Why use anything but TIPS?

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willthrill81
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Re: Why use anything but TIPS?

Post by willthrill81 »

tonyclifton wrote: Wed Oct 13, 2021 5:51 pm
billthecat wrote: Wed Oct 13, 2021 5:20 pm I don't buy TIPS because I don't understand them. It seems like you are betting that actual inflation will be higher than what folks generally expect, and I don't see why I would know better than the market.
There is no bet. It is not a wager. If you wish to learn more about what they are the wiki has info and the two books mentioned up thread.

Saying TIPS are a bet is like saying Treasuries are a bet that the US Government won’t default. Better not!

One strong case, IMHO, against TIPS is that they haven’t been “tested” in a high inflationary period as they came into existence in 1997 and there hasn’t been a high inflationary period since then (thankfully).

If someone is seeking higher yields go for it elsewhere!
Those buying nominal Treasuries could be argued to be 'betting' that actual inflation will be lower than what the bond market is predicting. Those buying nominal Treasuries are taking on the risk of unexpected inflation but without much, if any, expected return for taking on that risk.
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Re: Why use anything but TIPS?

Post by hudson »

Orangutan wrote: Wed Oct 13, 2021 8:08 am My first post to this forum was “Why use anything but Treasuries”. Now I am asking the same thing, but for TIPS.

I run 1/2 Intermediate-Term Treasuries, half TIPS.

Yeah, I get that TIPS have historically made the line more squiggly and they temporarily sink a bit when stocks do - but they’re still doing their job as the bond portion of a portfolio. Whether inflation is transitory or not, it’s still made me reassess my fixed income strategy. Why am I exposing half of my fixed income to a huge risk? Why would I not want something in real terms? Also, I-Bonds are cool.

Thank you in advance.
Anything but TIPS?
That's where I'm leaning when I have funds to invest.
If 3% CDs were available, I might go there.
Munis might be worth a look?
The next question is what kind of TIPS? short, intermediate, long, duration matched individual TIPS, or duration matched ETFs?
When I move to TIPS, I will likely use a non-rolling individual TIPS ladder.
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Re: Why use anything but TIPS?

Post by billthecat »

tonyclifton wrote: Wed Oct 13, 2021 5:51 pm
billthecat wrote: Wed Oct 13, 2021 5:20 pm I don't buy TIPS because I don't understand them. It seems like you are betting that actual inflation will be higher than what folks generally expect, and I don't see why I would know better than the market.
There is no bet. It is not a wager. If you wish to learn more about what they are the wiki has info and the two books mentioned up thread.

Saying TIPS are a bet is like saying Treasuries are a bet that the US Government won’t default. Better not!

One strong case, IMHO, against TIPS is that they haven’t been “tested” in a high inflationary period as they came into existence in 1997 and there hasn’t been a high inflationary period since then (thankfully).

If someone is seeking higher yields go for it elsewhere!
But (following the example in the WIki) the price of TIPS reflects the expected inflation adjustment to the principal and interest payments. So if actual inflation is lower than expected, you would have overpaid for the bond. If inflation is higher than expected, you would get paid more than what was already priced in. Isn't that betting that actual inflation will be higher than what folks generally expect?
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Re: Why use anything but TIPS?

Post by willthrill81 »

billthecat wrote: Wed Oct 13, 2021 8:08 pm
tonyclifton wrote: Wed Oct 13, 2021 5:51 pm
billthecat wrote: Wed Oct 13, 2021 5:20 pm I don't buy TIPS because I don't understand them. It seems like you are betting that actual inflation will be higher than what folks generally expect, and I don't see why I would know better than the market.
There is no bet. It is not a wager. If you wish to learn more about what they are the wiki has info and the two books mentioned up thread.

Saying TIPS are a bet is like saying Treasuries are a bet that the US Government won’t default. Better not!

One strong case, IMHO, against TIPS is that they haven’t been “tested” in a high inflationary period as they came into existence in 1997 and there hasn’t been a high inflationary period since then (thankfully).

If someone is seeking higher yields go for it elsewhere!
But (following the example in the WIki) the price of TIPS reflects the expected inflation adjustment to the principal and interest payments. So if actual inflation is lower than expected, you would have overpaid for the bond. If inflation is higher than expected, you would get paid more than what was already priced in. Isn't that betting that actual inflation will be higher than what folks generally expect?
After a TIPS bond has been purchased, changes to inflation make no difference to the TIPS holder at all. Inflation and the uncertainties pertaining thereto are removed from the picture.

As I noted above, it could just as easily be argued that those buying nominal Treasuries are 'betting' that inflation will be below what the market expects.

In reality, if inflation comes in at what the market expects, the real returns of both nominal Treasuries and TIPS would be very nearly the same.

The problem with nominal Treasuries is that they offer only a tiny, arguably close to zero, premium for taking on inflation risk as compared to TIPS. And when you consider that the risk of unexpected inflation has historically been the single biggest risk to nominal bonds, there isn't much, if any, good reason to hold nominal Treasuries rather than TIPS.
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Re: Why use anything but TIPS?

Post by chrisdds98 »

willthrill81 wrote: Wed Oct 13, 2021 9:03 pm there isn't much, if any, good reason to hold nominal Treasuries rather than TIPS.
crash insurance. long treasuries performed much better than TIPS during 2008
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Re: Why use anything but TIPS?

Post by Kinkajou82 »

I'm definitely asking myself this question. Thankfully I have more than a decade to figure out the answer as I'm still 100% equities now according to my plan.

The context of my thinking is that my plan is already assuming (and I could easily be wrong, I know nothing) that a Total Bond Index will lose to inflation by 0.2%. If that's the case, I'm thinking, why don't I just lock-in the performance with TIPS and avoid all the drama of both the upside and downside?
Last edited by Kinkajou82 on Wed Oct 13, 2021 10:25 pm, edited 1 time in total.
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Re: Why use anything but TIPS?

Post by willthrill81 »

chrisdds98 wrote: Wed Oct 13, 2021 9:57 pm
willthrill81 wrote: Wed Oct 13, 2021 9:03 pm there isn't much, if any, good reason to hold nominal Treasuries rather than TIPS.
crash insurance. long treasuries performed much better than TIPS during 2008
First, are you comparing apples to apples, that is, long-term nominal Treasuries to long-term TIPS? I'm not aware that any long-term TIPS funds existed back in 2008.

Second, if long-term nominals did indeed outperform long-term TIPS in a single event, does this mean that we can count on that happening regularly?
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Re: Why use anything but TIPS?

Post by chrisdds98 »

willthrill81 wrote: Wed Oct 13, 2021 10:24 pm
chrisdds98 wrote: Wed Oct 13, 2021 9:57 pm
willthrill81 wrote: Wed Oct 13, 2021 9:03 pm there isn't much, if any, good reason to hold nominal Treasuries rather than TIPS.
crash insurance. long treasuries performed much better than TIPS during 2008
First, are you comparing apples to apples, that is, long-term nominal Treasuries to long-term TIPS? I'm not aware that any long-term TIPS funds existed back in 2008.

Second, if long-term nominals did indeed outperform long-term TIPS in a single event, does this mean that we can count on that happening regularly?
if the crash is deflationary I would expect it to perform well. check out the many long treasury threads, they are the traditional flight to safety asset.
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Re: Why use anything but TIPS?

Post by secondopinion »

willthrill81 wrote: Wed Oct 13, 2021 10:24 pm
chrisdds98 wrote: Wed Oct 13, 2021 9:57 pm
willthrill81 wrote: Wed Oct 13, 2021 9:03 pm there isn't much, if any, good reason to hold nominal Treasuries rather than TIPS.
crash insurance. long treasuries performed much better than TIPS during 2008
First, are you comparing apples to apples, that is, long-term nominal Treasuries to long-term TIPS? I'm not aware that any long-term TIPS funds existed back in 2008.

