Dieter wrote: ↑Thu Sep 29, 2022 6:08 pm
barrett wrote: ↑Thu Sep 29, 2022 5:31 pm
Kbg wrote: ↑Thu Sep 29, 2022 2:48 pm
Why do BHs love them...they eliminate inflation risk which is a HUGE benefit.
And yet I see that iShares TIPS Bond ETF is down 17.78% YTD. And yes, I get that the performance of a fund is different than buying a bond and holding it to maturity. Still, that just looks to me like another asset that is getting creamed in the current environment.
I do appreciate you trying to explain TIPS, Kbg. I always get irked when I hear people say "I'm no good with names" or something similar and I always say to myself that they are just not trying. But, damn, I am that person when it comes to TIPS.
Yeah, rising rates have been a killer
And I don’t understand how TIPS in funds have their principle adjusted for inflation — every six months as interest is paid, or when the individual TIPS mature
They do seem to be doing better than nominal funds of the same duration, but not as much better as I’d expect
Using short duration TIPS reduces interest rate risk — and currently yield over 1% above inflation in VGs short term TIPS fund
Earlier I'd stated that William Bernstein would be on my Mount Rushmore of Personal Finance.
Here are the "notes" I took from one of his books (2011?) regarding what he had to say about TIPS. I'm sure what he said then still applies as that is what you get from classic / timeless advice.
If the Social Security “annuity” does not provide enough coverage and you don’t want to purchase a conventional annuity, a Treasury Inflation Protected Securities (TIPS) ladder can serve much—but not totally—the same purpose as the commercial inflation-indexed annuity and allow the retiree to keep control of most of his or her nest egg in an investment vehicle that is almost perfectly safe.
A word or two about TIPS. They are surely one of the most peculiar assets in the investment world. They are a marvelous way of protecting one’s cash flow against inflation, but they do so only when held to maturity. Before then, they can prove quite risky, in large part because their secondary market is thin.
The message here is clear: When using TIPS to fund your retirement, do so with a ladder whose maturities at least approximately match your projected needs; do not do so with a TIPS mutual fund, which may suffer capital loss just when you need the funds the most. In addition, the costs of owning a ladder of individual TIPS purchased at auction is near zero (and actually is zero for some brokerage accounts), far cheaper than even the thriftiest mutual fund or ETF.
Each of the three vehicles/strategies mentioned—fixed annuities, deferring Social Security, and a TIPS ladder—has pros and cons.
Commercial inflation-indexed annuities can at least theoretically provide a safe lifetime flow of real income, but they are vulnerable to crisis-related and company-specific default. Purchasing annuities from several different companies mitigates the latter problem, but not the former. In addition, these annuities are not “actuarially fair.” That is, the companies that market them need to make a profit, and so they do not pay out the full actuarial amount to the beneficiaries. As we shall soon see, this actuarial unfairness comes at a high cost.
Deferring Social Security does provide a payout that is more than actuarially fair, and it is highly secure. But, unfortunately, it allows the “purchase” of only a relatively small amount of income stream, whose actual amount is dependent on a retiree’s work history.
A TIPS ladder, in contrast, is also highly secure and inflation protected, but it does not allow for risk pooling. Ideally, the retiree does not need the stream from the TIPS ladder until age 70 or so and still has enough assets to buy a full 30-year ladder sufficient to pay for retirement needs in each year. Left-over assets can be invested in the “risk portfolio” (RP). Few investors, however, will be able to completely take care of their living expenses to the outer limits of their potential survival, say, age 100 or so. Table 5 summarizes the advantages and disadvantages of these three different approaches to a secure retirement LMP.
The message here is clear: When using TIPS to fund your retirement, do so with a ladder whose maturities at least approximately match your projected needs; do not do so with a TIPS mutual fund, which may suffer capital loss just when you need the funds the most. In addition, the costs of owning a ladder of individual TIPS purchased at auction is near zero (and actually is zero for some brokerage accounts), far cheaper than even the thriftiest mutual fund or ETF.
