Should everyone have TIPS?

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BogleBuddy12
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Should everyone have TIPS?

Post by BogleBuddy12 »

We often discuss on the forum the merits of retirees or near-retirees having some portion, perhaps 50%, of one’s bond portfolio in TIPS (whether individual or in a fund.)

However, there may be some benefit for younger people to hold TIPS as well. Let’s say you are 40 years old, and you have a portfolio of 70% stocks, 30% bonds. Some would presume, “stocks are your inflation hedge. There is no need for TIPS.”

But do stocks have a strong link to inflation? I have read conflicting research on this. Stocks may be an indirect inflation hedge, but not always.

TIPS, while not perfect, are a more direct link to the unexpected changes in inflation. If inflation rises and remains active for many years, some might be glad they held a TIPS fund.

Could a long-term portfolio in the accumulation phase benefit from having say 50% of the bond portion invested in TIPS?
dbr
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Re: Should everyone have TIPS?

Post by dbr »

In Portfolio Visualizer since 1985 three portfolios of 50% TSM vs 50% total bond, 25% total bond/25% TIPS, and 50% TIPS are virtually identical in everything PV calculates.

Tools like FireCalc don't have TIPS and TIPS didn't exist long enough to get a good historical record.

I would suggest that the answer to your question is that it doesn't matter, and if it does matter nobody knows for sure that it does.

In general there are far more choices in bonds than there is any solid reason to choose one over the other, so most questions about bonds have the answer "It doesn't matter." or, at most, "It depends." I have a very hard time recommending anything other than any diversified low cost intermediate term bond fund including or not including TIPS. Larry Swedroe once commented that bonds might as well be all TIPS but I don't recall if that was supposed to be in retirement or altogether. One might argue that as long as one is investing in fixed income not having inflation risk at any age just makes sense. You can decide that for yourself.

I know you are asking about accumulation phase, but let me say the only convincing result I have seen about bonds is that if you look at classic SWR research for moderate withdrawal rates too large an allocation to any bonds is bad and no allocation to bonds leaves you richer when you die than any other choice. At low withdrawal rates the allocation to bonds doesn't matter except regarding how rich you will be when you die. At too high a withdrawal rate bonds are the last thing that is going to save you. Allocation to bonds outweighs what bonds except maybe in some extreme examples.

Disclaimer: I have held about half my bonds in TIPS since somewhat before retirement till well after retirement date. There weren't any TIPS during our first three decades of investing.
Robot Monster
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Re: Should everyone have TIPS?

Post by Robot Monster »

David Swensen's lazy portfolio allocates equally to TIPS and nominal bonds.
https://www.bogleheads.org/wiki/Lazy_portfolios

I'm 46 and have 12% TIPS.
Elysium
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Re: Should everyone have TIPS?

Post by Elysium »

BogleBuddy12 wrote: Thu Jul 16, 2020 10:28 am We often discuss on the forum the merits of retirees or near-retirees having some portion, perhaps 50%, of one’s bond portfolio in TIPS (whether individual or in a fund.)

However, there may be some benefit for younger people to hold TIPS as well. Let’s say you are 40 years old, and you have a portfolio of 70% stocks, 30% bonds. Some would presume, “stocks are your inflation hedge. There is no need for TIPS.”

But do stocks have a strong link to inflation? I have read conflicting research on this. Stocks may be an indirect inflation hedge, but not always.

TIPS, while not perfect, are a more direct link to the unexpected changes in inflation. If inflation rises and remains active for many years, some might be glad they held a TIPS fund.

Could a long-term portfolio in the accumulation phase benefit from having say 50% of the bond portion invested in TIPS?
The right way to look at this is to think of what do you need inflation protection from, meaning do you have income needs from the portfolio that needs to be protected from inflation. Someone who is 40 in accumulation who expects to be employed for many more years do not have income needs from the portfolio, as their income needs are met by their human capital, your job/career. Once you start drawing from the portfolio then you are at high risk from inflation, and you do need protection. This is why retirees and near-retirees are recommended to have TIPS. That said, a 40 year old with 25% or more in Bonds could purchase long term TIPS to match duration and thus protect from inflation no matter what happens in the next 20-25 years. But then you will also need to transition out of that into intermediate/short duration bonds/tips as you get to retirement. The downside is that for stock heavy portfolios, TIPS aren't the best diversifiers always, nominal Treasury are better, therefore perhaps skip TIPS until 10 or less years to retirement. Obviously, no right answer. There is always something that gives.
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Re: Should everyone have TIPS?

Post by nisiprius »

I hate the word "should." Investing is so uncertain that the word "should" is rarely appropriate.

1) I love TIPS. I first bought TIPS in 1998. For reasons I don't fully understand, an awful lot of writers talk them down or pretend that they don't exist. My allocation in marketable bonds (i.e. not including series I savings bonds) is roughly equally divided between the Vanguard Total Bond Market index fund and the Vanguard Inflation-Protected Securities fund.

Investment writer Scott Burns proposed a "Margarita Portfolio" of 1/3rd each Total Stock, Total International Stock, and TIPS. He discusses it here. I don't regard him as a guru, and I just mention it to show that going all-TIPS for the bond allocation is well within the range of sane choices.

2) Nevertheless...

