TIPS Ladder vs. PP/GB in retirement

[Kevin K.]

While TIPS bonds aren't often discussed here they've certainly been a hot topic of late on mainstream forums like Bogleheads and sites such as Morningstar - in part because for the first time in many years it's possible to construct a ladder of them yielding a 4%+ inflation-adjusted safe withdrawal rate (SWR). Allan Roth's article in particular has received an enormous amount of interest:

https://www.advisorperspectives.com/art ... lot-easier

I'm wondering if anyone on this forum has considered (or implemented) something like what Roth describes. Historically the PP and (especially) the GB have offered significantly higher SWR's than TIPS but of course such backtesting includes a 40 year tailwind in bonds that's unlikely to be repeated anytime soon.

[vnatale]

While TIPS bonds aren't often discussed here they've certainly been a hot topic of late on mainstream forums like Bogleheads and sites such as Morningstar - in part because for the first time in many years it's possible to construct a ladder of them yielding a 4%+ inflation-adjusted safe withdrawal rate (SWR). Allan Roth's article in particular has received an enormous amount of interest:

https://www.advisorperspectives.com/art ... lot-easier

I'm wondering if anyone on this forum has considered (or implemented) something like what Roth describes. Historically the PP and (especially) the GB have offered significantly higher SWR's than TIPS but of course such backtesting includes a 40 year tailwind in bonds that's unlikely to be repeated anytime soon.

I am STRONGLY considering something like this!

[mathjak107]

the flaw here is there is still a considerable amount of sequence risk at work .

it takes at least a 2% real return the first 15 years of a 30 year retirement for 4% inflation adjusted to hold .

tips have performed poorly despite the higher inflation because of rising rates..

they may have a very hard time doing that.

the etf TIP has returned not a real return but a nominal return of 1.72% ytd

with inflation hitting a high of 9.1% in june of 2022 , fidelity inflation protected securities was down 12% vs down 13% for the fidelity us bond index over the year

personally i have zero faith in that article

[vnatale]

the flaw here is there is still a considerable amount of sequence risk at work .

it takes at least a 2% real return the first 15 years of a 30 year retirement for 4% inflation adjusted to hold .

tips have performed poorly despite the higher inflation because of rising rates..

they may have a very hard time doing that.

the etf TIP has returned not a real return but a nominal return of 1.72% ytd

with inflation hitting a high of 9.1% in june of 2022 , fidelity inflation protected securities was down 12% vs down 13% for the fidelity us bond index over the year

personally i have zero faith in that article

Yes, if you own the TIPS via a mutual fund or an EFT. No, if you follow the article.

You need to own the TIPS directly and hold them for the full term.

You WILL get a 4% real return for each of the next 30 years.

Wealth of information here regarding owning nominal Treasuries, TIPS, and iBonds: https://tipswatch.com/.

[D1984]

the flaw here is there is still a considerable amount of sequence risk at work .

it takes at least a 2% real return the first 15 years of a 30 year retirement for 4% inflation adjusted to hold .

tips have performed poorly despite the higher inflation because of rising rates..

they may have a very hard time doing that.

the etf TIP has returned not a real return but a nominal return of 1.72% ytd

with inflation hitting a high of 9.1% in june of 2022 , fidelity inflation protected securities was down 12% vs down 13% for the fidelity us bond index over the year

personally i have zero faith in that article

Yes, if you own the TIPS via a mutual fund or an EFT. No, if you follow the article.

You need to own the TIPS directly and hold them for the full term.

You WILL get a 4% real return for each of the next 30 years.

Wealth of information here regarding owning nominal Treasuries, TIPS, and iBonds: https://tipswatch.com/.

Just a slight clarification: I presume--when you were referring to investing in a 30 year TIPS ladder as the article suggested--you meant "you WILL be able to withdraw 4% a year in real terms completely risk-free" rather than "you WILL get a 4% actual real return".....right? Part of the 4% real withdrawal each year is simply selling that year's maturing TIPs and using up the principal and part of said withdrawal is the actual interest. IIRC from the Bogleheads thread on this TIPS are currently yielding a real return of 1.95% or 2.00% or so, not 4%.

