Is there a limit to the percentage of my portfolio that should be in inflation protected instruments?

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panhead
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Re: Is there a limit to the percentage of my portfolio that should be in inflation protected instruments?

Post by panhead »

TheTimeLord wrote: Wed Jun 29, 2022 11:30 am TIPS and I-Bonds now make up about 13% of my portfolio. I plan to continue to purchase TIPS for liability matching purposes. Is there a limit to the percentage of my portfolio that should be in these inflation protected instruments?
In my opinion, purchasing individual TIPS/I bonds as a ladder to get to age 70 social security makes the most sense. In reality, from age 62-69 you are essentially "buying" the higher annuity value which most people on this forum seem to think is a good idea. Since as far as I'm aware, one cannot purchase a true inflation indexed SPIA, this seems to be a reasonable exchange. Once the 62-69 ladder is in place, I think the answer gets foggy and depends on the size of your asset base.

My thinking on this was to come up with the income I desire through retirement, determine how much I will get from social security at age 70, determine how much it costs to build a inflation indexed ladder to age 70 social security, and then determine (using a SWR) how much the residual portfolio (minus the ladder cost) could likely generate in additional withdrawals. If the (SWR)*(Residual_portfolio)+ladder_rung = desired_income, I'm in good shape.

Note that if you create this ladder and stocks soar as your rungs mature, you can spend from your equity side to help keep things in balance and re-invest the TIPS rung in a intermediate term bond fund, or whatever in the fixed income space to try to hold your AA relatively level, otherwise you will be dealing with a rising equity glide path which may or may not be what you want.

I created this thread and got some good feedback:

viewtopic.php?t=379274

Good luck!
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TheTimeLord
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Re: Is there a limit to the percentage of my portfolio that should be in inflation protected instruments?

Post by TheTimeLord »

panhead wrote: Thu Jul 07, 2022 6:39 am
TheTimeLord wrote: Wed Jun 29, 2022 11:30 am TIPS and I-Bonds now make up about 13% of my portfolio. I plan to continue to purchase TIPS for liability matching purposes. Is there a limit to the percentage of my portfolio that should be in these inflation protected instruments?
In my opinion, purchasing individual TIPS/I bonds as a ladder to get to age 70 social security makes the most sense. In reality, from age 62-69 you are essentially "buying" the higher annuity value which most people on this forum seem to think is a good idea. Since as far as I'm aware, one cannot purchase a true inflation indexed SPIA, this seems to be a reasonable exchange. Once the 62-69 ladder is in place, I think the answer gets foggy and depends on the size of your asset base.

My thinking on this was to come up with the income I desire through retirement, determine how much I will get from social security at age 70, determine how much it costs to build a inflation indexed ladder to age 70 social security, and then determine (using a SWR) how much the residual portfolio (minus the ladder cost) could likely generate in additional withdrawals. If the (SWR)*(Residual_portfolio)+ladder_rung = desired_income, I'm in good shape.

Note that if you create this ladder and stocks soar as your rungs mature, you can spend from your equity side to help keep things in balance and re-invest the TIPS rung in a intermediate term bond fund, or whatever in the fixed income space to try to hold your AA relatively level, otherwise you will be dealing with a rising equity glide path which may or may not be what you want.

I created this thread and got some good feedback:

viewtopic.php?t=379274

Good luck!
I will give the thread a look. Thanks.
IMHO, Investing should be about living the life you want, not avoiding the life you fear. | Run, You Clever Boy! [9085]
protagonist
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Re: Is there a limit to the percentage of my portfolio that should be in inflation protected instruments?

Post by protagonist »

nisiprius wrote: Tue Jul 05, 2022 2:51 pm According to Larry Swedroe (in 2009)
And the recommendations from academic papers are that TIPS should dominate fixed income portfolios. One paper even recommended a 100 percent allocation to TIPS.
The abstract of that paper says (my boldfacing)
I decompose inflation risk into (i) a component that is correlated with factors that determine investor’s preferences and investment opportunities and real returns on real assets with risky cash flows (stocks, corporate bonds, real estate, commodities, etc.), and (ii) a residual inflation risk component. In equilibrium, only the first component earns a risk premium. Therefore investors should avoid exposure to the residual component. All nominal bonds, including the money-market account, have constant nominal cash flows and thus their real returns are equally exposed to residual inflation risk. In contrast, inflation-protected bonds provide a means to avoid cash flow and residual inflation risk. Hence, every investor should put 100% of her wealth in real assets (inflation-protected bonds, stocks, corporate bonds, real estate, commodities, etc.), and finance every long/short position in nominal bonds with an equal amount of other nominal bonds or by borrowing/lending cash, that is, investors should hold a zero-investment portfolio of nominal bonds and cash.
A decade or so ago, Larry Swedroe was advocating a 0% allocation to TIPS if yields were less than 1.5% real. His recommendations: https://www.financialwisdomforum.org/fo ... &mode=view

I recall seeing that table in one of his books though I forget which one.