3) On the whole it hasn't made much difference, but the historical record of how TIPS have behaved is that they have had some weird volatility. In particular, around 2007-2009 they first experienced an eerie 10% gain in 2007, and then an uncomfortable 10% drop in 2008. It's been suggested that this is because TIPS, despite being a kind of Treasury bond, are less liquid than other Treasury securities.

The bottom line is that TIPS have had more volatility and lower risk-adjusted return. Note, however, that we are still talking about bond-sized volatility, not stock-sized volatility.

4) Vanguard's reasoning for including TIPS in Target Retirement funds for older investors is that with age, the portfolio becomes more conservative. They argue that a young investor gets adequate inflation protection from stocks, but an older investor has less in stocks, therefore needs to get some inflation protection from within the bond component. I don't find this very convincing and the TIPS allocation is too low to help much anyway. But that is a rationale for "don't need them when you're young."

I would regard TIPS as being perfectly reasonable if you just plain like them, being aware that they are a kind of personal taste and that if you fine-tune your portfolio for a supposed optimum based on past history, including TIPS would have been not quite optimum.

5) By my standards, having lived through 1970-1980, there has been essentially no inflation in the time TIPS have been available, and all analyses of TIPS versus nominal have basically been looking at noise.
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nisiprius
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Re: Should everyone have TIPS?

Post by nisiprius »

<SOAPBOX ON>
A wag in the forum once said that TIPS is an acronym for The Investment Professionals Shun. For as long as I've owned them, I have been completely baffled by the attitude and I have to admit I engaged in conspiratorial thinking about it. For whatever reason, the usual sources of investment advice would rather you chose any of a long list of indirect, non-guaranteed, unreliable, "tends-to" inflation hedges, anything at all but TIPS.

I think TIPS are similar to index funds. They are just too easy, they get in the way of simplistic arguments for riskier assets, and there isn't any way that the investment industry can make much money by selling them.

There is an extraordinary range of slightly-dishonest statements that get made about TIPS. For example, with every other investment, if you just use the phrase "lose money" without qualification, it means a nominal dollar loss. When talking about TIPS, people who knock them will often use the phrase "lose money" to refer to real loss (failure to keep up with inflation). They also are sure to point out that income tax is assessed on dollar gains, not real gains, so if TIPS exactly keep up with inflation before taxes, they fall behind after taxes. This, of course, is true of all investments, not just TIPS.

Ditto Series I savings bonds.
<SOAPBOX OFF>
...wait...
<SOAPBOX ON AGAIN>
BogleBuddy12 wrote: Thu Jul 16, 2020 10:28 am...But do stocks have a strong link to inflation? I have read conflicting research on this. Stocks may be an indirect inflation hedge, but not always...
Warren Buffett's mentor, professor Benjamin Graham, wrote this in The Intelligent Investor, 4th ed., 1973:
Benjamin Graham wrote:(p. 20) On this point we can be categorical. There is no close time connection between inflationary (or deflationary) conditions and the movement of common-stock earnings and prices. The obvious example is the recent period 1966-1970. The rise in the cost of living was 22%... but both stock earnings and stock prices have declined since 1965. There are similar contradictions in both directions in the record of previous five-year periods.
<SOAPBOX OFF>
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vineviz
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Re: Should everyone have TIPS?

Post by vineviz »

BogleBuddy12 wrote: Thu Jul 16, 2020 10:28 am However, there may be some benefit for younger people to hold TIPS as well. Let’s say you are 40 years old, and you have a portfolio of 70% stocks, 30% bonds. Some would presume, “stocks are your inflation hedge. There is no need for TIPS.”

But do stocks have a strong link to inflation? I have read conflicting research on this. Stocks may be an indirect inflation hedge, but not always.

TIPS, while not perfect, are a more direct link to the unexpected changes in inflation. If inflation rises and remains active for many years, some might be glad they held a TIPS fund.

Could a long-term portfolio in the accumulation phase benefit from having say 50% of the bond portion invested in TIPS?
First, can we explain to the 40-year old investor why 30% in bonds is an excessively conservative allocation to begin with?

Second, stock returns DO have a strong positive correlation over relatively long periods of time. Certainly not a perfect 1.0 correlation, but definitely strong.

Third, as others have mentioned, neither stocks nor bonds are the MOST POWERFUL inflation-linked asset a typical 40-year old investor has. Rather, that asset is their human capital. Real wage growth is generally positive, so investors who are still accumulating (i.e. are pre-retirement) are typically investing nominal dollars and not real dollars.

Fourth, for young but highly risk-averse investors it is true that TIPS are probably the closest thing to a risk-free asset available to them. A long-term TIPS fund like PIMCO 15+ Year U.S. TIPS Index Exchange-Traded Fund (LTPZ) would indeed comprise a portion of their fixed income allocation.
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rich126
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Re: Should everyone have TIPS?

Post by rich126 »

dbr wrote: Thu Jul 16, 2020 10:48 am In Portfolio Visualizer since 1985 three portfolios of 50% TSM vs 50% total bond, 25% total bond/25% TIPS, and 50% TIPS are virtually identical in everything PV calculates.

Tools like FireCalc don't have TIPS and TIPS didn't exist long enough to get a good historical record.

I would suggest that the answer to your question is that it doesn't matter, and if it does matter nobody knows for sure that it does.

