a fan of longer term as he buys longer term tips. Interesting article, thanks for posting.
If you want to use TIPS for future funding needs, with specific amounts maturing every year, you are going to need to buy longer-term TIPS. I have TIPS extending out to 2043, with “near equal” amounts maturing every year, except for adjustments around the gap years of 2035 to 2039.
For other purposes, I can understand a focus on shorter-term TIPS because of the lower volatility. Then again, as you note, there are attractive real yields across all maturities.
With Secure 2.0 and the new 10-year period for drawing down inherited IRAs and Roths, I now restrict long term TIPS to 10 years.
While I would love to hold longer term TIPS, I don’t want the hassles for my children — moving them into a taxable account could be a logistical nightmare and selling them off before they mature might not be the best option at the time.
For me, the Great Financial Crisis (now 16 years in the rearview mirror — yikes!) upset investing norms and conventions. What used to be (generally) proven tenets have gotten tossed around. So many more dynamics to consider.
One aspect I have read about is financial repression. The US and other countries, post WW2, used it. In a time of high debt and high inflation the government suppresses interest rates (they don’t want to pay higher interest rates on the debt, so they keep interest rates down). Combine this with high inflation and you have a loss of purchasing power (low or negative real rates of return).
Now, who is to say that the government would not monkey with government securities. All those “juicy” TIPS with 2%+ fixed rates (and add in high inflation payments on top) could become targets for hanky panky. The government could manipulate the inflation statistics to “show” inflation is less.
Today, we say that could never happen, that there are many checks and balances in the system. But, in this topsy-turvy world we are living in how can we not think such things are possible?
While I don’t obsess about such situations, I do resent having to even think about such situations.
I don’t really fear the government (at least the current government) deciding to doctor the inflation numbers to any great extent. The bureaucrats doing the work would never be silent — it would be revealed in days and become a huge financial scandal. Do the current inflation numbers accurately reflect reality? I think so, but everyone’s inflation reality is different.
Your comments on wanting maturities of 10 years or less is a great example of how asset allocation needs to be tailored to your personal needs. There is no “one” correct answer. In my case, our entire traditional IRA remains will be going to charity. (We have no children or grandchildren.) Charity makes the most sense and they can deal with the complexities of TIPS.
Good point to lock in historical real return. Maybe I need to lengthen my duration a bit (I don’t like losing money in bonds; that what stocks are for :))
I suppose if we see 10+% on UST30Y as we did in the 1980s to drive inflation down, no bond will perform well entering that environment. But…as has been said many times…
TIPS, at any maturity date, provides a nice/known “real” return … simply ignore the price volatility at long duration.
Another thought … if EVERYONE moves part of their bond allocation to TIPS, that’ll drive price up; yield down. Advantage goes to those who move first (that us blog readers!).
TIPS still seems still a niche investment for geeks and independent thinkers vs mainstream fin-advisors with their dang 1% wrap fee.
Most financial advisers don’t talk about TIPS (too boring) and if they do, they will generally recommend TIPS funds instead of individual TIPS. If you use an asset-under-management adviser, try to get individual TIPS and I Bonds excluded from the management fee.
Often TIPS are referred to as beating inflation, but they act as any bond does. When inflation rises, the FED increases rates, and TIPs decrease in value. So you aren’t matching inflation during those times for sure. Hopefully they drop in price less than a non-inflation protected security, and that’s where they seem appealing. So ‘explicit inflation protection’ sounds better than it actually is.
I’ve looked at how an equal duration TIPs and regular Treasury performed during the recent past and the TIPs had a significant advantage, but it still lost money. I’ve tried to look at longer time periods but TIPs just haven’t been around that long.
Thanks for your information – I enjoy reading your posts. My TIPs education is ongoing.
All of this is true. TIPS performed poorly in the rather quick transition from deeply negative real yields to historically high real yields, an increase in some cases of nearly 400 basis points. When TIPS had negative real yields, I wasn’t a buyer. Today is a better buying opportunity, especially if you can commit to holding to maturity.
Agree. Every dog (allocation) has its day. Expecting one part of your portfolio to cover everything all the time is voodoo economics. The stock portion is the only part that can throw off excess inflation protection. The inflation for those that post here is probably 10x + what the gov reports, unless you got a Snap lifestyle. I know my basket of Amazon and Costco goods is up 25%. I got 40% cash/bond like(ibonds, Annuity, money market), 20% gold ETFs and bitcoin miners, 40% high yield option income ETFs (ROC). Im retired an tired.
The USG is addicted to spending/entitlements, debt, and, the Fed, QE. I don’t see risk of deflation or benefits for nominal bonds given break-even inflation in the 2-3% range (agree that the Fed will tolerate ~2% inflation; rising to 3% in next couple years).
Allocating 50% of your bond portfolio to TIPS is my vote (up to 75% in a state with high-taxes). Given today’s yield curve, keep duration shortish (based on age) to protect against Greenspan-type Fed chief hiking rates. No more than 10 years for youngsters (50 y/o); down to 5 years for those >70 y/o. Under 50 y/o probably immaterial given their typical high stock allocation (bonds used for rebalancing).
Christine Benz published this idea maybe too early given rise in yields lately; also heavily discussed on Bogleheads of course (as is everything!).
https://www.morningstar.com/personal-finance/best-inflation-fighting-investments-retirement-portfolios
Would a TIPS fund like VTIP qualify as a good investment for the 10% inflation protection bucket?
Absolutely!
Funds like VTIP keep everything simple at negligible cost. Duration is short (less interest rate sensitivity) for VTIP.
I don’t own any individual TIPS funds right now, but VTIP would be my recommendation for someone who doesn’t care to buy individual TIPS. Over the last 10 years, It had a negative total returns in just two years: 2014 (-1.41%) and then in 2022 (-2.96%). Last year’s total return was 4.62%. This year to date it has a total return on 1.72%.
These aren’t inflation beating numbers but they are a lot better than the broad TIP fund indexes (down 12.2% in 2022) or bond-fund indexes (down 13.1%).