I recall asking him to explain the logic to me since I was a novice and he was "the expert", and I never understood his point.
Last edited by protagonist on Thu Jul 07, 2022 4:33 pm, edited 1 time in total.
Hebell
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Re: Is there a limit to the percentage of my portfolio that should be in inflation protected instruments?

Post by Hebell »

You have to assume that Swedroe could not have envisioned the demand for TIPS leading to negative real yield, as inflation took off with interest rates lagging behind. It makes his table seem rather dated doesn't it?
protagonist
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Re: Is there a limit to the percentage of my portfolio that should be in inflation protected instruments?

Post by protagonist »

Hebell wrote: Thu Jul 07, 2022 4:29 pm You have to assume that Swedroe could not have envisioned the demand for TIPS leading to negative real yield, as inflation took off with interest rates lagging behind. It makes his table seem rather dated doesn't it?
Yes, but even then, if the purpose of TIPS was wealth preservation in the face of future high inflation (as opposed to growth with its inherent risks), it doesn't make sense to me now, nor did it then, that your goal would not be met unless the yield was that high or higher. And people were certainly thinking in terms of wealth preservation around the time I was asking him about that, in the years post-2008. I don't think much has changed in that regard.
protagonist
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Re: Is there a limit to the percentage of my portfolio that should be in inflation protected instruments?

Post by protagonist »

Statistical wrote: Fri Jul 01, 2022 9:54 am
TheTimeLord wrote: Wed Jun 29, 2022 11:30 am TIPS and I-Bonds now make up about 13% of my portfolio. I plan to continue to purchase TIPS for liability matching purposes. Is there a limit to the percentage of my portfolio that should be in these inflation protected instruments?
If held to maturity TIPS are arguably lower risk. As investors all we care about is real returns and treasuries can have both positive and negative real returns. Regardless of the coupon the real return will only be known in hindsight. With TIPS the real return is known at time of purchase.

Since riskier assets have a risk premium that would suggest long term nominal treasuries will outperform tips. They have an added risk or uncertainty to them. In reality the difference has been incredibly small.

So back to your original question I think it is largely preference. I see no issue with treasuries making up 100% of your bond exposure and all of them being TIPS. Now your bond yields over the long run will be very close to 0% real (<1% possibly <0.5%). As such you may need a higher stock allocation (85/15 with bonds being 100% TIPS vs 80/20 with bonds being total bond fund).

Comparison of 100% equities, 85/15 (TIPS), and 80/20 (total bond)
https://www.portfoliovisualizer.com/bac ... tion3_2=15


The backtest portfolio site you referenced made me curious what would have happened for a 50-50 portfolio, if you didn't increase your stock allocation when replacing the total US bond portion with TIPS. I expected that the 50/50 stocks/total US bond portfolio would have outperformed, but in fact, the 50/50 stocks/TIPS won out by quite a margin (and with considerable less risk). (The calculator automatically replaced your 1972-2022 time range with 2001-2022 due to lack of prior TIPS data). https://www.portfoliovisualizer.com/bac ... sisResults

In fact, even 35% stocks/65% TIPS beat 50% stocks/50% total US bonds according to that tool. Of course, you can't say much about the next 22 years based on the past 22, but if accurate, I found that interesting and unexpected, especially given the raging bond market during that prior period- the 10 year Treasury rate at the start of 2001 was about 5%.
Dude2
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Re: Is there a limit to the percentage of my portfolio that should be in inflation protected instruments?

Post by Dude2 »

Hebell wrote: Thu Jul 07, 2022 4:29 pm You have to assume that Swedroe could not have envisioned the demand for TIPS leading to negative real yield, as inflation took off with interest rates lagging behind. It makes his table seem rather dated doesn't it?
I would not put it that demand for TIPS lead to negative real yields. (Indeed, in this you might ask yourself what drove real rates prior to the invention of TIPS.) Real rates just kept going down, eventually crossing the 0 line, and that had been the trend. Maybe we all believed some sort of natural phenomenon would step in to prevent this, but taking the long view and having benefit of hindsight, there was no reason not to believe it would happen.