In general there are far more choices in bonds than there is any solid reason to choose one over the other, so most questions about bonds have the answer "It doesn't matter." or, at most, "It depends." I have a very hard time recommending anything other than any diversified low cost intermediate term bond fund including or not including TIPS. Larry Swedroe once commented that bonds might as well be all TIPS but I don't recall if that was supposed to be in retirement or altogether. One might argue that as long as one is investing in fixed income not having inflation risk at any age just makes sense. You can decide that for yourself.

I know you are asking about accumulation phase, but let me say the only convincing result I have seen about bonds is that if you look at classic SWR research for moderate withdrawal rates too large an allocation to any bonds is bad and no allocation to bonds leaves you richer when you die than any other choice. At low withdrawal rates the allocation to bonds doesn't matter except regarding how rich you will be when you die. At too high a withdrawal rate bonds are the last thing that is going to save you. Allocation to bonds outweighs what bonds except maybe in some extreme examples.

Disclaimer: I have held about half my bonds in TIPS since somewhat before retirement till well after retirement date. There weren't any TIPS during our first three decades of investing.
What kind of estimate do they use in 1985 for tips? They didn't exist until 1997.
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Forester
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Re: Should everyone have TIPS?

Post by Forester »

I don't trust instruments like this, so other investors can be the guinea pigs as far as I'm concerned.
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galeno
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Re: Should everyone have TIPS?

Post by galeno »

My rules for TIPS.

Ports with >/= 60% equities no TIPS.

Ports with </= 60% equities fill the gap with TIPS.
KISS & STC.
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Ramjet
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Re: Should everyone have TIPS?

Post by Ramjet »

If you have some long bonds and the rest TIPS you should be covered for both inflation and deflation risk
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Re: Should everyone have TIPS?

Post by jason2459 »

galeno wrote: Thu Jul 16, 2020 12:26 pm My rules for TIPS.

Ports with >/= 60% equities no TIPS.

Ports with </= 60% equities fill the gap with TIPS.
Any specific reason for that?

I'm basically 95/5. That 5% bonds is split up about equally to long term treasuries and Total bond market through a target date fund and then some TIPS I have separate from that Target date fund to bring that percentage up to 5%.

As time goes by that target date fund will slide my bond allocation higher and I'll increase my TIPS allocation too to increase my bond % in a more controlled to my liking fashion. I like TIPS as that control knob. I'm around 40. Maybe I'm wrong to do this? but I understand it and like it.
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Re: Should everyone have TIPS?

Post by Ferdinand2014 »

TIPS make sense closer to retirement in my opinion. Right now I am in the accumulation phase and have many years of working (human) capital rising ahead of me, a paid off house (no rising rent) and weekly contributions to stocks purchased in today’s dollars paid back to me in rising dividends and unrealized capital gains later in life. When I can no longer continue to buy stocks nor have rising human capital, I will consider adding TIPS.
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Re: Should everyone have TIPS?

Post by Ben Mathew »

In a simple world where unexpected inflation and deflation does not affect the real economy, stocks would be helped by unexpected inflation. That's because they hold real assets that are not affected by inflation, but owe nominal debt whose value is reduced by inflation.

In a complicated world where unexpected inflation and deflation impacts the real economy, all sorts of things can happen. But I consider these second order effects. Owning a well diversified global stock portfolio owning real assets all over the world, I'm just not very worried about unexpected inflation or deflation in one country. The concern is more when bonds get to be a substantial part of the portfolio. When that happens, I think TIPS are essential. I could not sleep at night holding a large nominal bond portfolio whose value depends greatly on the decisions of a handful of Fed officials.
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Re: Should everyone have TIPS?

Post by hudson »

vineviz wrote: Thu Jul 16, 2020 11:49 am A long-term TIPS fund like PIMCO 15+ Year U.S. TIPS Index Exchange-Traded Fund (LTPZ) would indeed comprise a portion of their fixed income allocation.
not bad
.2 Expense Ratio
effective duration 21.65 years
https://www.pimco.com/en-us/investments ... raded-fund
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Re: Should everyone have TIPS?

Post by Robot Monster »

Ben Mathew wrote: Thu Jul 16, 2020 1:12 pm In a simple world where unexpected inflation and deflation does not affect the real economy, stocks would be helped by unexpected inflation. That's because they hold real assets that are not affected by inflation, but owe nominal debt whose value is reduced by inflation.

In a complicated world where unexpected inflation and deflation impacts the real economy, all sorts of things can happen. But I consider these second order effects. Owning a well diversified global stock portfolio owning real assets all over the world, I'm just not very worried about unexpected inflation or deflation in one country. The concern is more when bonds get to be a substantial part of the portfolio. When that happens, I think TIPS are essential. I could not sleep at night holding a large nominal bond portfolio whose value depends greatly on the decisions of a handful of Fed officials.
Imagine if you went all in on Vanguard Wellesley Income Fund, which is 60% nominal bonds with an average duration of 8 years, thinking all that bond was making your investment nice and safe.
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Re: Should everyone have TIPS?

Post by Coltrane75 »

BogleBuddy12 wrote: Thu Jul 16, 2020 10:28 am Could a long-term portfolio in the accumulation phase benefit from having say 50% of the bond portion invested in TIPS?
Definitely. I would have my long-term investments in a long-term TIPS fund if my 401k had it on offer.

Just a bonus: I use TIPS in my HSA and own I Bonds for short-term reserves.
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Re: Should everyone have TIPS?