[mathjak107]

you are correct .tips are not returning 4%.


this whole premise is flawed.

when i inquired in april about how tip returns are calculated because of the high yields posted , jack bowers from fidelity insight wrote me back

Matt,

When the SEC implemented a bunch of rules for reporting yield-to-maturity a few decades ago, inflation-protected bond funds didn’t exist. These funds don’t work like regular bond funds, and depending on the mix of issues and their payment schedules, the SEC’s mandate produces some downright crazy figures that are essentially meaningless. You have to look at the distribution yield to see what’s really going in: less than 0.1% income over the last 12 months.

Jack

[vnatale]

the flaw here is there is still a considerable amount of sequence risk at work .

it takes at least a 2% real return the first 15 years of a 30 year retirement for 4% inflation adjusted to hold .

tips have performed poorly despite the higher inflation because of rising rates..

they may have a very hard time doing that.

the etf TIP has returned not a real return but a nominal return of 1.72% ytd

with inflation hitting a high of 9.1% in june of 2022 , fidelity inflation protected securities was down 12% vs down 13% for the fidelity us bond index over the year

personally i have zero faith in that article

Yes, if you own the TIPS via a mutual fund or an EFT. No, if you follow the article.

You need to own the TIPS directly and hold them for the full term.

You WILL get a 4% real return for each of the next 30 years.

Wealth of information here regarding owning nominal Treasuries, TIPS, and iBonds: https://tipswatch.com/.

Just a slight clarification: I presume--when you were referring to investing in a 30 year TIPS ladder as the article suggested--you meant "you WILL be able to withdraw 4% a year in real terms completely risk-free" rather than "you WILL get a 4% actual real return".....right? Part of the 4% real withdrawal each year is simply selling that year's maturing TIPs and using up the principal and part of said withdrawal is the actual interest. IIRC from the Bogleheads thread on this TIPS are currently yielding a real return of 1.95% or 2.00% or so, not 4%.

As usual ... you are correct! I DEFINITELY mis-stated!

The two concluding paragraphs of the article:

"While this strategy isn’t perfect, it produced a safe 4.3% annualized real withdrawal rate for 30 years with no risk (except for the bonds between 2033 and 2039). Think of it as a 30-year period-certain inflation-adjusted portfolio. One large difference between this strategy and the 3.3% real withdrawal rate from a balanced portfolio is that there is a 90% probability that the latter will leave money after 30 years. I wouldn’t rely entirely on a TIPS ladder even though it’s inflation protected and backed by the U.S. government.

This strategy protects against inflation, which is justifiably on many clients’ minds and provides comfort knowing that a calculated specific real amount of spending power will be available each year. This is a very attractive strategy for someone wanting a guaranteed inflation-adjusted cash flow in addition to Social Security."

[mathjak107]

if it don’t sound right it usually aint. ha ha

[vnatale]

you are correct .tips are not returning 4%.


this whole premise is flawed.

when i inquired in april about how tip returns are calculated because of the high yields posted , jack bowers from fidelity insight wrote me back

Matt,

When the SEC implemented a bunch of rules for reporting yield-to-maturity a few decades ago, inflation-protected bond funds didn’t exist. These funds don’t work like regular bond funds, and depending on the mix of issues and their payment schedules, the SEC’s mandate produces some downright crazy figures that are essentially meaningless. You have to look at the distribution yield to see what’s really going in: less than 0.1% income over the last 12 months.

Jack

Did you review this table in the article? I later found out that the author (Alan Roth, one of four on my Personal Finance Mt. Rushmore) after first investing $100,000 into this plan ... later expanded it to a full $1 milllion.

Capture.JPG (190.75 KiB) Viewed 27680 times

[mathjak107]

base rate is 1.86% so it is an assumption that the inflation kicker will generate the rest ..but lower inflation expectations will see that kicker fall

[vnatale]

base rate is 1.86% so it is an assumption that the inflation kicker will generate the rest ..but lower inflation expectations will see that kicker fall

Not "lower inflation expectations" but actual lower inflation.

