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November 15, 2011
How Much Should Retirees Stake in TIPS?
So assuming you've decided you'd like to include inflation-protected investments in your portfolio, what's the right amount? At first blush it might appear that you'd want all of your fixed-income portfolio in TIPS; that's the tack embraced by some academics and other investment theorists.
At first blush I determined that I wanted my entire investment portfolio (not just the fixed-income part) in TIPS heading into the great recession (with some cash for liquidity on the side). I guess that puts me in the "other investment theorist" camp.
After all, if there's a bond investment that helps offset the corrosive effects of inflation, why would you want to forgo it for one that doesn't offer that protection?
In my opinion, the article should have ended right there (unless it was willing to explore the risks of owning bonds in general, which it was not).
The key reason is diversification. While some corporate, foreign, and municipal bonds carry inflation protection, TIPS are the most widely available and liquid type of inflation-linked bonds, and most inflation-protected bond funds skew heavily or even entirely toward TIPS. That means an investor in search of an all-inflation-protected fixed-income portfolio would have to go out of his way to avoid a heavy emphasis on government bonds; at the same time, he'd hold relatively less in corporate, asset-backed, and other bond types, which will outperform Treasuries and other government-backed bonds at various points in time.
It has been my intent to go out of my way to embrace government bonds. No diversification was needed nor desired. That's not entirely true I guess. I very nearly backed up the truck on "asset-backed" bonds heading into the great asset crash but I flipped a coin and it came up tails. Whew! Crisis averted, lol.
In all seriousness, I'm a retiree. I don't really care how the other bonds perform relative to TIPS (either better or worse). All I care about is that my investments keep up with inflation if bought in an auction and held to maturity. That's it. In the bond world, only TIPS can offer me that assurance (at least before taxes anyway).
Put another way, if I was looking to maximize gains then I could always just drop the fire insurance on my home and hope for the best. Chances are good that I would be wealthier over the long-term. Unfortunately, hindsight could show that my house burned to the ground instead. The loss of my house through fire is not a risk I am willing to take.
I would also point out that buying government bonds directly from the government means I don't have to pay excessive Wall Street middlemen fees and annual expenses. That really appeals to me.
So the answer to the question about how much retirees should hold in TIPS falls somewhere between 0 and 100%. But where?
Here's another way to put that.
So the answer to the question about how much extra risk retirees should expose themselves to in order to potentially gain some extra reward is somewhere between 100% and 0%.
As a retiree, I have chosen to expose myself to 0% extra risk and am willing to forgo any additional rewards and/or pain. I'm not suggesting that TIPS are completely safe. I'm simply arguing that they are most likely safer than the other options that Christine Benz is pushing.
And finally, this is where the real fun begins.
A version of this article appeared on July 21, 2011.
On July 21, 2011 the 30-year TIPS rate was 1.64%. I put my entire IRA into one non-diversified 29-year TIPS bond at an even higher rate earlier this year. It is money I will be needing about 29 years from now. I wanted to lock in that rate. I did not want to take the extra risk that the rate would drop. I avoided diversification not out of greed, but rather out of safety.
The 30-year TIPS now yields a mere 0.79%. Hindsight has not been at all kind to well-diversified second blushes.
This is not investment advice. I'm simply offering up my thoughts as they relate to my particular portfolio and risk tolerances. Embracing risk in retirement just doesn't seem like a great plan to me (especially given the name of my blog).
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13 comments:
It has been my intent to go out of my way to embrace government bonds.
For heaven's sake, WHY?!?
Is it because the clowns in DC have proven to be pillars of fiscal prudence?? Is it because the other clowns at the Fed have proven to be Volcker-esque defenders of a strong dollar???
If you don't need the extra reward, don't take the extra risk. But what about the sovereign risk? Have you any tax-effective way of buying, say, index-linked government bonds from Sweden, Australia, NZ, Canada.....? Though I'll grant that a return to a Little Ice Age would be bad news for Canada and Sweden.
tj and the bear,
For heaven's sake, WHY?!?
Name an alternative. Just one. I'm not picky.
dearieme,
I decided a long time ago that I would stick with the known evil over an unknown one.