Post by fatcoffeedrinker »

Forester wrote: Thu Jul 16, 2020 12:15 pm I don't trust instruments like this, so other investors can be the guinea pigs as far as I'm concerned.
Trust that the US will make good on them? Trust that the US won't intentionally understate CPI? Trust that other investors will buy them when you want to sell them? Serious question. Just curious what aspect is not trustworthy.
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Re: Should everyone have TIPS?

Post by dbr »

rich126 wrote: Thu Jul 16, 2020 12:12 pm

What kind of estimate do they use in 1985 for tips? They didn't exist until 1997.
My bad. PV puts in a date range starting in 1985, the earliest date they run, but if a ticker doesn't actually exist until later the analysis only covers the period when it does exist. The data I reported starts in 2001 where the fund I used for TIPS was VIPSX.

It is a drawback for back testing that even going back to 1985 is not really enough, and, as you say, testing TIPS is problematic due to short time set.

A person could try to approach this using a Monte Carlo simulation if one were confident of a returns distribution for TIPS, but that probably runs into the same issues in the end.

I don't know what else to do to answer questions like this unless someone has an approach different from consulting empirical evidence. There probably are some ideas out there.

I would still stick by my contention that investment performance is always such a variable thing that deciding definitely that one should choose X and not choose Y is usually impossible.
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Re: Should everyone have TIPS?

Post by pascalwager »

Ben Mathew wrote: Thu Jul 16, 2020 1:12 pm In a simple world where unexpected inflation and deflation does not affect the real economy, stocks would be helped by unexpected inflation. That's because they hold real assets that are not affected by inflation, but owe nominal debt whose value is reduced by inflation.

In a complicated world where unexpected inflation and deflation impacts the real economy, all sorts of things can happen. But I consider these second order effects. Owning a well diversified global stock portfolio owning real assets all over the world, I'm just not very worried about unexpected inflation or deflation in one country. The concern is more when bonds get to be a substantial part of the portfolio. When that happens, I think TIPS are essential. I could not sleep at night holding a large nominal bond portfolio whose value depends greatly on the decisions of a handful of Fed officials.
This statement (bolded, above) confuses me. Do foreign country stocks necessarily have a high correlation to US inflation?
16% TSM | 16% TISM | 7% LV | 7% SV/SC | 7% ISV/ISC | 7% EM | 20% TIPS | 20% STIG | Bonds 9.1 years duration
alluringreality
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Re: Should everyone have TIPS?

Post by alluringreality »

BogleBuddy12 wrote: Thu Jul 16, 2020 10:28 amBut do stocks have a strong link to inflation? I have read conflicting research on this.
I get the impression that there may have been times when large cap US stock might not have done very well in relation to inflation, at least Global Asset Allocation gives that impression for the 1973-1981 values that include synthetic TIPS. Inflation might mean a rising rate environment. David Swensen suggests rising rates could be detrimental to both nominal bonds and stocks. The following Bridgewater image also tends to question how well a portfolio that only contains nominal bonds and stocks might perform in rising inflation. Gold could be another portfolio consideration related to inflation, although personally I'm more comfortable with inflation linked government bonds for my purposes. I keep some near-term assets available (I Bonds, Savings, CDs), in order to keep from worrying about my stock holdings going underwater. Realistically my economic value in the current unemployment environment is likely lower than in an economy with full employment, which of course might not apply to all occupations.
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Re: Should everyone have TIPS?

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fatcoffeedrinker wrote: Thu Jul 16, 2020 2:47 pm
Forester wrote: Thu Jul 16, 2020 12:15 pm I don't trust instruments like this, so other investors can be the guinea pigs as far as I'm concerned.
Trust that the US will make good on them? Trust that the US won't intentionally understate CPI? Trust that other investors will buy them when you want to sell them? Serious question. Just curious what aspect is not trustworthy.
TIPS may be OK for shorter term planning or as a small "cash" part of the portfolio, but I don't like the idea of them as a sizeable part of a portfolio, since you're trusting that the entity which is creating inflation in the first place (the government) will accurately report inflation, when they may have strong incentives to understate it. The higher & more prolonged inflation is, the less likely it is that the TIPS construct will prove to be robust IMHO.
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Re: Should everyone have TIPS?

Post by j0e0r7 »

vineviz wrote: Thu Jul 16, 2020 11:49 am
First, can we explain to the 40-year old investor why 30% in bonds is an excessively conservative allocation to begin with?
Over the course of the past 15 years or so, conventional wisdom has gone from "age in bonds" (Bogle) to "age minus 10" and now even that seems to be considered excessively conservative. What's changed in that short period of time? Is it recency bias based on stocks having a strong showing in this period, or is there a fundamental change in stocks and bonds that I should know about? Because I think stock-bond ratio is probably the most important decision an investor will make.
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Re: Should everyone have TIPS?