If one is to buy the same term nominal Treasuries and TIPS today the difference between their rates is the market sentiment for what inflation will be for that term. If the market sentiment ended up being correct then you'll get the exact same return from both.

I think now it is about 2.4% so will use that for my examples.

If actual inflation turned out to be greater than 2.4% then the TIPS will have had the greater real return. If less than 2.4% then the Treasuries will have had the greater real return.

I want the greater protection on inflation which has no limit or can definitely be quite high, just as we witnessed int the late 70s, early 80s before Volker worked his magic.

I won't mind anywhere as much losing on the downside if inflation is less. I'll probably be more than made up for it on the Equity side.

[D1984]

base rate is 1.86% so it is an assumption that the inflation kicker will generate the rest ..but lower inflation expectations will see that kicker fall

My understanding is that this is not the case (i.e. Mr. Roth is not depending on a high inflation kicker to generate returns that will allow him to withdraw 4% real each year). Instead it is a simple mathematical calculation that at a given real rate (say, 1.86%) one needs to set aside x amount in order to cover the withdrawal next year, a slightly smaller amount (because compounding has more time to do its work) for the withdrawal the year after that, a still smaller amount for the withdrawal the year after the year after the next year, etc, etc, and so on until you only have to set aside a pretty small sum in order to have year thirty's withdrawal of 4% of the initial amount in real terms.

From what I recall on Bogleheads it takes somewhere around 1.65 or 1.70% real on TIPS for this (being able to withdraw 4% real for thirty years guaranteed) to even begin to work; anything less than that and you either need to accept a smaller withdrawal percentage, accept that your withdrawals will last less than thirty years, or set aside more to begin with.

Needless to say, if inflation is higher then the nominal return on the TIPS will be higher (since both their principal and coupon are indexed to inflation) but the real return will be exactly the same (the reverse is also true; if inflation is lower than expected the nominal return on the TIPS will be lower but in that case, the actual amount needed to fund a real inflation-adjusted 4$ withdrawal will also be lower so again, its, a wash). This goes to show that this method isn't relying on an assumed high inflation rate in order to make the 4% withdrawals work.

Of course, the whole "set aside x amount in order to have a given real amount in the future" works even if TIPS have negative yields (much of 2020 and 2021) but then you would have to set aside more than you wished to withdraw in real terms (e.g. if you wanted $10K in real terms in year 30 and 30-year TIPS had a negative yield then you would have no choice but to set aside somewhat more than $10K in today's dollars in order to have a guaranteed $10K in real dollars thirty years down the line) but at that point you are guaranteeing yourself a negative real yield so why not instead go with a portfolio of stocks/bonds/commodities/REITs etc and just hope the 4% rule works. At rates where we are now that "invest and cross your fingers and hope that the 4% rule doesn't fail this year's crop of retirees" is no longer the only option.

[Kevin K.]

OK the discussion has gone a bit into the weeds so I'll try to bring it back around a bit,

John Rekenthaler did a good comparison of TIPS, nominal Treasuries and SPIA'S recently:

https://www.morningstar.com/bonds/retir ... -annuities

TIPS obviously outperform if there's sustained high inflation but the differences aren't huge otherwise. I think that using them is clearly going to be much more appealing to Bogleheads and others whose entire universe of acceptable investing options is restricted to stocks and bonds. Using TIPS to guarantee an income floor is far more appealing than annuities, since the latter are both subject to huge erosion of value due to inflation and have counterparty risk. That's why, for example, both Allan Roth and William Bernstein are so dead set against annuities.

As a Golden Butterfly investor myself I find these options less compelling. I've already got nominal Treasuries, well-diversified equities (including a big slug of small-cap value, which tends to outperform during periods of high inflation) and gold for SHTF insurance. But I can see the appeal (especially for folks like Roth with an exponentially larger nest egg than I have) of putting enough of one's tax-deferred accounts into a 30 year TIPS ladder to cover essential expenses and then comfortably investing the rest in volatile, well-diversified equities.

[joypog]

If you have a lot of cash, TIPS makes sense. If you want any sort of long return, the protection comes at a high cost. I'm pretty conservative (ha, we're all here right?!) and I quickly gave up on TIPS after an intial study of the product.