Real rates just do what they do.

https://en.wikipedia.org/wiki/Real_interest_rate
If real interest rates are high, the cost of borrowing may exceed the real physical return of some potentially purchased machines (in the form of output produced); in that case those machines will not be purchased. Lower real interest rates would make it profitable to borrow to finance the purchasing of a greater number of machines.

The real interest rate is used in various economic theories to explain such phenomena as capital flight, business cycles and economic bubbles. When the real rate of interest is high, because demand for credit is high, then the usage of income will, all other things being equal, move from consumption to saving, and physical investment will fall. Conversely, when the real rate of interest is low, income usage will move from saving to consumption, and physical investment will rise.
https://www.minneapolisfed.org/article/ ... e-long-run
Real interest rates since the 1960s have been characterized by three broad long-run trends: (1) rates have declined across numerous countries since the 1980s, (2) long-run average real interest rates are near their low for the 60-year period we examine and (3) over the past quarter century, long-run interest rates have converged internationally, consistent with an increasingly financially integrated world.

These findings have four implications.

First, real interest rates were declining long before the global financial crisis of 2007-09 and its aftereffects and well before the fizzling of the IT boom.

Second, the likelihood of nominal interest rates hitting the zero lower bound has increased compared with the likelihood prior to the Great Recession.

Third, increasing financial integration may lead to even closer international rate convergence.

Fourth, there was a sustained increasing trend in long-run real interest rates prior to the 1980s, which suggests that the current downward trend could also reverse.

Finally, since the 1980s, the trend in global fixed investment is downward. Coupled with our main finding of the declining long-run real interest rates, this suggests that forces leading to lower investment demand have been relatively more important than those leading to increased desired saving. Put differently, while our evidence is not inconsistent with the global saving glut hypothesis, it indicates that in addition to a saving glut, there must have been forces that reduced global investment demand, and these forces must have been more important.
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TheTimeLord
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Re: Is there a limit to the percentage of my portfolio that should be in inflation protected instruments?

Post by TheTimeLord »

TheTimeLord wrote: Wed Jun 29, 2022 11:30 am TIPS and I-Bonds now make up about 13% of my portfolio. I plan to continue to purchase TIPS for liability matching purposes. Is there a limit to the percentage of my portfolio that should be in these inflation protected instruments?
They are now at roughly 22.7% and look likely to peak a bit higher.
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protagonist
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Re: Is there a limit to the percentage of my portfolio that should be in inflation protected instruments?

Post by protagonist »

TheTimeLord wrote: Wed Jul 13, 2022 8:08 am
TheTimeLord wrote: Wed Jun 29, 2022 11:30 am TIPS and I-Bonds now make up about 13% of my portfolio. I plan to continue to purchase TIPS for liability matching purposes. Is there a limit to the percentage of my portfolio that should be in these inflation protected instruments?
They are now at roughly 22.7% and look likely to peak a bit higher.
Did you decide to shoot for 100% of your fixed income investments?
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TheTimeLord
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Re: Is there a limit to the percentage of my portfolio that should be in inflation protected instruments?

Post by TheTimeLord »

protagonist wrote: Wed Jul 13, 2022 10:29 am
TheTimeLord wrote: Wed Jul 13, 2022 8:08 am
TheTimeLord wrote: Wed Jun 29, 2022 11:30 am TIPS and I-Bonds now make up about 13% of my portfolio. I plan to continue to purchase TIPS for liability matching purposes. Is there a limit to the percentage of my portfolio that should be in these inflation protected instruments?
They are now at roughly 22.7% and look likely to peak a bit higher.
Did you decide to shoot for 100% of your fixed income investments?
That is the direction I am moving, with T-Bills and short term CDs for liquidity. The only fixed income I have been buying is TIPS and T-Bills and I am dealing with any existing holdings as they mature. I sold all my bond funds in either March or April of 2020 as I remember and have just been buying individual CDs and Treasuries since. I can't say I would never buy nominals again, but if I did it would likely be because I felt interest rates had become high enough that it would be likely they would see nice capital gains going forward, so as a risk asset. Hope that makes sense, I am not a write things 100% in some kind of person regarding finances as I allow my viewpoint to evolve and moderate.
IMHO, Investing should be about living the life you want, not avoiding the life you fear. | Run, You Clever Boy! [9085]
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