Post by dbr »

j0e0r7 wrote: Thu Jul 16, 2020 4:29 pm
vineviz wrote: Thu Jul 16, 2020 11:49 am
First, can we explain to the 40-year old investor why 30% in bonds is an excessively conservative allocation to begin with?
Over the course of the past 15 years or so, conventional wisdom has gone from "age in bonds" (Bogle) to "age minus 10" and now even that seems to be considered excessively conservative. What's changed in that short period of time? Is it recency bias based on stocks having a strong showing in this period, or is there a fundamental change in stocks and bonds that I should know about? Because I think stock-bond ratio is probably the most important decision an investor will make.
I don't think there is any reasoning that stocks have become less risky. In addition there is constant mumbling that the expected return for stocks going forward is less than we have had in the past. So if you conclude that stocks might return less but be just as risky as ever, I am not sure where the idea would come from that a conservative portfolio should have a lot in stocks. Regarding bonds we agree prospects for returns in bonds are down, but bonds are still not very risky so they still do what people want them to do, which is reduce the risk in the portfolio.

So the question is, are these things about risk or are they about expected* return?

*Note in this context expected means the average value of the distribution of possible returns, and risk, of course, means how widely those returns are distributed, probably measure/defined by standard deviation of that same distribution.
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Re: Should everyone have TIPS?

Post by vineviz »

j0e0r7 wrote: Thu Jul 16, 2020 4:29 pm
vineviz wrote: Thu Jul 16, 2020 11:49 am
First, can we explain to the 40-year old investor why 30% in bonds is an excessively conservative allocation to begin with?
Over the course of the past 15 years or so, conventional wisdom has gone from "age in bonds" (Bogle) to "age minus 10" and now even that seems to be considered excessively conservative. What's changed in that short period of time?
I’m not sure we can ever count on “conventional wisdom” as being either conventional or wise.

Expert advice 15 years ago was pretty much the same as today: for retirement goals the target bond allocation for a 40-year old with moderate risk aversion is likely they range of 0% - 10%.
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Re: Should everyone have TIPS?

Post by dbr »

I would add that trying to invest by label as in conservative vs moderate vs aggressive is silly. It is straightforward to specify an asset allocation in numbers, to make some estimates of what the investment properties of such asset allocations are, and to do the best we can to see how well those properties match what we want to do. You look at how well the range of options serves one's needs and at how damaging the consequences might be if things don't go well, and then you make a decision. You pays yer money and you takes yer choice.
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Re: Should everyone have TIPS?

Post by Northern Flicker »

vineviz wrote: First, can we explain to the 40-year old investor why 30% in bonds is an excessively conservative allocation to begin with?
The answer is no because (age-10) as a percentage to hold in fixed income is a perfectly reasonable retirement portfolio allocation. I would classify it as moderately aggressive. Investors with the nerve to be more aggressive may choose to do so, but they are taking the risk that life circumstance will shorten their investment horizon to be substantially shorter than they projected.
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Re: Should everyone have TIPS?

Post by vineviz »

Northern Flicker wrote: Thu Jul 16, 2020 5:43 pm
vineviz wrote: First, can we explain to the 40-year old investor why 30% in bonds is an excessively conservative allocation to begin with?
The answer is no because (age-10) as a percentage to hold in fixed income is a perfectly reasonable retirement portfolio allocation. I would classify it as moderately aggressive. Investors with the nerve to be more aggressive may choose to do so, but they are taking the risk that life circumstance will shorten their investment horizon to be substantially shorter than they projected.
If you think age-10 is “aggressive” for a 40 year old investor then I’d say that is an indication that your personal level of risk aversion is well above average.
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Re: Should everyone have TIPS?

Post by Ben Mathew »

pascalwager wrote: Thu Jul 16, 2020 3:43 pm
Ben Mathew wrote: Thu Jul 16, 2020 1:12 pm In a simple world where unexpected inflation and deflation does not affect the real economy, stocks would be helped by unexpected inflation. That's because they hold real assets that are not affected by inflation, but owe nominal debt whose value is reduced by inflation.

In a complicated world where unexpected inflation and deflation impacts the real economy, all sorts of things can happen. But I consider these second order effects. Owning a well diversified global stock portfolio owning real assets all over the world, I'm just not very worried about unexpected inflation or deflation in one country. The concern is more when bonds get to be a substantial part of the portfolio. When that happens, I think TIPS are essential. I could not sleep at night holding a large nominal bond portfolio whose value depends greatly on the decisions of a handful of Fed officials.
This statement (bolded, above) confuses me. Do foreign country stocks necessarily have a high correlation to US inflation?
No, I wouldn't expect foreign stocks to be positively correlated to US inflation. The idea was that international stocks would be less affected than US stocks by unexpected US inflation or deflation. So holding international stocks helps via diversification (not as a hedge).
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Re: Should everyone have TIPS?

Post by Ben Mathew »

Forester wrote: Thu Jul 16, 2020 3:54 pm
fatcoffeedrinker wrote: Thu Jul 16, 2020 2:47 pm
Forester wrote: Thu Jul 16, 2020 12:15 pm I don't trust instruments like this, so other investors can be the guinea pigs as far as I'm concerned.
Trust that the US will make good on them? Trust that the US won't intentionally understate CPI? Trust that other investors will buy them when you want to sell them? Serious question. Just curious what aspect is not trustworthy.
TIPS may be OK for shorter term planning or as a small "cash" part of the portfolio, but I don't like the idea of them as a sizeable part of a portfolio, since you're trusting that the entity which is creating inflation in the first place (the government) will accurately report inflation, when they may have strong incentives to understate it. The higher & more prolonged inflation is, the less likely it is that the TIPS construct will prove to be robust IMHO.
Even if inflation is measured poorly, don't you think that if we end up with higher than expected inflation for a prolonged period of time, a person holding TIPS with its imperfect inflation adjustment will still be a lot better off than a person holding nominal bonds which have no inflation adjustment at all?
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Re: Should everyone have TIPS?