That said I do have some money in TIPS to help lock in money for when my kids are going to college. I treat that as part of the "cash" portion of my portfolio

[vnatale]

If you have a lot of cash, TIPS makes sense. If you want any sort of long return, the protection comes at a high cost. I'm pretty conservative (ha, we're all here right?!) and I quickly gave up on TIPS after an intial study of the product.

That said I do have some money in TIPS to help lock in money for when my kids are going to college. I treat that as part of the "cash" portion of my portfolio

In the last few months I read so much about TIPS in books and articles and discussions that I'm 100% sold them to be used in all that is presently in Vanguard's Treasury Money Market fund (VUSXX). Or at least 60% to 80% of it. With balance going into nominal Treasuries.

[barrett]

OK the discussion has gone a bit into the weeds so I'll try to bring it back around a bit,

John Rekenthaler did a good comparison of TIPS, nominal Treasuries and SPIA'S recently:

https://www.morningstar.com/bonds/retir ... -annuities

TIPS obviously outperform if there's sustained high inflation but the differences aren't huge otherwise. I think that using them is clearly going to be much more appealing to Bogleheads and others whose entire universe of acceptable investing options is restricted to stocks and bonds. Using TIPS to guarantee an income floor is far more appealing than annuities, since the latter are both subject to huge erosion of value due to inflation and have counterparty risk. That's why, for example, both Allan Roth and William Bernstein are so dead set against annuities.

As a Golden Butterfly investor myself I find these options less compelling. I've already got nominal Treasuries, well-diversified equities (including a big slug of small-cap value, which tends to outperform during periods of high inflation) and gold for SHTF insurance. But I can see the appeal (especially for folks like Roth with an exponentially larger nest egg than I have) of putting enough of one's tax-deferred accounts into a 30 year TIPS ladder to cover essential expenses and then comfortably investing the rest in volatile, well-diversified equities.

Thanks for posting the Rekenthaler article, Kevin. To answer your original question, I have not purchased a 30-year TIPS ladder but I did build a five-year ladder this year with positions maturing on January 15 of each year from 2024 to 2028. I did this in my tIRA to avoid the tax complications of doing so in a taxable account, and also because the tIRA is where I have the most $ and therefore the most ability to make significant asset allocation changes (and without immediate tax consequences).

My reason for doing the above is to provide a bit of extra inflation protection before claiming SS at age 70 in 2028. But I've also tried to not pick a winner between nominals and TIPS and hold roughly equal amounts of both. My ladder of nominal treasuries is only a one-year ladder so far, but I may extend that out another year or two. And whether or not to add to the TIPS ladder as a position matures is something that I will determine when the time comes.

Between the I-Bonds I have in taxable and sizable slug of TIPS & nominals in my tIRA, I have some diversification on the fixed-income side. I may also at some point replace some nominals with TIPS in my Roth account as well, but so far that account is probably not large enough for this to move the needle.

[vnatale]

Along with the Tipswatch website this book is a tremendous resource regarding all things TIPS:



https://www.amazon.com/dp/B08HN9PYGC/?r ... l_huc_item

Explore TIPS: A Practical Guide to Investing in Treasury Inflation-Protected Securities

[seajay]

Here in the UK our Index Linked Gilts, similar to TIPS have price appreciation (inflation element) tax exempt, coupon interest is however taxable, but where over recent years coupon interest is very low, near insignificant tax. A good option for building up a compliment to other sources of income such as state pension. So some drop enough into a ladder to have pension+ladder cover basic needs/expenses, invest the rest elsewhere.

A factor there however is that alternatives are more inclined to be have cake and eat it, provide a reasonable income, and leave a decent residual real value, whereas with a TIPS ladder it all gets spent (assuming you live long enough to see all of the rungs having matured).

Another factor is that the CPI rate of inflation may totally differ to your personal rate of inflation. There's also the risk of rule changes, for instance the UK could at any time decide to tax the inflationary uplift element rather than leaving it as untaxed. We used to have stock capital gains taxation calculations that discounted inflation over the holding period such that you only paid capital gains taxes on the real gains, that were changed so as to levy capital gains taxation on nominal gains.