Table 5.
Pros and Cons of Major Liability Matching Portfolio Strategies
Buy inflation-adjusted fixed annuity
Pros: Inflation-protected income stream for duration of one or joint lives
Cons: Default/failure, particularly in the event of systemic financial crisis. Adverse “adjustment” of inflation formula. Company profit motive detracts from actuarial fairness
Defer Social Security to age 70
Pros: Secure, inflation-protected income stream for duration of joint lives
Cons: Adverse “adjustment” of inflation formula. Benefit available to each retiree limited by work history
Buy TIPS ladder
Pros: Secure, inflation-protected income stream
Cons: Absence of risk pooling requires either a very long ladder or purchase of “longevity insurance.” Adverse “adjustment” of inflation formula
A TIPS ladder protects the retiree from a severe financial crisis in a way that commercial annuities cannot, and it comes fairly close to providing a lifetime income. Table 6 sets out the tradeoff between the risks of a commercial annuity and a TIPS ladder.
Which is worse, the risk of running out of money with TIPS at age 95 or the risk of a severe financial crisis or company failure that would crater the annuity income stream? Your guess is as good as mine. A reasonable person has at least three options in this situation: the TIPS ladder, the commercial annuity, or some combination of the two. Best of all would be to completely avoid this dilemma by being able to purchase at age 75 a supplementary 30-year rung that would take them to age 105 or to have the equivalent in risk-free assets to do so.
My opinion is that the first course, a simple 20-year TIPS ladder, is the best choice. It eliminates default risk, which I think is the most important consideration. The financial crisis of 2007–2009 occurred, in no small part, because of the systemic risk inherent in a financial market that is dominated by a few huge banks. Now, several years later, there are fewer still, and the resultant Dodd-Frank reform has been so watered down that it does little to diminish the likelihood or severity of the next financial crisis.
While we may well avoid another crisis, particularly one that might devastate the insurance industry, I would not want to bet my retirement on it with either an immediate annuity or a deferred annuity. The possibility of running out of money with my preferred choice, the TIPS ladder, should also concentrate Frank and his wife’s thinking on making some minor adjustments to their living standard. Were they to reduce their expenses by just $2,000 per year—from $56,000 to $54,000, they would have $418,000 left in their IRA at age 70. At TIPS yield and reinvestment rates of 0%, 1%, and 2%, an $18,000 burn rate would last them to ages 93.2, 96.4, and 101.3, respectively.
And just to reiterate, the success of all of these strategies hinges on deferring Social Security until 70. The only reason not to do so would be ill health and shortened life expectancy for both spouses.
The major remaining issue might be the potential need for high out-of-pocket medical expenses or long-term care, which is a major risk for both twins. Long-term care insurance, in particular, is expensive (up to several thousand dollars per year), is often unreliable, and carries very high deductibles. Faced with unexpectedly high losses from this line of coverage, insurance companies are bailing out of the field, and those that are left are rapidly raising their rates. We are likely not far from the day when, if you can afford long-term care insurance, you can probably afford to pay for long-term care on your own. Such is life in a country with a dysfunctional health-care system and an inadequate safety net.
This discussion, then, in no way mandates that all investors should immunize their retirement income with annuities, TIPS, or even a delay in Social Security draw until age 70. As we’ve already seen, health status, the absolute level of assets, personal preference, and the tax status of the nest egg all enter into the analysis. But this exercise does provide a rough rule of thumb. By age 70, the investor should have accumulated enough safe assets, including Treasury bills and notes and CDs, to fund, at a bare minimum, 20 years of the cash-flow needs remaining after Social Security and pension payments. An LMP of 25 years of living expenses would be even better. Further, with today’s historically low TIPS and annuity payouts, it might not be a bad idea to hold off purchasing TIPS for a while.