Second, if long-term nominals did indeed outperform long-term TIPS in a single event, does this mean that we can count on that happening regularly?
If there is prolonged deflation or low inflation beyond expected, then long-term nominals are going to do better than TIPS. See my post on the business cycle.
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Re: Why use anything but TIPS?

Post by Orangutan »

secondopinion wrote: Wed Oct 13, 2021 11:10 pm
willthrill81 wrote: Wed Oct 13, 2021 10:24 pm
chrisdds98 wrote: Wed Oct 13, 2021 9:57 pm
willthrill81 wrote: Wed Oct 13, 2021 9:03 pm there isn't much, if any, good reason to hold nominal Treasuries rather than TIPS.
crash insurance. long treasuries performed much better than TIPS during 2008
First, are you comparing apples to apples, that is, long-term nominal Treasuries to long-term TIPS? I'm not aware that any long-term TIPS funds existed back in 2008.

Second, if long-term nominals did indeed outperform long-term TIPS in a single event, does this mean that we can count on that happening regularly?
If there is prolonged deflation or low inflation beyond expected, then long-term nominals are going to do better than TIPS. See my post on the business cycle.
That's a discussion on a bet. Consider an increasing and persistent inflationary environment. You wouldn't catch up for a very, very long time. How would it feel to see your bonds drop 40+%? Long duration TIPS would be a more fitting discussion for this post.
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Re: Why use anything but TIPS?

Post by HanSolo »

Ramjet wrote: Wed Oct 13, 2021 10:11 am 100% FI in TIPS makes a lot more sense to me, some thoughts:

...

3) Bogleheads hate bets, e.g., don't buy individual stocks, invest in the total market. How do Bogleheads reconcile that Nominal Bonds are a "bet" on inflation. We turn a blind eye when it is convenient
In the same sense that the stock market reflects the market consensus on the value of stocks, the nominal bond market reflects the market consensus on the value of bonds.

Buying TIPS, on the other hand, is a "bet" that the market consensus is wrong. That's why I don't buy TIPS.
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Re: Why use anything but TIPS?

Post by tonyclifton »

HanSolo wrote: Thu Oct 14, 2021 3:29 am Buying TIPS, on the other hand, is a "bet" that the market consensus is wrong. That's why I don't buy TIPS.
When originally issued or reissued, TIPS are priced by auction. The market sets the price during the auction process.

When individual TIPS are sold on the secondary market, they are priced by the market and can be bought and sold during trading hours.

TIPS funds are bundles of individual TIPS. TIPS funds are priced by the market and can be bought and sold during trading hours.

The TIPS spread (difference in yields between Treasury bonds and TIPS) is a measure of the market's expectation of inflation.

Hopefully the above illustrates that the market's perspective are intertwined with TIPS.

None of the above implies the yields are great. But, if you have $1,000 today and want to spend $1,000 in the future and get the same value then TIPS are a great option.
Last edited by tonyclifton on Thu Oct 14, 2021 4:45 am, edited 1 time in total.
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Re: Why use anything but TIPS?

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tonyclifton wrote: Thu Oct 14, 2021 3:48 am
HanSolo wrote: Thu Oct 14, 2021 3:29 am Buying TIPS, on the other hand, is a "bet" that the market consensus is wrong. That's why I don't buy TIPS.
When originally issued or reissued, TIPS are priced by auction. The market sets the price.

When individual TIPS are sold on the secondary market, they are priced by the market.
Yes, of course. The market sets the price for both nominals and TIPS. The difference is that TIPS are designed to outperform when inflation is higher than consensus expectation. I'm not saying it's wrong to buy them. In fact, they're perfect for those who want to place a bet that the consensus expectation is wrong. I'm just not interested in that bet.
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Re: Why use anything but TIPS?

Post by Dude2 »

In the context of buying 50/50 nominal Treasurys/TIPS and then one or the other doing well based on the reality of inflation versus the prediction of inflation -- in that context I can see the bet analogy. I see the point about shunning TIPS in favor of the collective wisdom of the market (in that context) plus the fact that they represent a tiny fraction of the investment grade bond market (for people interested in investing in total markets).

On the other hand, TIPS have a utility for many investors from a LMP perspective, and everything mentioned in this thread concerning their removal of inflation risk still stands.

In addition, if you hold a TIPS to maturity you remove risk from deflation, so I don't buy the argument that only nominals shine in deflationary economies.

Hold up all the pluses and minuses of TIPS against the criteria for what you actually want bonds to do in your portfolio and decide if they are right for you.
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Re: Why use anything but TIPS?

Post by hudson »

chrisdds98 wrote: Wed Oct 13, 2021 9:57 pm
willthrill81 wrote: Wed Oct 13, 2021 9:03 pm there isn't much, if any, good reason to hold nominal Treasuries rather than TIPS.
crash insurance. long treasuries performed much better than TIPS during 2008
In 2008, I held a Vanguard TIPS fund. I blinked when the share price dropped. I speculate that TIPS dropped as some larger financial institutions were dumping TIPS because they were trying to survive. TIPS also may have dropped because of the panic factor. I decided to not to sell because the TIPS were treasuries. The holdings were solid.

Bottom Line: Speculating with long treasuries or TIPS could work but it would give me heartburn.
I vote for holding either long treasuries or TIPS for one's planned duration.
Last edited by hudson on Thu Oct 14, 2021 6:02 am, edited 1 time in total.
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Re: Why use anything but TIPS?

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Dude2 wrote: Thu Oct 14, 2021 4:45 am On the other hand, TIPS have a utility for many investors from a LMP perspective, and everything mentioned in this thread concerning their removal of inflation risk still stands.
I have no argument with that. The thing that doesn't stand is this comment:
Ramjet wrote: Wed Oct 13, 2021 10:11 am 3) Bogleheads hate bets, e.g., don't buy individual stocks, invest in the total market. How do Bogleheads reconcile that Nominal Bonds are a "bet" on inflation. We turn a blind eye when it is convenient
The nominal bond market existed long before the TIPS market. Saying that nominals are a "bet" means that everyone was making a non-Bogleheadish "bet" for centuries, which is obviously false. I think the "blind eye" comment is self-referential.
Dude2 wrote: Thu Oct 14, 2021 4:45 am In addition, if you hold a TIPS to maturity you remove risk from deflation, so I don't buy the argument that only nominals shine in deflationary economies.
If your meaning is that there's no case where TIPS underperform nominals, I'm not sure about that.

Considering the LMP concern as you mentioned, if we apply the same logic to the stock market, we would then advocate variable annuities in place of, or in addition to, broad-market equity funds. But I haven't seen people clamoring for that.

Since I don't have LMP concerns, I invest neither in TIPS nor in variable annuities.

Bottom line, I gave my answer to the OP's question. And I have no problem that others find TIPS useful for their objectives. There's no implication that what I do, others must do. My advice: you do you.
Last edited by HanSolo on Thu Oct 14, 2021 6:07 am, edited 1 time in total.
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Re: Why use anything but TIPS?

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HanSolo wrote: Thu Oct 14, 2021 5:04 am If your meaning is that there's no case where TIPS underperform nominals, I'm not sure about that.
Probably I'd have to say something about "on a risk adjusted basis" that there isn't any reason that nominals would outperform TIPS in a deflationary environment. Just trying to not go down the road of believing that only nominals, i.e. long treasuries, will "hold up" in deflation. Can't see any reason that high quality, long treasury TIPS wouldn't hold up identically (unless the case is made that a fund will not hold them to maturity, so their face value is eroded due to trading). I just see it as one more reason that TIPS, if used correctly, are a better choice of bond. They are exactly the same as a nominal treasury minus inflation risk.
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Re: Why use anything but TIPS?

