I realize why some people love TIPS

[TripleB]

When I go on sites like Bogleheads, there are people who just adore TIPS and think they are perfect for retirement and "guarantee a specified real yield."

I've never quite understood why these people are so pro-TIPS and it seemed ridiculous to me. As I read another pro-TIPS thread on the other forum this morning, it hit me.

Some people are pro-TIPS because the alternative is scary. The same types of people are religious, because the alternative (that death is final and absolute) is scary.

If TIPS weren't an accurate tracker of inflation, and weren't able to support people in retirement, then the option is, there is no guaranteed retirement. How can one retire if CPI numbers are skewed? If inflation is really 5% to 15% but CPI reports it at 2%, and investments are pegged to CPI, then a person can never really retire. And that's scary.

[MediumTex]

TIPS are probably not so bad if held to maturity and you don't ask more of them than they can deliver.

The basic problem with TIPS will always be present, however, and that is that the same agent that created the inflation is selling you the inflation protection.

I wonder how TIPS would have performed in Weimar Germany.  I suspect not very well.

It's funny, but with TIPS it's like the investor tacitly acknowledges that the government has failed to prevent the devaluation of the currency, but for whatever reason the investor doesn't seem to worry that the government will also fail in its TIPS endeavor.

TIPS are sort of like a storm shelter built out of balsa wood.  As long as the storm is very mild, you will probably never notice how flimsy the shelter is, and as long as you maintain your faith that the shelter will protect you everything will be fine.  If a real storm ever comes, though, there will likely to be a lot of disillusioned people.

[craigr]

If the US dollar ever gets serious inflation I suspect that TIPS are going to get walloped.

There is a case to be made for using them for the cash allocation (but better than a simple T-Bill? Not so sure.). However the idea of buying inflation insurance from the people causing inflation is a conflict of interest that an investor just can't ignore.

[clacy]

It is pretty funny to me how "pro-tips" the bogleheads are.  While at the same time, they bash the PP because of its gold holdings.

I personally would rather leave my inflation protection to a time tested, market based solution (gold), then leaving it up to the government, who has a vested interest in keeping inflation reporting as low as possible.

[stone]

Aren't TIPS just another asset class and probably no more or less likely to be mis-priced either way than the HBPP assets such as stocks, LTT and gold? Long term TIPS are volatile and do not correlate entirely with any of the HBPP assets. Having them as part of a plan B outside the PP doesn't look entirely stupid to me. They could be used to rebalance against other assets just as with the assets in the HBPP. Gold does have the complication that it can be dug up from the ground at $800 per ounce or whatever. That does provide a spooky drop zone once a sustained period of negative real interest rates have pushed the gold price up and up.

The problem with CPI is that the basket evolves. Imagine people at time zero all drink champagne and fly to Hawaii for holiday. Fifty years later they may eat just home grown barley and walk to their place of work digging up land fill garbage to scavenge for bits of plastic. A "typical shopping basket" will be changed somewhat and the changes would be swapping something fancy for something cheap. Even if prosperity remains constant, people tend to seek better value new alternatives and each innovation lets some inflation slip by. The thing is though that TIPS trade at a market set rate. Lack of faith in TIPS simply acts to make them trade at better value.

[moda0306]

stone,

I do suppose that long-term TIPS are quite volatile.  I was thinking more 5 year TIPS as being most common.

Maybe I'm wrong on that assumption.

The thing is with adding other asset to the PP for further diversification, you get diminishing returns pretty quickly for trying to find assets that behave differently than the 4 core PP assets, as there's already so much diversification there.  That said, it'd be an interesting exercise to figure out if we HAD to add one more PP asset, what would be the best thing to add based on volatility and correlation, as well as any macroeconomic correlations we see as being valid. 

[stone]

Moda, in the UK we have 45year index linked gilts. They gyrate around wildly in price. It might not be entirely stupid to have a planB portfolio consisting of say long term TIPS, junk bonds and forestry or whatever. I'm not saying it would be a good idea, I'm just saying I don't see them especially bad. I think they are quite different from gold rather than being an inferior version of gold.

[stone]

I just checked out the chart for the UK long term index linked gilt TR8F. It has increased in price by over 20% in the past five weeks. It didn't spike up in price when gold was spiking up over the summer. They really look to act very differently from each other. It also seems different from conventional UK LTT.

[lazyboy]

From craigr:

"There is a case to be made for using them for the cash allocation (but better than a simple T-Bill? Not so sure.). However the idea of buying inflation insurance from the people causing inflation is a conflict of interest that an investor just can't ignore."

Hi Craig,

What IS the case that can be made for using TIPS for the cash allocation? I'm not sure how that would or could work, theoretically speaking. The returns are certainly attractive on VIPSX as compared to VFISX. And it would be nice to get some decent return on a portion of the cash portfolio.

[Indices]

I wouldn't use TIPS for the cash portion personally. They wouldn't do well in deflationary environments and cash would do decently.

[TripleB]

What IS the case that can be made for using TIPS for the cash allocation? I'm not sure how that would or could work, theoretically speaking. The returns are certainly attractive on VIPSX as compared to VFISX. And it would be nice to get some decent return on a portion of the cash portfolio.