Post by abuss368 »

Ferdinand2014 wrote: Thu Jul 16, 2020 12:54 pm TIPS make sense closer to retirement in my opinion. Right now I am in the accumulation phase and have many years of working (human) capital rising ahead of me, a paid off house (no rising rent) and weekly contributions to stocks purchased in today’s dollars paid back to me in rising dividends and unrealized capital gains later in life. When I can no longer continue to buy stocks nor have rising human capital, I will consider adding TIPS.
Great advice that Bogleheads would be wise to follow. :beer
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Re: Should everyone have TIPS?

Post by UpperNwGuy »

vineviz wrote: Thu Jul 16, 2020 6:24 pm
Northern Flicker wrote: Thu Jul 16, 2020 5:43 pm
vineviz wrote: First, can we explain to the 40-year old investor why 30% in bonds is an excessively conservative allocation to begin with?
The answer is no because (age-10) as a percentage to hold in fixed income is a perfectly reasonable retirement portfolio allocation. I would classify it as moderately aggressive. Investors with the nerve to be more aggressive may choose to do so, but they are taking the risk that life circumstance will shorten their investment horizon to be substantially shorter than they projected.
If you think age-10 is “aggressive” for a 40 year old investor then I’d say that is an indication that your personal level of risk aversion is well above average.
Age minus 20 seems more appropriate for most investors, and I would not consider that to be aggressive.
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Re: Should everyone have TIPS?

Post by Northern Flicker »

vineviz wrote: Thu Jul 16, 2020 6:24 pm
Northern Flicker wrote: Thu Jul 16, 2020 5:43 pm
vineviz wrote: First, can we explain to the 40-year old investor why 30% in bonds is an excessively conservative allocation to begin with?
The answer is no because (age-10) as a percentage to hold in fixed income is a perfectly reasonable retirement portfolio allocation. I would classify it as moderately aggressive. Investors with the nerve to be more aggressive may choose to do so, but they are taking the risk that life circumstance will shorten their investment horizon to be substantially shorter than they projected.
If you think age-10 is “aggressive” for a 40 year old investor then I’d say that is an indication that your personal level of risk aversion is well above average.
I said it was moderately aggressive. Being 70% stocks means you have the nerves to watch 35% of your nest egg evaporate, and to just calmly rebalance near the bottom of a bear market. I don't think that is a level of risk aversion that is way above average. Many individuals overestimate their risk tolerance and liquidate their entire portfolio to cash when it is down 40%.
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Re: Should everyone have TIPS?

Post by Robot Monster »

Northern Flicker wrote: Thu Jul 16, 2020 9:07 pm Many individuals overestimate their risk tolerance and liquidate their entire portfolio to cash when it is down 40%.
What I didn't realize was how profoundly my risk tolerance would change; it absolutely dove more than expected during the onset of the pandemic and, perversely, just when I needed my psychological defenses the most they were the most vulnerable. Perhaps many people are overestimating their risk tolerance because they think it's a static thing that won't change during such times of stress.
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Re: Should everyone have TIPS?

Post by nedsaid »

BogleBuddy12 wrote: Thu Jul 16, 2020 10:28 am We often discuss on the forum the merits of retirees or near-retirees having some portion, perhaps 50%, of one’s bond portfolio in TIPS (whether individual or in a fund.)

However, there may be some benefit for younger people to hold TIPS as well. Let’s say you are 40 years old, and you have a portfolio of 70% stocks, 30% bonds. Some would presume, “stocks are your inflation hedge. There is no need for TIPS.”

But do stocks have a strong link to inflation? I have read conflicting research on this. Stocks may be an indirect inflation hedge, but not always.

TIPS, while not perfect, are a more direct link to the unexpected changes in inflation. If inflation rises and remains active for many years, some might be glad they held a TIPS fund.

Could a long-term portfolio in the accumulation phase benefit from having say 50% of the bond portion invested in TIPS?
Stocks and bonds both adjust for the effects of inflation. After the 1970's Stagflation, it took a decade or more to get your inflation adjustment from stocks. The United States essentially funded World War II through inflation, I heard a couple of stories that purchasers of War Bonds found that the bonds lost about 1/2 of their purchasing power over time. We experienced a bond bear market from about 1946-1981, bonds lost purchasing power over time. Afterwards, bonds experienced an almost 40 bear bull market. To sum up, neither stocks or bonds are perfect inflation hedges. Inflation spikes are bad for both stocks and bonds but the markets will eventually adjust. With stocks, it might take more than a decade. With bonds, it might take a generation or longer.
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Re: Should everyone have TIPS?

Post by dbr »

A difference between stocks and TIPS as inflation "protection" is that TIPS are perfectly protected themselves but by that very fact offer nothing to the rest of the portfolio. Stocks, on the other hand, have no inflation protection as such but have enough return to be able to eventually outrun inflation and to outrun inflation by enough that the portfolio as a whole does not lose real value. If you look at real returns the difference is that the expected real return from stocks is always(?) positive while the expected real return from TIPS can be negative even while they are protected from inflation.
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Re: Should everyone have TIPS?