Post by HanSolo »

Dude2 wrote: Thu Oct 14, 2021 5:16 am ... there isn't any reason that nominals would outperform TIPS in a deflationary environment.
Are you sure? There's the potential that negative-yielding TIPS underperform positive-yielding Treasuries.
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Re: Why use anything but TIPS?

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HanSolo wrote: Thu Oct 14, 2021 5:28 am Are you sure? There's the potential that negative-yielding TIPS underperform positive-yielding Treasuries.
Oh I concede that I am not sure about anything. This is a very theoretical discussion. I believe in reference frames though. We just have to place both nominals and TIPS in the same reference frame, i.e. talk about them both in either real terms or in nominal terms. When we do that, we see that both TIPS and nominals currently show negative real rates.
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Re: Why use anything but TIPS?

Post by dcabler »

Ramjet wrote: Wed Oct 13, 2021 11:08 am
Dude2 wrote: Wed Oct 13, 2021 10:39 am FIPDX is kind of the Total Bond Market Index Fund for TIPS
Thanks, I didn't know about this fund

Avg. duration about 5.5 years
Note that there is something odd about the way that Fidelity calculates the duration for this fund. There are other funds, like SCHP, that track the same index and reports a longer avg. duration. I went back and forth with Fidelity on this and finally gave up. Also note that most funds self-report duration based on nominal yields, not real yields.

But to get something closer to the true avg. duration calculated using real yields, here are two options:
1. #cruncher's thread where he calculates average duration for most of the TIPs indices that various funds follow. For this fund, use the calculation for 1+ Years
viewtopic.php?p=6252320#p6252320
2. On Fidelity's site, start at the link below. Click on Prospectus, then click on the Portfolio Characteristics Tab and scroll down till you see "Spread Duration".
https://fundresearch.fidelity.com/mutua ... /31635T104

#cruncher updates his post pretty often and you can always go to his spreadsheet that he links in the thread. Fidelity, on the other hand, doesn't update all that often and there can be considerable lag. For example as of today, what they report in the link above is from 8/31.

Cheers.
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Re: Why use anything but TIPS?

Post by Ramjet »

HanSolo wrote: Thu Oct 14, 2021 5:04 am
Dude2 wrote: Thu Oct 14, 2021 4:45 am On the other hand, TIPS have a utility for many investors from a LMP perspective, and everything mentioned in this thread concerning their removal of inflation risk still stands.
I have no argument with that. The thing that doesn't stand is this comment:
Ramjet wrote: Wed Oct 13, 2021 10:11 am 3) Bogleheads hate bets, e.g., don't buy individual stocks, invest in the total market. How do Bogleheads reconcile that Nominal Bonds are a "bet" on inflation. We turn a blind eye when it is convenient
The nominal bond market existed long before the TIPS market. Saying that nominals are a "bet" means that everyone was making a non-Bogleheadish "bet" for centuries, which is obviously false. I think the "blind eye" comment is self-referential.
Ramjet wrote: Wed Oct 13, 2021 10:11 am In addition, if you hold a TIPS to maturity you remove risk from deflation, so I don't buy the argument that only nominals shine in deflationary economies.
If your meaning is that there's no case where TIPS underperform nominals, I'm not sure about that.

Considering the LMP concern as you mentioned, if we apply the same logic to the stock market, we would then advocate variable annuities in place of, or in addition to, broad-market equity funds. But I haven't seen people clamoring for that.

Since I don't have LMP concerns, I invest neither in TIPS nor in variable annuities.

Bottom line, I gave my answer to the OP's question. And I have no problem that others find TIPS useful for their objectives. There's no implication that what I do, others must do. My advice: you do you.
I did not say this, you misquoted someone
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Re: Why use anything but TIPS?

Post by Ramjet »

dcabler wrote: Thu Oct 14, 2021 5:55 am
Ramjet wrote: Wed Oct 13, 2021 11:08 am
Dude2 wrote: Wed Oct 13, 2021 10:39 am FIPDX is kind of the Total Bond Market Index Fund for TIPS
Thanks, I didn't know about this fund

Avg. duration about 5.5 years
Note that there is something odd about the way that Fidelity calculates the duration for this fund. There are other funds, like SCHP, that track the same index and reports a longer avg. duration. I went back and forth with Fidelity on this and finally gave up. Also note that most funds self-report duration based on nominal yields, not real yields.

But to get something closer to the true avg. duration calculated using real yields, here are two options:
1. #cruncher's thread where he calculates average duration for most of the TIPs indices that various funds follow. For this fund, use the calculation for 1+ Years
viewtopic.php?p=6252320#p6252320
2. On Fidelity's site, start at the link below. Click on Prospectus, then click on the Portfolio Characteristics Tab and scroll down till you see "Spread Duration".
https://fundresearch.fidelity.com/mutua ... /31635T104

#cruncher updates his post pretty often and you can always go to his spreadsheet that he links in the thread. Fidelity, on the other hand, doesn't update all that often and there can be considerable lag. For example as of today, what they report in the link above is from 8/31.

Cheers.
Thanks
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Re: Why use anything but TIPS?

Post by dodecahedron »

HanSolo wrote: Thu Oct 14, 2021 4:39 am
tonyclifton wrote: Thu Oct 14, 2021 3:48 am
HanSolo wrote: Thu Oct 14, 2021 3:29 am Buying TIPS, on the other hand, is a "bet" that the market consensus is wrong. That's why I don't buy TIPS.
When originally issued or reissued, TIPS are priced by auction. The market sets the price.

When individual TIPS are sold on the secondary market, they are priced by the market.
Yes, of course. The market sets the price for both nominals and TIPS. The difference is that TIPS are designed to outperform when inflation is higher than consensus expectation. I'm not saying it's wrong to buy them. In fact, they're perfect for those who want to place a bet that the consensus expectation is wrong. I'm just not interested in that bet.
As someone who personally knows the folks who designed TIPS, they were not "designed to outperform when inflation is higher than consensus expectation," as Hans Solo asserts. They do in fact outperform when inflation is higher, but that is like saying your homeowner's insurance "was designed to outperform when your house burns down," or that your auto coverage is "designed to outperform when you get in an accident," or that your life insurance is "designed to outperform when you die young."

TIPS were designed not as a bet but as a risk mitigation vehicle, as a way for investors to insure a desired portion of their fixed income investment against substantial loss of purchasing power in the event of high inflation, to lock in a real return they find satisfactory.

They are not perfect (nothing is) but I for one am glad to have TIPS and I bonds as an available option. Also grateful that Social Security is indexed for inflation, as are (most) parameters of income tax code. It adds a modicum of predictability and stability to future projections of purchasing power of my (conservative) portfolio.

I bought a large chunk of TIPS in late 2018, about 25% of my total portfolio, when real returns were about 1%. I decided I would happily settle for that.
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Re: Why use anything but TIPS?

Post by 1moreyr »

dbr wrote: Wed Oct 13, 2021 9:39 am It might be difficult to find a convincing argument for why not use anything but TIPS for the fixed income portion of one's holdings.

Current negative real rates are not different between TIPS and nominal bonds. The yield premium for TIPS has historically been very small.

The rest is just esoteria that does not determine decision making.

You might be interested in reading the pros and cons for TIPS in Larry Swedroe's bond book. I would post a copy of that here except that it might be a copyright violation and anyway you should probably read the whole book to answer your questions. Note there is a link to Amazon at the top of these pages which gets BH some support.
Which book are you referring to by Swedroe? i see a couple and wanted to double check before i pushed the button. it is the bond investing (i assume) or the retirement book?

thanks in advance
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Re: Why use anything but TIPS?

