Treasury Inflation-Protected Securities

By David Enna, Tipswatch.com

While returning home from New Zealand a few days ago, I got into an airport conversation with a traveling friend. I mentioned I had a lot of things to do once I got home (about 30 hours later):

“Taxes. Yeah, we have to finish filing our income taxes … plus, we really need to look at rebalancing our portfolio, with stocks at an all-time high,” I said.

My friend, a retired long-time financial adviser, got a shocked look on her face. “Oh, rebalancing! I always advised my clients to do it, but we haven’t done a thing since 2016. We just don’t get around to it.”

As it turns out, that financial adviser’s faux pas was probably a very good thing. Over the last 10 years, the S&P 500 has had an annualized total return of 12.5%, a spectacular performance. Letting your stock allocation ride higher created a lot of wealth.

But my wife and I are conservative investors, so we hold to a plan to maintain a conservative asset allocation by rebalancing our portfolio, when needed, to line up with these goals:

• 23.3% in U.S. stocks (primarily in low-cost total U.S. stock funds)
• 11.7% in international stocks (similar low-cost index funds)
• 61.5% in bonds/fixed income (includes low-cost index funds + TIPS, I Bonds, CDs, nominal Treasurys)
• 3.5% in cash.

This allocation — 35% in stocks and 65% in fixed income/cash — is probably way too conservative for most investors. But this is a reflection of where we are in life. Asset allocation is a very personal thing.

Back in 2018, my wife and I went through a financial planning exercise with Allan Roth, a well-known adviser and author. When I saw that he titled his website “Dare to Be Dull,” I knew we found the right guy. Roth charges by the hour for a one-time, long-term focused plan and then recommends, “fire me.”

During our discussions, I suggested the 35%/65% asset mix and to my surprise, Roth agreed. Why? Because that was our comfort level. Plus, it would work for our needs.

Early on, I offered that we would probably be willing to raise the stock allocation to 40% if he thought that would be better. Roth responded, “OK, if you want to raise your stock allocation, I want you to wait until the stock market declines 20% and then do it.” Hmmm … OK.

As it turns out, I have heard Roth mention this advice many times since then, noting that no client has ever done it in the heat of a bear market. The man is clever. Our asset allocation was fine, and will continue to be fine.

If you want to get Roth’s advice at a very low cost, I suggest buying his book: “How a Second Grader Beats Wall Street.” His writing style is brisk and easy to understand, and he drives home the philosophy of low-cost index investing and simple portfolio structure. I also advise subscribing to his newsletter, which links to his many articles for AARP.com, ETF.com and AdvisorPerspectives.com.

In his book, Roth calls rebalancing “market timing that actually works.”

When you stop and think about it, rebalancing is a systematic way of buying low and selling high. … It forces us out of the ranks of the faux contrarian into the less-traveled ranks of the true contrarian. … Rebalancing forces us to sell some of what’s hot and buy some of what’s not.

Asset rebalancing and asset location are key principals of Roth’s philosophy. By “asset location” I mean optimizing the assets in each of your accounts. For example:

• Taxable brokerage, bank accounts: Ideal for stock holdings because of favorable tax rates on capital gains and dividends. Plus, spendable cash.
• Traditional tax-deferred accounts: Ideal for bond funds, REITS, nominal Treasurys, TIPS, etc., plus any actively managed fund that could generate high capital gains or dividends. Also the place to hold assets you plan to donate to charity. These holdings will eventually be subject to required minimum distributions.
• Roth accounts: Ideal for stock funds, with the assumption that these will be your longest-held assets. These assets will never be taxed, even if inherited.
• I Bonds: A separate category, since interest is tax-deferred but not subject to RMDs. I classify my I Bond holdings as “bonds,” but they have some qualities of cash, since they are protected from loss and redemption is flexible.

By following Roth’s guidelines, we were able to simply our portfolio — one of his key principals. The number of holdings and accounts is much smaller. I can calculate our asset allocation accurately within one hour. How often should this be done? I can’t give a definitive answer, but we do the calculation about three times a year. Sometimes we take actions, many times we don’t.

Here is the history of our rebalancing decisions over the last 4 1/2 years:

A key thing to keep in mind is that you don’t need to hit the percentage marks exactly — being off a few percentage points is fine. The point is to be aware of how market trends are setting your asset allocation adrift. And the rebalancing can be in small moves. For example, when you need to raise cash in retirement, an updated asset allocation can guide your decision. (Truth is, we generally do rebalancing in gradual moves.)

Note that in December 2019 we were close to our asset allocation and no action needed to be taken. But by March 2020 — in the midst of the pandemic-induced market panic — we needed to sell bonds and buy stocks. We did. Since then, the stock market has been on a run higher, so we have sold stocks at times and 1) bought bond funds in tax-deferred accounts, or 2) withdrew money to raise our cash levels, or 3) converted from traditional to Roth accounts.

Both the stock and bond markets took a hit in 2022, which left our asset allocation intact. No action was needed. In more recent times, as the stock market has been rising, we have again lowered our stock holdings and bought bonds — which finally look more attractive.

Not for every investor

If you haven’t rebalanced in recent years, and you hold a large stock allocation, your investments have done a lot better than mine. Congratulations! You just have to realize that your holdings have gotten a bit more risky over time. If your investing timeline is long, that is probably OK.

A lot of investors and financial advisors discourage rebalancing, and in fact that includes the guiding light of investing, Jack Bogle. He said this in an 2013 interview with Morningstar’s Christine Benz:

I am in a small minority on the idea of rebalancing. I don’t think you need to do it. The data bear me out, because the higher-yielding asset is going to be stocks over the long term. That’s the way the capital markets work. …

There is a comfort level for an investor. …. Anybody that feels they should rebalance, I think they should rebalance. I wouldn’t tell them not to. But I’d say, do it in a little more sensible way than it’s done.

I wouldn’t have some formula: oh my God, I’ve gone from 60% to 61%. I better get back to 60%. On a given day, that may happen in these markets. So it should be some range. Say you want to stay close to 65%. If you get below 60%, you can rebalance. If you get above 70%, you rebalance. And you try and not do it not with any great frequency.

A contrary view comes in this video from the Money Guys, Brian Preston and Bo Hanson, who have a popular YouTube channel dispensing solid, no-nonsense advice. They call rebalancing “a skill set that will serve you over the long term,” especially during the draw-down years of retirement:

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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.