No complaints so far.
tj and the bear,
I should point out again that I bought gold and silver in 2004 when they were much closer to the bargain table.
I told myself that I would only be selling them once. I had (and have) no intentions to trade them.
Right or wrong, I sold in 2006. There's no going back to me at these prices. Not even close. I think they are in the same kind of bubble real estate was in before that "sure thing" collapsed.
At least real estate can be used productively. Other than collect it and admire its shininess, what good is gold at these prices?
Mark,
At what point did, say, toilet paper become "too expensive" in Zimbabwean dollars? How many z-dollars did TP have to cost before TP was "in a bubble"?? When did z-bonds become more attractive than TP?!?
tj and the bear,
As you know, I'm a big fan of stocking up on toilet paper (and have personally). I definitely don't think there is a toilet paper bubble.
At what point does gold become too expensive to you compared to the price of toilet paper?
Where's the Zimbabwe style hyperinflation? October's CPI was actually deflationary (again).
You have a tough time with analogies?
It was never about the TP, of course, but the dying currency it was "priced" in. Oh, and just because the heat is being turned up more slowly doesn't mean you won't eventually boil.
Called Vanguard on Saturday to ask about buying/holding TIPS in my Roth/follover IRA accounts. If I use the web, no commission, no holding fees. The agent I spoke to sounded older and was quietly not enthusiastic. Pointed out that I could still lose money, that inflation could rachet up, and that if I bought the TiPS fund, experts would be buying for me, which he thought was a plus.Vanguard folks are usually noncomittal, so interesting that he managed to convey his reservations.
I'm still planning on the January auction, and submitting my bid on the day of the auction (thank you chart porn).
tj and the bear,
You have a tough time with analogies?
It isn't an analogy to me.
When I originally felt that gold was in a bubble I never claimed that it was in a bubble compared to dollars. In fact, I specifically said that I thought gold was a bubble relative to toilet paper.
I claimed it was in a bubble compared to the other things I could buy with dollars (namely toilet paper, canned goods, and so on).
If the price of the things I need (such as toilet paper) doubles in price but gold does not double (because it has already become too expensive as investors rushed in), then it will not be a good inflation hedge over the long-term.
That's all I have said and that's all I am saying.
In other words, I do not think that any asset is good at any price (dotcom stocks, real estate, gold, silver).
fried,
Pointed out that I could still lose money, that inflation could rachet up, and that if I bought the TiPS fund, experts would be buying for me, which he thought was a plus.
I'm shocked that a financial expert would think that financial experts buying for you would be a plus. Shocked I tell you! ;)
In sharp contrast, I see financial experts as parasitical (both the one you called and the one he thinks should buy bonds for you). They'll do whatever they can to latch on to a perfectly healthy nest egg and start sucking the lifeblood out of them (via ongoing annual expenses).
Keep this in mind. It is your nest egg (and nest eggs of other investors) that powers the lights and pays the wages of the person you talked to on the phone.
mark,
all true. I find it interesting myself that I bought ibonds starting back in 2001, but never looked into TiPS or even ebonds. I was still locked into the fixed/equities distribution mindset. Adding sovereign risk to the equation ups the ante, but the casino has returned very little to long term investors over the past 12 years.
Now I find myself watching e bond rates and wondering if the treasury direct decision to go all electronic will reduce the amount of ibonds I can buy in January to 5K.
You know, you start reading blogs and your world view begins to shift.
Hoocodanode?
fried,
Now I find myself watching e bond rates and wondering if the treasury direct decision to go all electronic will reduce the amount of ibonds I can buy in January to 5K.
In 2008, they cut the amount we could buy by 83%. In 2012, the paperless system will reduce the amount we can buy by an additional 50%. Meanwhile, inflation is also reducing the amount we can save (since a fixed $5000 continues to be worth less and less thanks to inflation).
There is some good news though. Ben Bernanke is aware of the problem.
September 7, 2010
The Failed Keynesian Phillips Curve
But Mr. Bernanke also warned that huge trade imbalances between the United States and the rest of the world had played a central role in the global economic crisis and that they could do so again.
...
“The United States must increase its national saving rate,” he said.
Nothing fixes a national saving rate problem like continually reducing the amount we can save. Sarcasm!
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