Post by HanSolo »

Ramjet wrote: Thu Oct 14, 2021 5:56 am
HanSolo wrote: Thu Oct 14, 2021 5:04 am
Dude2 wrote: Thu Oct 14, 2021 4:45 am On the other hand, TIPS have a utility for many investors from a LMP perspective, and everything mentioned in this thread concerning their removal of inflation risk still stands.
...
Ramjet wrote: Wed Oct 13, 2021 10:11 am In addition, if you hold a TIPS to maturity you remove risk from deflation, so I don't buy the argument that only nominals shine in deflationary economies.
I did not say this, you misquoted someone
Sorry, cut-and-paste error. I have edited my post.
Dude2 wrote: Thu Oct 14, 2021 5:45 am Oh I concede that I am not sure about anything. This is a very theoretical discussion. I believe in reference frames though. We just have to place both nominals and TIPS in the same reference frame, i.e. talk about them both in either real terms or in nominal terms. When we do that, we see that both TIPS and nominals currently show negative real rates.
dodecahedron wrote: Thu Oct 14, 2021 5:58 am As someone who personally knows the folks who designed TIPS, they were not "designed to outperform when inflation is higher than consensus expectation," as Hans Solo asserts.
I'm happy to re-word that as "they're designed to do what they were designed to do, and one noticeable effect is that they tend to outperform when inflation runs higher than what was expected."

I'm not here to debate what TIPS do, or whether anyone should invest in them or not. My point is:

1. Anyone who claims that investing in nominal bonds (and no TIPS) is "non-Boglehead" is making a false claim. That's just "more Boglehead than thou", which is no better than name-calling.

2. While I don't own TIPS, I make no claim about whether Bogleheads should or should not own TIPS. The ones who want to should, and the ones who don't want to should not (as long as each understands their own reasons and investment objectives).

It really is that simple.
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Re: Why use anything but TIPS?

Post by Dude2 »

I think the take-away from a topic like this should be that, if I were to invest in only inflation protected instruments (TIPS/I-Bonds), I wouldn't be scared that I was taking on more risk. I would be taking on less risk. However, I should expect less reward. Therefore I certainly should be scared that I am missing out on reward. The fear of missing out on reward is a prime motivator. The reason we invest at all is to be rewarded. This is why we see many threads that are anti-bond.

My purpose for investing in bonds is to de-risk my portfolio. Why wouldn't I use TIPS for that? Some may answer that there has to be a line drawn and that negative real yields are the line. Therefore, just use cash. Even cash is getting eaten away by inflation, though, so you can't win.
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Re: Why use anything but TIPS?

Post by HanSolo »

Dude2 wrote: Thu Oct 14, 2021 6:34 am I think the take-away from a topic like this should be that,
Since the topic question is "why use anything but TIPS", I see the take-away as being that we learn that different people do different things, and we can find out the reasons why they do what they do.

Just because different people do different things, it doesn't mean there's an issue. The only issue I see is when someone claims that someone else's choice is wrong. That's fallacious because each person gets to decide for themselves.
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Re: Why use anything but TIPS?

Post by Dude2 »

HanSolo wrote: Thu Oct 14, 2021 6:39 am
Dude2 wrote: Thu Oct 14, 2021 6:34 am I think the take-away from a topic like this should be that,
Since the topic question is "why use anything but TIPS", I see the take-away as being that we learn that different people do different things, and we can find out the reasons why they do what they do.

Just because different people do different things, it doesn't mean there's an issue. The only issue I see is when someone claims that someone else's choice is wrong. That's fallacious because each person gets to decide for themselves.
Right. No arguments. In general I think that Bogleheads support the use of IBonds, and they support the use of LMP strategies using TIPS. Otherwise, recommended use of TIPS is murky, some trying to adopt a 50/50 TIPS/nominal approach, others a 0/100 approach.

I think a 100/0 approach (outside the context of the LMP) is theoretically sound, but needs to have both eyes wide open that this is a very low risk, low reward proposition. People like Swedroe may use this to justify more risk on the stock side.

Personally, my thinking is that I assume a 60/40 stock/nominal bond portfolio as the sweet spot. Any additional bonds I want above and beyond that are TIPS. If I want a 50/50 portfolio, it will be a 50/40/10, stock/nom/TIPS. I do this because with larger bond proportion I want to mitigate inflation risk. (and I thank grok from opening my eyes to this). If you are at 60% stock or greater in your portfolio and see no reason for TIPS, in my universe that is a sound approach. Who knows?
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Re: Why use anything but TIPS?

Post by hudson »

1moreyr wrote: Thu Oct 14, 2021 6:04 am
dbr wrote: Wed Oct 13, 2021 9:39 am It might be difficult to find a convincing argument for why not use anything but TIPS for the fixed income portion of one's holdings.

Current negative real rates are not different between TIPS and nominal bonds. The yield premium for TIPS has historically been very small.

The rest is just esoteria that does not determine decision making.

You might be interested in reading the pros and cons for TIPS in Larry Swedroe's bond book. I would post a copy of that here except that it might be a copyright violation and anyway you should probably read the whole book to answer your questions. Note there is a link to Amazon at the top of these pages which gets BH some support.
Which book are you referring to by Swedroe? i see a couple and wanted to double check before i pushed the button. it is the bond investing (i assume) or the retirement book?

thanks in advance
Larry's bond book. It worked for me.

https://www.amazon.com/Only-Guide-Winni ... 9242806615
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Re: Why use anything but TIPS?

Post by tonyclifton »

hudson wrote: Thu Oct 14, 2021 7:06 am
1moreyr wrote: Thu Oct 14, 2021 6:04 am
dbr wrote: Wed Oct 13, 2021 9:39 am It might be difficult to find a convincing argument for why not use anything but TIPS for the fixed income portion of one's holdings.

Current negative real rates are not different between TIPS and nominal bonds. The yield premium for TIPS has historically been very small.

The rest is just esoteria that does not determine decision making.

You might be interested in reading the pros and cons for TIPS in Larry Swedroe's bond book. I would post a copy of that here except that it might be a copyright violation and anyway you should probably read the whole book to answer your questions. Note there is a link to Amazon at the top of these pages which gets BH some support.
Which book are you referring to by Swedroe? i see a couple and wanted to double check before i pushed the button. it is the bond investing (i assume) or the retirement book?

thanks in advance
Larry's bond book. It worked for me.

https://www.amazon.com/Only-Guide-Winni ... 9242806615
Agreed about the above book and link.

This is also an informative book:
"Explore TIPS: A Practical Guide to Investing in Treasury Inflation-Protected Securities" by Finance Buff (Harry Sit). Harry contributed to the Boglehead's Guide to Investing and even has his own page on the wiki.
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Re: Why use anything but TIPS?

Post by dbr »

1moreyr wrote: Thu Oct 14, 2021 6:04 am
dbr wrote: Wed Oct 13, 2021 9:39 am It might be difficult to find a convincing argument for why not use anything but TIPS for the fixed income portion of one's holdings.

Current negative real rates are not different between TIPS and nominal bonds. The yield premium for TIPS has historically been very small.

The rest is just esoteria that does not determine decision making.

You might be interested in reading the pros and cons for TIPS in Larry Swedroe's bond book. I would post a copy of that here except that it might be a copyright violation and anyway you should probably read the whole book to answer your questions. Note there is a link to Amazon at the top of these pages which gets BH some support.
Which book are you referring to by Swedroe? i see a couple and wanted to double check before i pushed the button. it is the bond investing (i assume) or the retirement book?

thanks in advance
Yes, for TIPS the bond book. He has a good book on general investing, the retirement book, and one on alternative investments.
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Re: Why use anything but TIPS?

Post by dbr »

It is just worth repeating that people probably should not be choosing between TIPS and nominals in order to make bets which might outperform the other. A previous poster points out that TIPS serve the purpose of removing certain risks, and that is the reason one would use them. I don't think it is useful to consider expected vs unexpected inflation in this. TIPS simply index for any inflation.