[vnatale]

Here in the UK our Index Linked Gilts, similar to TIPS have price appreciation (inflation element) tax exempt, coupon interest is however taxable, but where over recent years coupon interest is very low, near insignificant tax. A good option for building up a compliment to other sources of income such as state pension. So some drop enough into a ladder to have pension+ladder cover basic needs/expenses, invest the rest elsewhere.

A factor there however is that alternatives are more inclined to be have cake and eat it, provide a reasonable income, and leave a decent residual real value, whereas with a TIPS ladder it all gets spent (assuming you live long enough to see all of the rungs having matured).

Another factor is that the CPI rate of inflation may totally differ to your personal rate of inflation. There's also the risk of rule changes, for instance the UK could at any time decide to tax the inflationary uplift element rather than leaving it as untaxed. We used to have stock capital gains taxation calculations that discounted inflation over the holding period such that you only paid capital gains taxes on the real gains, that were changed so as to levy capital gains taxation on nominal gains.

More than a chance. I'd rate it a given. But at least close and in the right direction.

[Pet Hog]

It took me a while to understand why this approach works. It sounds more complicated than it really is. I crunched some numbers to convince myself. Perhaps this spreadsheet will be of use to others. Using the example of $4000 annual income from a $100,000 investment -- therefore a 4% safe withdrawal rate -- and assuming a flat rate curve yielding 1.22% each year for 30 years (in reality the real yield varies per maturity, so this spreadsheet provides just an approximation of the real world).

tips safe withdrawal rate.png (67.66 KiB) Viewed 27508 times

So, if I want to obtain $4000 a year from now, and I can get a real return of 1.22%, then I can invest $3951.79 (because 3951.79 x 1.0122 = 4000). Similarly, getting $4000 in two years at 1.22% requires $3904.16 (3904.16 x 1.0122^2 = 4000). And so on to year 30, where only $2780.16 is required (2780.16 x 1.0122^30 = 4000). Summing all those 30 initial investments gives a total of slightly less than $100,000. In other words, invest $100,000 in 30 different bonds, each with a real yield of 1.22%, and I can withdraw $4000 each year for 30 years, ending with $0 in my account.

Why did I choose 1.22% as the real yield? Because it's the number that gives a 4% SWR. Using the same spreadsheet with a real yield of 1.86% gives a SWR of 4.38% from a $91,344 investment.

If anyone's interested, I can find the real yield for each maturity and repeat the calculation to give a more accurate representation of the investment returns.

[Pet Hog]

One way to understand this investment approach is to consider the SWR of cash under a mattress. If you have $100,000, you could withdraw $3333 each year for 30 years. That's a 3.33% SWR, but obviously affected by inflation. The SWR would also be 3.33% when invested in TIPS with no real return, only giving inflation protection. So the Alan Roth scheme is asking what real return would you need to convert a 3.33% SWR into a 4% real SWR, and the answer is 1.22%. In the real world, it seems you require an average of something like 1.7%, as D1984 stated above.

[vnatale]

It took me a while to understand why this approach works. It sounds more complicated than it really is. I crunched some numbers to convince myself. Perhaps this spreadsheet will be of use to others. Using the example of $4000 annual income from a $100,000 investment -- therefore a 4% safe withdrawal rate -- and assuming a flat rate curve yielding 1.22% each year for 30 years (in reality the real yield varies per maturity, so this spreadsheet provides just an approximation of the real world).


tips safe withdrawal rate.png


So, if I want to obtain $4000 a year from now, and I can get a real return of 1.22%, then I can invest $3951.79 (because 3951.79 x 1.0122 = 4000). Similarly, getting $4000 in two years at 1.22% requires $3904.16 (3904.16 x 1.0122^2 = 4000). And so on to year 30, where only $2780.16 is required (2780.16 x 1.0122^30 = 4000). Summing all those 30 initial investments gives a total of slightly less than $100,000. In other words, invest $100,000 in 30 different bonds, each with a real yield of 1.22%, and I can withdraw $4000 each year for 30 years, ending with $0 in my account.