Post by vineviz »

Northern Flicker wrote: Thu Jul 16, 2020 9:07 pm I said it was moderately aggressive. Being 70% stocks means you have the nerves to watch 35% of your nest egg evaporate, and to just calmly rebalance near the bottom of a bear market. I don't think that is a level of risk aversion that is way above average.
All the evidence we have shows us that most young investors are, in fact, routinely able to maintain equity allocations well above 70%.

For comparison, let's compare the allocations of the 25 largest target-date 2045 funds. These funds are held by millions of investors between the ages of 35 and 45. The average bond allocation is 9%, the ten most conservative funds average 11% in bonds, and the five most aggressive funds average 5%.

A 30% bond allocation would be over four standard deviations above average: that's not even close to what experts would call "moderate". It's more conservative than the MOST conservative fund in the group. Over 95% of the assets in target-date 2045 funds are in funds with <10% bonds.
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Re: Should everyone have TIPS?

Post by aj76er »

vineviz wrote: Fri Jul 17, 2020 9:45 am
Northern Flicker wrote: Thu Jul 16, 2020 9:07 pm I said it was moderately aggressive. Being 70% stocks means you have the nerves to watch 35% of your nest egg evaporate, and to just calmly rebalance near the bottom of a bear market. I don't think that is a level of risk aversion that is way above average.
All the evidence we have shows us that most young investors are, in fact, routinely able to maintain equity allocations well above 70%.

For comparison, let's compare the allocations of the 25 largest target-date 2045 funds. These funds are held by millions of investors between the ages of 35 and 45. The average bond allocation is 9%, the ten most conservative funds average 11% in bonds, and the five most aggressive funds average 5%.

A 30% bond allocation would be over four standard deviations above average: that's not even close to what experts would call "moderate". It's more conservative than the MOST conservative fund in the group. Over 95% of the assets in target-date 2045 funds are in funds with <10% bonds.
What this fails to take into account is the average size of the 2045 portfolio. I’m guessing it’s a small amount relative to one’s retirement needs. On the other hand, if someone saves diligently and/or gets lucky on an early career windfall, has 25x their living expenses by age 40, then I can’t fault them for being more conservative than average.
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Re: Should everyone have TIPS?

Post by vineviz »

aj76er wrote: Fri Jul 17, 2020 9:53 am
What this fails to take into account is the average size of the 2045 portfolio. I’m guessing it’s a small amount relative to one’s retirement needs. On the other hand, if someone saves diligently and/or gets lucky on an early career windfall, has 25x their living expenses by age 40, then I can’t fault them for being more conservative than average.
I think you hit the nail on the head: investors with significantly greater-than-average wealth probably can afford to choose an allocation with less-than-average market exposure. I wouldn’t fault them for making a conservative choice either.

But the average 40-year old American has less than $70,000 in retiremenT savings, and I’m confident the average Boglehead is well below 25x expenses by age 40.

We aren’t helping “typical” investors by codifying the experience and preferences of a tiny minority of atypical investors as if they are “moderate” rules of thumb.
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Re: Should everyone have TIPS?

Post by bikechuck »

I understand individual TIPS but every time I try to think through whether or not a TIPS fund would be as good I get a headache and I lose confidence in my ability to think through the question with any confidence.

For now, in my mid 60's I have none either individually or in a fund though I probably should. Inertia is a powerful force.
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Re: Should everyone have TIPS?

Post by rlangford »

Currently, a 10 year TIPS has a real yield of -0.84% (Bloomberg) , not a screaming buy. However, the breakeven inflation rate is running about 1.46% for 10 years (10 year nominal treasuries yielding 0.62% (Bloomberg)), which could end up being low compared to actual inflation for the next 10 years. Nobody knows if inflation will be higher than 1.46% even when the Fed targets 2%. Hard to know what to do but I would lean towards TIPS rather than nominal treasuries, or hedge your bets and buy both.
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Re: Should everyone have TIPS?

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dbr wrote: Fri Jul 17, 2020 9:06 am If you look at real returns the difference is that the expected real return from stocks is always(?) positive while the expected real return from TIPS can be negative even while they are protected from inflation.
I don't understand why you say "expected" real return from TIPS. The real return from TIPS is absolutely known at the point you buy them. :confused
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Re: Should everyone have TIPS?

Post by abuss368 »

dbr wrote: Thu Jul 16, 2020 10:48 am In Portfolio Visualizer since 1985 three portfolios of 50% TSM vs 50% total bond, 25% total bond/25% TIPS, and 50% TIPS are virtually identical in everything PV calculates.

I would suggest that the answer to your question is that it doesn't matter, and if it does matter nobody knows for sure that it does.
Very well said. Every time I looked at including TIPS again it appears to not make much, if any, difference. Any short or intermediate investment grade bond fund that is low cost and diversified will provide safety and income to a portfolio.
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Re: Should everyone have TIPS?

Post by abuss368 »

We invested in the Vanguard Intermediate Term TIPS fund many years back. We eventually simplified and consolidated with Total Bond and this has worked well.

Keep investing simple.
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Re: Should everyone have TIPS?

Post by FIREchief »

abuss368 wrote: Fri Jul 17, 2020 1:12 pm Keep investing simple.
Is buying TIPS not "simple?" :confused
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Re: Should everyone have TIPS?