As such it does seem an indexed bond would be an obvious choice.
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Re: Why use anything but TIPS?

Post by dml130 »

Just out of curiosity, which duration (long, short, intermediate?) TIPS would have done best under 1970's inflation?
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Re: Why use anything but TIPS?

Post by BigJohn »

Dude2 wrote: Thu Oct 14, 2021 6:34 am I think the take-away from a topic like this should be that, if I were to invest in only inflation protected instruments (TIPS/I-Bonds), I wouldn't be scared that I was taking on more risk. I would be taking on less risk. However, I should expect less reward. Therefore I certainly should be scared that I am missing out on reward. The fear of missing out on reward is a prime motivator. The reason we invest at all is to be rewarded. This is why we see many threads that are anti-bond.

My purpose for investing in bonds is to de-risk my portfolio. Why wouldn't I use TIPS for that? Some may answer that there has to be a line drawn and that negative real yields are the line. Therefore, just use cash. Even cash is getting eaten away by inflation, though, so you can't win.
The risk/reward paradigm is valid when comparing US government bonds to other types. When you buy something ultra-safe with the lowest possible default risk, you should expect less reward. That paradigm is a bit less clear when you compare nominal Treasuries to TIPS. If inflation is at the current expected level, then both have the same negative real yield. So when I but TIPS, am I taking on more risk or less? My view is summed up well by dodecahedron
dodecahedron wrote: Thu Oct 14, 2021 5:58 am TIPS were designed not as a bet but as a risk mitigation vehicle, as a way for investors to insure a desired portion of their fixed income investment against substantial loss of purchasing power in the event of high inflation, to lock in a real return they find satisfactory.
To me this is not about a risk/reward trade-off. I have a fairly bond heavy portfolio in early retirement. Having read William Berstein's "Ages of Investors" series, I recognize that unexpected and persistent high inflation is one of the most significant risks to my financial well being. While TIPS aren't perfect, they are the best available mechanism to mitigate that risk. Two concerns have been raised in this discussion multiple times.

With TIPS, I "lose" if inflation is less than expected.... To me, this about inflation insurance and insurance has a cost. This loss is the potential cost of inflation insurance and is no different than the cost of my homeowners insurance if my house never burns down. And just like homeowners insurance, there is significant asymmetry of outcomes. Owning TIPS might cost me 1% lower return if inflation is 1% vs the expected 2% but, I'll lose a lot more if we have anything close to a repeat of the late 70's/early 80's.

With TIPS, I "lose" if there is deflation... I agree that TIPS won't serve you well in this environment. If deflation is low and transitory, this is just another cost of inflation insurance. Obviously, it could be a much bigger impact if deflation is high and persistent so, the key question is how likely is that. Again, I'll go back to William Bernstein's books and say that I think the chances of high and persistent deflation are far smaller than high and persistent inflation. But who knows, the future could well be different than the past which is why I went 50/50 TIPS/nominals.

TIPS are not a panacea to solve all bond investment worries. However, they are a great risk mitigation tool for those who need/want some inflation insurance. :beer
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Re: Why use anything but TIPS?

Post by Stormbringer »

It seems to me that during the drawdown phase, a TIPS ladder would be less risky (but more work) than a TIPS fund. When you sell TIPS from a fund, you are selling a cross-section of TIPS with various maturity dates, and market value at the time of sale is impacted by prevailing interest rates at the time. A TIPS ladder, with each bond being held to maturity, would eliminate that interest rate risk.
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Re: Why use anything but TIPS?

Post by S_Track »

willthrill81 wrote: Wed Oct 13, 2021 11:33 am
secondopinion wrote: Wed Oct 13, 2021 11:26 am
Ramjet wrote: Wed Oct 13, 2021 10:11 am 100% FI in TIPS makes a lot more sense to me, some thoughts:

1) TIPS will cover actual inflation, Nominal Bond rates take into account estimated inflation. I thought Bogleheads "don't know nuthin"

2) But TIPS make up a small segment of overall bonds. Who cares? There is essentially no credit risk, they are backed by the full faith of the U.S. Government

3) Bogleheads hate bets, e.g., don't buy individual stocks, invest in the total market. How do Bogleheads reconcile that Nominal Bonds are a "bet" on inflation. We turn a blind eye when it is convenient

4) TIPS aren't as liquid as Nominal Bonds. Ok. They are close. Solution, have a year or two of expenses in cash or a CD
On 1, we do not need to know anything; the market has priced it in.

On 3, what other asset besides nominal bonds protect against below expected inflation when almost everything else is at least somewhat inflation-hedged? If no one knows anything, then why not?
If you buy TIPS, you remove the impact of inflation, whatever transpires, from the funds used to buy the TIPS. You know precisely what the real return of your TIPS will be when you buy them. Yes, you might come out ahead with nominal bonds if inflation is below what the market expected, but you might lose. Unless you are paid a premium for taking on the risk of unexpected inflation, there is little or no logical reason to take on that risk. The cost of the unexpected inflation 'insurance' provided by TIPS has been arguably close to zero for a long time now, so investors buying nominal bonds when they could buy TIPS are just taking on additional risk, a risk that has historically been a very substantial risk for nominal bonds, for very little or no compensation.
So if we compare YTD of Short-Term Treasury Index Fund Admiral Shares (VSBSX) -0.23% to Vanguard Short-Term Inflation-Protected Securities Index Fund Admiral Shares (VTAPX) +4.45%, so far this year the TIPS fund has done better. The duration is similar in these two funds, is it correct to conclude there was unexpected inflation this year? Thanks
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Re: Why use anything but TIPS?

Post by sycamore »

Orangutan wrote: Wed Oct 13, 2021 8:08 am Why use anything but TIPS?
Note these quotes:
NiceUnparticularMan wrote: Wed Oct 13, 2021 11:34 am Oh, one other thought: I think there are certain sorts of non-marketable investments that could potentially substitute for TIPS such that you might need little or none of them even if you would otherwise find them attractive. I am thinking primarily of Social Security...
dodecahedron wrote: Thu Oct 14, 2021 5:58 am Also grateful that Social Security is indexed for inflation...
I think they're relevant for lots of people, myself included. Social Security benefits get adjusted for inflation, and my benefits will cover a large enough portion of my expected expenses. And the stock portion of my portfolio should grow enough to keep up with inflation, which will cover the rest of my expected expenses. What is "large enough" depends on each investor. Some may feel it's not enough and thus might have a preference for TIPS. I don't see that paying the premium for TIPS is necessary in my case.
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Re: Why use anything but TIPS?

Post by JackoC »

hudson wrote: Wed Oct 13, 2021 7:09 pm
Orangutan wrote: Wed Oct 13, 2021 8:08 am My first post to this forum was “Why use anything but Treasuries”. Now I am asking the same thing, but for TIPS.

I run 1/2 Intermediate-Term Treasuries, half TIPS.

Yeah, I get that TIPS have historically made the line more squiggly and they temporarily sink a bit when stocks do - but they’re still doing their job as the bond portion of a portfolio. Whether inflation is transitory or not, it’s still made me reassess my fixed income strategy. Why am I exposing half of my fixed income to a huge risk? Why would I not want something in real terms? Also, I-Bonds are cool.

Thank you in advance.
Anything but TIPS?
That's where I'm leaning when I have funds to invest.
If 3% CDs were available, I might go there.
Munis might be worth a look?
My CD ladder pays just over 3% on average... :happy (basically a JOKE, attempted humor can easily backfire on the internet). It actually does pay 3%, but obviously that's because I bought the CD's on average a few years ago so the decline in rates will play out in slow motion when I gradually replace those CD's with probably (the next maturity is in 2022) much lower yielding ones. It's the mirror image of CD's not going up in mark to market value when rates go down.