Why did I choose 1.22% as the real yield? Because it's the number that gives a 4% SWR. Using the same spreadsheet with a real yield of 1.86% gives a SWR of 4.38% from a $91,344 investment.

If anyone's interested, I can find the real yield for each maturity and repeat the calculation to give a more accurate representation of the investment returns.

That is not what the article did in what I copied here (above)?

viewtopic.php?f=1&t=13057#p250882

[Pet Hog]

That is not what the article did in what I copied here (above)?

viewtopic.php?f=1&t=13057#p250882

That's a "real real-world" example! Roth's "annual cash flow" entries I suspect include all dividends and maturing principal? Mine is hypothetical, considering dividends as reinvested and the ability to buy fractional bonds -- neither of which is realistic with only $100,000. I was more interested in what real yield would be needed to reach 4% SWR and what the approach means and why it works. On second thought, what I modeled isn't close to what Roth did because he bought almost equal dollar amounts of all bonds and is using dividends as cash flow. It's similar but not the same.

[seajay]

Don't forget that with a 4% 30 year SWR TIPS ladder that assumes all is spent, no residual. For other asset allocations 4% 30 year SWR was around the worst case outcome, left nothing remaining ... but in the more usual/average case tended to leave a very decent residual amount remaining, in some cases multiples more of the inflation adjusted start date portfolio value.

TIPS ladders guarantee that at the end, nothing is left. Whilst also involving other risk factors, such as taxation or policy changes that may occur over those 30/whatever years. Is in many respects like buying fire insurance from a arsonist as someone hereabouts once described it (MediumTex?).

4% SWR from other asset allocations was also historically safe, within the limits of past history. To fall outside of that is suggestive that forward time will involve more extremes than historically seen. Investing in a TIPS ladder is indicative that you expect such extremes, and when so that TIPS will still be honored (when perhaps the actual inclination might be to revise TIPS taxation in a unfavorable manner for investors).

Yes if you want a TIPS ladder then thinking about each rung is the easier approach. If a nine year TIPS bond is priced to a 1% real yield then for 10K of inflation adjusted money in 9 years time then you discount present day money by that 1% real yield. 1.01^9 = 1.0937 and divide the 10K amount by that = 9143.4 invested into that rung. At least from a simple approach. In practice you have interest factors as well to consider. Similarly if the 9 year TIPS real yield was -1%, then 0.99^9 = 0.9135 and dividing 10K by that = 10946.7 i.e. you need to put aside nearly 11K today in order to secure a 10K inflation adjusted maturity value in 9 years time.

TIPS ladders are perhaps better suited for relatively short periods. If you're near 60 and will receive a 20K/year inflation adjusted occupational pension in 5 years time, then you might in-fill that difference with a TIPS ladder rather than using stocks, where 5 years is a relatively short period - too volatile/risky. So at a assumed 0% TIPS real yield right across 1 to 5 year TIPS bonds loading 5 years of 20K into a 5 year TIPS ladder in effect has you sitting on a regular 20K/year inflation adjusted income from age 60 onward, first 5 years covered by TIPS, until the occupational pension kicks in.

[seajay]

To put some figures out there, over 120+ years I estimate that a PP sustained a 30 year 4% SWR in all but 1.5% of cases, and where they failed it still got to support most of 30 years. If for instance the worst case only supported 25 years in 1.5% of cases, then likely that was still better than the prospect of a 65 year old retiree living another 25 years to age 90.

In two thirds of 30 year cases the PP ended 30 years of 4% SWR with more than half of the inflation adjusted start date amount still available. Again reasonable odds.

In 40% of cases it ended with 100% or more of the inflation adjusted start date amount available at the end of 30 years of 4% SWR.

In the average case it ended with 100% of your inflation adjusted start date portfolio value still available at the end of 30 years.

Whilst generally the ride was relatively smooth, few bumps, and where portfolio drawdowns were more like pot-holes, relatively short lived events before bouncing back on track again.

Taking the average case, whilst TIPS might better insure against the 1.5% of cases that ran a few years short of 30 years for the PP, the cost of that insurance is you forewent the 100% of inflation adjusted portfolio value that on average remained at the end of 30 years. That's a pretty expensive insurance cost.