Post by dbr »

FIREchief wrote: Fri Jul 17, 2020 12:55 pm
dbr wrote: Fri Jul 17, 2020 9:06 am If you look at real returns the difference is that the expected real return from stocks is always(?) positive while the expected real return from TIPS can be negative even while they are protected from inflation.
I don't understand why you say "expected" real return from TIPS. The real return from TIPS is absolutely known at the point you buy them. :confused
I wasn't sure if I should write that that way or not. I actually went back and inserted it later. The thought is that the real return from a TIPS at any point in time is the coupon, which is known, and whatever the real price change on the market is. Assuming that capital changes in bond investing are on average zero we do know the expected return but we don't know how much we might gain or lose if we sell the TIPS at some time. Naturally one can assume the TIPS is only redeemed at maturity and then the expected return is certainly the return.

But that was just a minor observation. The point was to mention one of the ways TIPS and stocks have different behavior to take into account when one is worrying about inflation.
Last edited by dbr on Fri Jul 17, 2020 2:03 pm, edited 1 time in total.
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Re: Should everyone have TIPS?

Post by abuss368 »

FIREchief wrote: Fri Jul 17, 2020 1:15 pm
abuss368 wrote: Fri Jul 17, 2020 1:12 pm Keep investing simple.
Is buying TIPS not "simple?" :confused
Depends on each individual investors strategies and goals. No two investors are alike.
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Re: Should everyone have TIPS?

Post by Northern Flicker »

vineviz wrote: Fri Jul 17, 2020 11:52 am
aj76er wrote: Fri Jul 17, 2020 9:53 am
What this fails to take into account is the average size of the 2045 portfolio. I’m guessing it’s a small amount relative to one’s retirement needs. On the other hand, if someone saves diligently and/or gets lucky on an early career windfall, has 25x their living expenses by age 40, then I can’t fault them for being more conservative than average.
I think you hit the nail on the head: investors with significantly greater-than-average wealth probably can afford to choose an allocation with less-than-average market exposure. I wouldn’t fault them for making a conservative choice either.

But the average 40-year old American has less than $70,000 in retiremenT savings, and I’m confident the average Boglehead is well below 25x expenses by age 40.

We aren’t helping “typical” investors by codifying the experience and preferences of a tiny minority of atypical investors as if they are “moderate” rules of thumb.
There's nothing like an 11 year bull market for making investors feel invincible and risk-tolerant.

A 40-year old saving diligently from say age 25 may have enough retirenent savings relative to their income to consider 91% stocks to be excessively risky.

Target date funds have been in an arms race on stock allocations. If one large fund company juices their equity percentage, others follow suit, because they do not want to risk underperformibg their competition.

Certainly there are aggressive retirement investors. But if you are less risk tolerant than that, being only moderately aggressive is not a mistake.
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Re: Should everyone have TIPS?

Post by vineviz »

Northern Flicker wrote: Fri Jul 17, 2020 2:00 pm There's nothing like an 11 year bull market for making investors feel invincible and risk-tolerant.
I see this rationalization a lot but not a lot of evidence to support it.

The flip side of this argument, of course, is that a 40 year "bull market" for bonds has undoubtedly clouded the judgement of many investors. There's a core group of Bogleheads who are still investing as if they expect to continue getting real returns on bonds of 4% or more. That kind of belief can definitely warp the perception of the risk/reward tradeoff between stocks and fixed income.

Anyway, target date funds have been around long enough that we can observe investor behavior over the course of multiple 20%+ drawdowns. In doing so, we can see that the vast majority of younger investors in TDFs just shrug it off and carry on.

I'm much less worried about the typical 90/10 40-year old investor than I am about a 40/60 retiree.
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Re: Should everyone have TIPS?

Post by dodecahedron »

Ben Mathew wrote: Thu Jul 16, 2020 7:58 pm
pascalwager wrote: Thu Jul 16, 2020 3:43 pm
Ben Mathew wrote: Thu Jul 16, 2020 1:12 pm In a simple world where unexpected inflation and deflation does not affect the real economy, stocks would be helped by unexpected inflation. That's because they hold real assets that are not affected by inflation, but owe nominal debt whose value is reduced by inflation.

In a complicated world where unexpected inflation and deflation impacts the real economy, all sorts of things can happen. But I consider these second order effects. Owning a well diversified global stock portfolio owning real assets all over the world, I'm just not very worried about unexpected inflation or deflation in one country. The concern is more when bonds get to be a substantial part of the portfolio. When that happens, I think TIPS are essential. I could not sleep at night holding a large nominal bond portfolio whose value depends greatly on the decisions of a handful of Fed officials.
This statement (bolded, above) confuses me. Do foreign country stocks necessarily have a high correlation to US inflation?
No, I wouldn't expect foreign stocks to be positively correlated to US inflation. The idea was that international stocks would be less affected than US stocks by unexpected US inflation or deflation. So holding international stocks helps via diversification (not as a hedge).
I also think of my international equities as a partial inflation hedge, but I frame my rationale a bit differently. If the US dollar weakens in the future against foreign currencies, the cost of some goods and services that I buy will go up (either because the things themselves are mainly produced overseas or because the things are produced in the US but have critical components that are produced overseas.) At the same time, the value of my international equities should also be going up (because it is not currency hedged.)

That said, I have much more in TIPS than in international equities. If I had to choose only one or the other, I would go with TIPS. But glad to have at least some of each. There are many other sources of inflation aside from a weakened dollar.
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