However those CD's were IMO superior investments to nominal treasuries*, for the simple reason they had too much more expected return *when purchased* to 'explain away' as treasury fans sometimes try to, the average spread over corresponding treasury (on 4-5+ yr CD's) was 1.38%. That's a lot for basically the same credit risk. Although, sadly, besides absolute rates being lower now the 5 yr CD to treasury spread is much lower also, only 0.26% between the best CD listed on 'depositaccounts' now for my location and the 5 yr treasury (though the 1.38% was achieved with cherry picking beyond generic good deals).

For TIPS vs. CD it still comes back to interpreting the value, to the individual investor, of the inflation protection. It is certainly not a 'bet' to choose not to take inflation risk, that's a ridiculous assertion. But the subjective value of avoiding that risk does vary by person and situation, and it does also matter what else is in your portfolio and perception of inflation risk to those others things over the relevant horizon (are risk asset valuations *now* more dependent on inflation and rates staying fairly low than they usually have been, I think they probably are, and color graphs of the past can't answer this). If so that's an advantage to 5 yr TIPS v a 5 yr CD, but, that's not considering the put option you generally have on the CD to withdraw the money with an Early Withdrawal Penalty which will go 'in the money' if rates spike. I find the rate sensitivity of CD's tolerable given that put option for 'rates and inflation much higher' cases, if the spread over nominal treasury (presumed approx expected return of TIPS also) is wide enough.

I have only odds and ends of nominal treasuries, a small allocation to TIPS, a necessarily small one to I-bonds because of the purchase limit (though I-bonds are now a far superior investment to nominals, TIPS, or CD's at 0% real) and a larger allocation to CD's. You mentioned muni's but that's more individually based because depends on tax and other factors. I have a similar amount in CD's and muni's but it's partly because it would be a hassle to hold direct CD's in some parts of my portfolio (trusts), same could be true of somebody investing for example mainly in 401k (I'm not considering CD's through brokers which yield significantly less than cherry-picked-to-the-max direct CD deals).

*nor do you need actual cash treasuries to 'rebalance' to stocks, I use futures for that so would only ever sell out fixed income instruments prior to maturity in true (therefore rare) emergencies. Other people's practices and situations may differ in this respect.
Last edited by JackoC on Thu Oct 14, 2021 9:58 am, edited 1 time in total.
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Re: Why use anything but TIPS?

Post by secondopinion »

Orangutan wrote: Wed Oct 13, 2021 11:20 pm
secondopinion wrote: Wed Oct 13, 2021 11:10 pm
willthrill81 wrote: Wed Oct 13, 2021 10:24 pm
chrisdds98 wrote: Wed Oct 13, 2021 9:57 pm
willthrill81 wrote: Wed Oct 13, 2021 9:03 pm there isn't much, if any, good reason to hold nominal Treasuries rather than TIPS.
crash insurance. long treasuries performed much better than TIPS during 2008
First, are you comparing apples to apples, that is, long-term nominal Treasuries to long-term TIPS? I'm not aware that any long-term TIPS funds existed back in 2008.

Second, if long-term nominals did indeed outperform long-term TIPS in a single event, does this mean that we can count on that happening regularly?
If there is prolonged deflation or low inflation beyond expected, then long-term nominals are going to do better than TIPS. See my post on the business cycle.
That's a discussion on a bet. Consider an increasing and persistent inflationary environment. You wouldn't catch up for a very, very long time. How would it feel to see your bonds drop 40+%? Long duration TIPS would be a more fitting discussion for this post.
On the other hand, flat make both equally appealing and decreasing and persistent non-inflationary environment make nominal bonds better. How would it feel to see your bonds gain 40+%? My guess is that neither the drop or gain will happen to that extent.
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Re: Why use anything but TIPS?

Post by willthrill81 »

S_Track wrote: Thu Oct 14, 2021 8:48 am
willthrill81 wrote: Wed Oct 13, 2021 11:33 am
secondopinion wrote: Wed Oct 13, 2021 11:26 am
Ramjet wrote: Wed Oct 13, 2021 10:11 am 100% FI in TIPS makes a lot more sense to me, some thoughts:

1) TIPS will cover actual inflation, Nominal Bond rates take into account estimated inflation. I thought Bogleheads "don't know nuthin"

2) But TIPS make up a small segment of overall bonds. Who cares? There is essentially no credit risk, they are backed by the full faith of the U.S. Government

3) Bogleheads hate bets, e.g., don't buy individual stocks, invest in the total market. How do Bogleheads reconcile that Nominal Bonds are a "bet" on inflation. We turn a blind eye when it is convenient

4) TIPS aren't as liquid as Nominal Bonds. Ok. They are close. Solution, have a year or two of expenses in cash or a CD
On 1, we do not need to know anything; the market has priced it in.

On 3, what other asset besides nominal bonds protect against below expected inflation when almost everything else is at least somewhat inflation-hedged? If no one knows anything, then why not?
If you buy TIPS, you remove the impact of inflation, whatever transpires, from the funds used to buy the TIPS. You know precisely what the real return of your TIPS will be when you buy them. Yes, you might come out ahead with nominal bonds if inflation is below what the market expected, but you might lose. Unless you are paid a premium for taking on the risk of unexpected inflation, there is little or no logical reason to take on that risk. The cost of the unexpected inflation 'insurance' provided by TIPS has been arguably close to zero for a long time now, so investors buying nominal bonds when they could buy TIPS are just taking on additional risk, a risk that has historically been a very substantial risk for nominal bonds, for very little or no compensation.
So if we compare YTD of Short-Term Treasury Index Fund Admiral Shares (VSBSX) -0.23% to Vanguard Short-Term Inflation-Protected Securities Index Fund Admiral Shares (VTAPX) +4.45%, so far this year the TIPS fund has done better. The duration is similar in these two funds, is it correct to conclude there was unexpected inflation this year? Thanks
VTAPX has a longer duration than VSBSX (2.73 vs. 1.98), so they're not exactly an apples to apples comparison but pretty close.

It does appear that the market's expectation for inflation over the next ~2 years has increased this year. All else being equal, increasing expectations of inflation will results in TIPS outperforming nominals.
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Re: Why use anything but TIPS?

Post by willthrill81 »

secondopinion wrote: Thu Oct 14, 2021 9:57 am
Orangutan wrote: Wed Oct 13, 2021 11:20 pm
secondopinion wrote: Wed Oct 13, 2021 11:10 pm
willthrill81 wrote: Wed Oct 13, 2021 10:24 pm
chrisdds98 wrote: Wed Oct 13, 2021 9:57 pm

crash insurance. long treasuries performed much better than TIPS during 2008
First, are you comparing apples to apples, that is, long-term nominal Treasuries to long-term TIPS? I'm not aware that any long-term TIPS funds existed back in 2008.

Second, if long-term nominals did indeed outperform long-term TIPS in a single event, does this mean that we can count on that happening regularly?
If there is prolonged deflation or low inflation beyond expected, then long-term nominals are going to do better than TIPS. See my post on the business cycle.
That's a discussion on a bet. Consider an increasing and persistent inflationary environment. You wouldn't catch up for a very, very long time. How would it feel to see your bonds drop 40+%? Long duration TIPS would be a more fitting discussion for this post.
On the other hand, flat make both equally appealing and decreasing and persistent non-inflationary environment make nominal bonds better. How would it feel to see your bonds gain 40+%? My guess is that neither the drop or gain will happen to that extent.
The bottom line is that nominals might outperform TIPS, and they might underperform. But when you buy an individual TIPS bond at least, you know precisely what the real return of that bond will be if you hold it to maturity. You literally remove inflation from the funds used to buy the bond altogether. And since the bond market prices in both of these risks into the current price of TIPS, you should be very confident that you have gotten a fair price for the TIPS you buy without making a 'bet' regarding future inflation; again, TIPS remove inflation from consideration.

Unless you believe that you have some kind of information edge over the market or wish to hedge a specific risk while increasing another risk (e.g., protecting against lower than expected inflation with nominals while accepting the risk of higher than expected inflation), there certainly isn't a strong argument for an individual investor to prefer nominal bonds over TIPS.
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Re: Why use anything but TIPS?

Post by secondopinion »

willthrill81 wrote: Thu Oct 14, 2021 10:29 am
secondopinion wrote: Thu Oct 14, 2021 9:57 am
Orangutan wrote: Wed Oct 13, 2021 11:20 pm
secondopinion wrote: Wed Oct 13, 2021 11:10 pm
willthrill81 wrote: Wed Oct 13, 2021 10:24 pm

First, are you comparing apples to apples, that is, long-term nominal Treasuries to long-term TIPS? I'm not aware that any long-term TIPS funds existed back in 2008.

Second, if long-term nominals did indeed outperform long-term TIPS in a single event, does this mean that we can count on that happening regularly?
If there is prolonged deflation or low inflation beyond expected, then long-term nominals are going to do better than TIPS. See my post on the business cycle.
That's a discussion on a bet. Consider an increasing and persistent inflationary environment. You wouldn't catch up for a very, very long time. How would it feel to see your bonds drop 40+%? Long duration TIPS would be a more fitting discussion for this post.
On the other hand, flat make both equally appealing and decreasing and persistent non-inflationary environment make nominal bonds better. How would it feel to see your bonds gain 40+%? My guess is that neither the drop or gain will happen to that extent.
The bottom line is that nominals might outperform TIPS and they might underperform. But when you buy an individual TIPS bond at least, you know precisely what the real return of that bond will be if you hold it to maturity. You literally remove inflation from the funds used to buy the bond altogether.

Unless you believe that you have some kind of information edge over the market or wish to hedge a specific risk while increasing another risk (e.g., protecting against lower than expected inflation with nominals while accepting the risk of higher than expected inflation), there certainly isn't a strong argument for an individual investor to prefer nominal bonds over TIPS.
Hedging is the precise reason.

As another note, companies often borrow with fixed-rate debt; so they are doing the opposite of holding nominal bonds. The only hedge for that debt they carry is to buy nominal bonds. Otherwise, they and you lose to unexpected low inflation. It might not take much to hedge that portion, but something to think about. Again, part of the business cycle.
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Re: Why use anything but TIPS?

Post by billthecat »

willthrill81 wrote: Wed Oct 13, 2021 9:03 pm
billthecat wrote: Wed Oct 13, 2021 8:08 pm
tonyclifton wrote: Wed Oct 13, 2021 5:51 pm
billthecat wrote: Wed Oct 13, 2021 5:20 pm I don't buy TIPS because I don't understand them. It seems like you are betting that actual inflation will be higher than what folks generally expect, and I don't see why I would know better than the market.
There is no bet. It is not a wager. If you wish to learn more about what they are the wiki has info and the two books mentioned up thread.

Saying TIPS are a bet is like saying Treasuries are a bet that the US Government won’t default. Better not!

One strong case, IMHO, against TIPS is that they haven’t been “tested” in a high inflationary period as they came into existence in 1997 and there hasn’t been a high inflationary period since then (thankfully).

If someone is seeking higher yields go for it elsewhere!
But (following the example in the WIki) the price of TIPS reflects the expected inflation adjustment to the principal and interest payments. So if actual inflation is lower than expected, you would have overpaid for the bond. If inflation is higher than expected, you would get paid more than what was already priced in. Isn't that betting that actual inflation will be higher than what folks generally expect?
After a TIPS bond has been purchased, changes to inflation make no difference to the TIPS holder at all. Inflation and the uncertainties pertaining thereto are removed from the picture.

As I noted above, it could just as easily be argued that those buying nominal Treasuries are 'betting' that inflation will be below what the market expects.

In reality, if inflation comes in at what the market expects, the real returns of both nominal Treasuries and TIPS would be very nearly the same.

The problem with nominal Treasuries is that they offer only a tiny, arguably close to zero, premium for taking on inflation risk as compared to TIPS. And when you consider that the risk of unexpected inflation has historically been the single biggest risk to nominal bonds, there isn't much, if any, good reason to hold nominal Treasuries rather than TIPS.
I think you're just taking issue with my characterizing it as a "bet" but in my defense:
https://obliviousinvestor.com/tips-vs-nominal-treasury-bonds/ wrote: If you expect inflation to be above the market’s expectation (1.63% in this case), TIPS are a better bet. If you expect inflation to be below the market’s expectation, go with nominal bonds.
And, yes, nominal bonds are a bet too.
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Re: Why use anything but TIPS?

Post by willthrill81 »

billthecat wrote: Thu Oct 14, 2021 10:43 am
willthrill81 wrote: Wed Oct 13, 2021 9:03 pm
billthecat wrote: Wed Oct 13, 2021 8:08 pm
tonyclifton wrote: Wed Oct 13, 2021 5:51 pm
billthecat wrote: Wed Oct 13, 2021 5:20 pm I don't buy TIPS because I don't understand them. It seems like you are betting that actual inflation will be higher than what folks generally expect, and I don't see why I would know better than the market.
There is no bet. It is not a wager. If you wish to learn more about what they are the wiki has info and the two books mentioned up thread.

Saying TIPS are a bet is like saying Treasuries are a bet that the US Government won’t default. Better not!

One strong case, IMHO, against TIPS is that they haven’t been “tested” in a high inflationary period as they came into existence in 1997 and there hasn’t been a high inflationary period since then (thankfully).

If someone is seeking higher yields go for it elsewhere!
But (following the example in the WIki) the price of TIPS reflects the expected inflation adjustment to the principal and interest payments. So if actual inflation is lower than expected, you would have overpaid for the bond. If inflation is higher than expected, you would get paid more than what was already priced in. Isn't that betting that actual inflation will be higher than what folks generally expect?
After a TIPS bond has been purchased, changes to inflation make no difference to the TIPS holder at all. Inflation and the uncertainties pertaining thereto are removed from the picture.

As I noted above, it could just as easily be argued that those buying nominal Treasuries are 'betting' that inflation will be below what the market expects.

In reality, if inflation comes in at what the market expects, the real returns of both nominal Treasuries and TIPS would be very nearly the same.

The problem with nominal Treasuries is that they offer only a tiny, arguably close to zero, premium for taking on inflation risk as compared to TIPS. And when you consider that the risk of unexpected inflation has historically been the single biggest risk to nominal bonds, there isn't much, if any, good reason to hold nominal Treasuries rather than TIPS.
I think you're just taking issue with my characterizing it as a "bet" but in my defense:
https://obliviousinvestor.com/tips-vs-nominal-treasury-bonds/ wrote: If you expect inflation to be above the market’s expectation (1.63% in this case), TIPS are a better bet. If you expect inflation to be below the market’s expectation, go with nominal bonds.
And, yes, nominal bonds are a bet too.
The semantics of what qualifies as a 'bet' could be argued endlessly to no effect at all, so there's no point in quibbling over it.

As I noted above, unless you believe that you have some kind of information edge over the market or wish to hedge a specific risk while increasing another risk (e.g., protecting against lower than expected inflation with nominals while accepting the risk of higher than expected inflation), there certainly isn't a strong argument for an individual investor to prefer nominal bonds over TIPS.
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Re: Why use anything but TIPS?

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secondopinion wrote: Thu Oct 14, 2021 9:57 am
Orangutan wrote: Wed Oct 13, 2021 11:20 pm
secondopinion wrote: Wed Oct 13, 2021 11:10 pm
willthrill81 wrote: Wed Oct 13, 2021 10:24 pm
chrisdds98 wrote: Wed Oct 13, 2021 9:57 pm

crash insurance. long treasuries performed much better than TIPS during 2008
First, are you comparing apples to apples, that is, long-term nominal Treasuries to long-term TIPS? I'm not aware that any long-term TIPS funds existed back in 2008.

Second, if long-term nominals did indeed outperform long-term TIPS in a single event, does this mean that we can count on that happening regularly?
If there is prolonged deflation or low inflation beyond expected, then long-term nominals are going to do better than TIPS. See my post on the business cycle.
That's a discussion on a bet. Consider an increasing and persistent inflationary environment. You wouldn't catch up for a very, very long time. How would it feel to see your bonds drop 40+%? Long duration TIPS would be a more fitting discussion for this post.
On the other hand, flat make both equally appealing and decreasing and persistent non-inflationary environment make nominal bonds better. How would it feel to see your bonds gain 40+%? My guess is that neither the drop or gain will happen to that extent.
I don't see the risk between the two as equal. Nominals will get clobbered in a high inflationary environment whereas TIPS won't to the same extent in a deflationary environment. And why do I care if there is deflation? TIPS will continue to maintain purchasing power. Now in an inflationary environment? Again, TIPS will continue to maintain purchasing power. Nominals will lose real wealth.

The risk is only on one side, no?
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Re: Why use anything but TIPS?

Post by secondopinion »

Orangutan wrote: Thu Oct 14, 2021 10:48 am
secondopinion wrote: Thu Oct 14, 2021 9:57 am
Orangutan wrote: Wed Oct 13, 2021 11:20 pm
secondopinion wrote: Wed Oct 13, 2021 11:10 pm
willthrill81 wrote: Wed Oct 13, 2021 10:24 pm

First, are you comparing apples to apples, that is, long-term nominal Treasuries to long-term TIPS? I'm not aware that any long-term TIPS funds existed back in 2008.

Second, if long-term nominals did indeed outperform long-term TIPS in a single event, does this mean that we can count on that happening regularly?
If there is prolonged deflation or low inflation beyond expected, then long-term nominals are going to do better than TIPS. See my post on the business cycle.
That's a discussion on a bet. Consider an increasing and persistent inflationary environment. You wouldn't catch up for a very, very long time. How would it feel to see your bonds drop 40+%? Long duration TIPS would be a more fitting discussion for this post.
On the other hand, flat make both equally appealing and decreasing and persistent non-inflationary environment make nominal bonds better. How would it feel to see your bonds gain 40+%? My guess is that neither the drop or gain will happen to that extent.
I don't see the risk between the two as equal. Nominals will get clobbered in a high inflationary environment whereas TIPS won't to the same extent in a deflationary environment. And why do I care if there is deflation? TIPS will continue to maintain purchasing power. Now in an inflationary environment? Again, TIPS will continue to maintain purchasing power. Nominals will lose real wealth.

The risk is only on one side, no?
TIPS are not directly opposite of nominal bonds; fixed-rate debt is. But as I have said many times before, nominal bonds gain from unexpected low inflation; for every risk there is a chance of a gain and loss. TIPS are not going to care either way; both nominal bonds and fixed-rate debt will in opposite ways. As one of my posts mentions, companies often take fixed-rate debt; so, the best way to hedge their stock (which considers that debt) is to own some nominal bonds. I think people are missing the fixed-rate debt in the picture. If you wanted to truly hedge inflation, you have to hedge the companies' debt that the stocks reflect.
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Re: Why use anything but TIPS?

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Orangutan wrote: Thu Oct 14, 2021 10:48 am The risk is only on one side, no?
Not only, no. If inflation averages 1% and the break-even point for TIPS is 2% inflation, for instance, nominal would come out ahead. That's a risk, but it seems like a small risk. The far bigger risk historically has been inflation being much higher than expected, clobbering the buying power of nominal bonds.
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Re: Why use anything but TIPS?

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secondopinion wrote: Thu Oct 14, 2021 10:34 am Hedging is the precise reason.

As another note, companies often borrow with fixed-rate debt; so they are doing the opposite of holding nominal bonds. The only hedge for that debt they carry is to buy nominal bonds. Otherwise, they and you lose to unexpected low inflation. It might not take much to hedge that portion, but something to think about. Again, part of the business cycle.
I think it illustrates the basic hang up where people end up saying 'buying TIPS is a bet' (which I don't think you are). A big reason US corporations have tended to fund themselves with fixed rate debt is simply convention. If you do what's conventional and it backfires, everyone else is doing it too so you don't look as stupid. And that's a more concentrated effect for corporate managers than individual investors.

European companies have been much more likely than US to fund themselves with floating rate debt. While actually inflation adjusted corporate debt has been very rare, floating tends to somewhat accomplish the same goals. Debt burden is less in severe recession where nominal cash flow and debt service cost will both tend to go down, works out also in at least moderately high inflation in the other direction. It does introduce the risk of very high debt service cost when real short term rates are high and cashflow doesn't fully follow. But again the reason they've done that has a lot to do with convention, just a different convention in their sphere (also the convention of borrowing more from banks, usually floating...by convention, and less from the bond market).

Note though in either case in the last at least 30 yrs it's more difficult to know the actual net interest rate risk of corporate debt not seeing what interest rate swaps and other hedges the company has done. For example when I say 'European companies more likely to fund themselves floating' I'm partly referring to much more common case of them issuing fixed rate bonds but receiving fixed/paying floating on a swap tied to the issuance. They do so because it's perceived that buyers of fixed rate debt of that issuer will result in a lower cost of floating debt after the swap than would be the case issuing floating rate notes directly to a different clientele looking for floating bonds. But the issuer wants floating in the end.

Again my point is just that people have different frames of reference, but often based on convention. For example the people saying 'buying TIPS is a bet on inflation' (which I find a silly statement) seem to be driven in part by a logic which says if buying TIPS isn't a bet, then buying nominals must be, but that's what every bond investor always did before a few decades ago. That was the convention. However disregarding convention seems to me elementary to deduce that this convention simply *was* taking risk to fund future real liabilities which buying TIPS is reducing (though not true in relatively unusual case of an individual investor seeking to fund nominal liabilities with bonds).
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Re: Why use anything but TIPS?

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willthrill81 wrote: Thu Oct 14, 2021 10:59 am
Orangutan wrote: Thu Oct 14, 2021 10:48 am The risk is only on one side, no?
Not only, no. If inflation averages 1% and the break-even point for TIPS is 2% inflation, for instance, nominal would come out ahead. That's a risk, but it seems like a small risk. The far bigger risk historically has been inflation being much higher than expected, clobbering the buying power of nominal bonds.
But why is that a risk to TIPS? That just says nominals outperformed TIPS for x period. My TIPS real wealth is still intact so it's irrelevant what nominals are doing relative to TIPS. The only risk here is nominals losing real wealth. Right?
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Re: Why use anything but TIPS?

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Orangutan wrote: Thu Oct 14, 2021 11:20 am
willthrill81 wrote: Thu Oct 14, 2021 10:59 am
Orangutan wrote: Thu Oct 14, 2021 10:48 am The risk is only on one side, no?
Not only, no. If inflation averages 1% and the break-even point for TIPS is 2% inflation, for instance, nominal would come out ahead. That's a risk, but it seems like a small risk. The far bigger risk historically has been inflation being much higher than expected, clobbering the buying power of nominal bonds.
But why is that a risk to TIPS? That just says nominals outperformed TIPS for x period. My TIPS real wealth is still intact so it's irrelevant what nominals are doing relative to TIPS. The only risk here is nominals losing real wealth. Right?
You're right that the only 'risk' is that TIPS could underperform nominals, but in the context of removing inflation risk from the funds used to buy the bonds, TIPS are the obviously better choice.
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