I made a post last week about how to use TIPS in the cash section. My basic idea is that you buy a 10 year TIPS at auction, hold it until maturity, and count all the dividends and the eventual principal return, as part of the cash portion of your PP.

Keep this to about 10% to 20% of your overall Cash portion (thus 2.5% to 5% of your total portfolio. The theory being that if the other 80% of your cash assets are highly liquid, then it's unlikely you will need to touch this "deep storage" TIPS. In that case, the risk of principal loss is low, because you are going to hold the TIPS to maturity and not have to sell on the secondary market, subject to the whims of interest rates.

I would NOT use a TIPS fund, because you are not guaranteed a return of principal if you hold it for any period of time, since the fund is constantly selling and buying new TIPS.

The idea would be to ignore the yield rate at any given time of the TIPS, and simply believe that over the 10 year period, the Total Return, will exceed what you can get on a risk-adjusted basis in a 1 year treasury Note.

[KevinW]

I agree of most of what's said on Bogleheads, but there are a handful of fundamental world-view questions that I think they get very wrong.  One of them seems to be that monetary policy is not a concern.  This shows up in their dismissal of commodities and especially precious metals.

It's also implicit in the language of "currency risk."  Bogle and the -heads say that diversifying out of USD-denominated assets adds currency risk.  So in their view, USD must now and forever be the safest currency.  And the safest thing is to hold only US stocks and US bonds.  I can imagine why Bogle's life experiences would make him believe that, but personally I'm not willing to stake my life savings on that remaining true indefinitely.

[moda0306]

Aren't you always incurring "currency risk," no matter what your investment, as long as it is denominated in some currency?

Therefore, investing 100% in one currency, I would think, would be extremely undesireable.

[KevinW]

Aren't you always incurring "currency risk," no matter what your investment, as long as it is denominated in some currency?

That's my belief, but apparently not Bogle's.

[moda0306]

I'm the last person to freak out about hyperinflation but it's ridiculous to hold all your assets in one currency, IMO.

The amount of risk you avoid simply by adding 10% gold to an otherwise USD portfolio is huge, and there's little price to pay.

[TripleB]

I agree of most of what's said on Bogleheads, but there are a handful of fundamental world-view questions that I think they get very wrong.  One of them seems to be that monetary policy is not a concern.  This shows up in their dismissal of commodities and especially precious metals.

It's also implicit in the language of "currency risk."  Bogle and the -heads say that diversifying out of USD-denominated assets adds currency risk.  So in their view, USD must now and forever be the safest currency.

If you read closely, that's not what they are saying. What they really say is "I spend USD so I want to save USD." In their mind, if you were a Canadian, you'd want Canadian Bonds instead of US bonds because they "spend in Canadian Dollars so they want to save in Canadian dollars."

That's wildly absurd, because if there's massive devaluation of the USD relative to other global currencies, then spending in USD, is buying items like food and gas that are valued according to the global marketplace.

[craigr]

I agree of most of what's said on Bogleheads, but there are a handful of fundamental world-view questions that I think they get very wrong.  One of them seems to be that monetary policy is not a concern.  This shows up in their dismissal of commodities and especially precious metals.

It's also implicit in the language of "currency risk."  Bogle and the -heads say that diversifying out of USD-denominated assets adds currency risk.  So in their view, USD must now and forever be the safest currency.

If you read closely, that's not what they are saying. What they really say is "I spend USD so I want to save USD." In their mind, if you were a Canadian, you'd want Canadian Bonds instead of US bonds because they "spend in Canadian Dollars so they want to save in Canadian dollars."

There is a lot of truth to this however. People that diversified into the Euro for instance are probably sweating some right now. It didn't provide any protection. The best currency protection is to own a slug of gold in your portfolio. IMO.

[MediumTex]

I agree of most of what's said on Bogleheads, but there are a handful of fundamental world-view questions that I think they get very wrong.  One of them seems to be that monetary policy is not a concern.  This shows up in their dismissal of commodities and especially precious metals.

It's also implicit in the language of "currency risk."  Bogle and the -heads say that diversifying out of USD-denominated assets adds currency risk.  So in their view, USD must now and forever be the safest currency.

If you read closely, that's not what they are saying. What they really say is "I spend USD so I want to save USD." In their mind, if you were a Canadian, you'd want Canadian Bonds instead of US bonds because they "spend in Canadian Dollars so they want to save in Canadian dollars."

There is a lot of truth to this however. People that diversified into the Euro for instance are probably sweating some right now. It didn't provide any protection. The best currency protection is to own a slug of gold in your portfolio. IMO.

I think that the thing people often miss when thinking about foreign currencies is that other countries have their own internal constituencies to cater to, and a rising currency is going to be seen as a bad thing by most exporters within a country.

Earlier this year when everyone was piling into the Swiss franc and feeling smart because they cast their lot with the Swiss, all I could think about was all those Swiss manufacturers of expensive equipment who were fuming as they were losing business solely due to currency fluctuations and solely because the EU was having trouble.  I'm sure the decision to devalue the franc was the result of a lot of political pressure within Switzerland.

No such internal exporter political pressure dynamic exists with gold, and to me that is one of the most important differences between gold and other currencies.

[Ad Orientem]

There have already been several reports that any deficit reduction package will include new standards for indexing inflation which are designed to produce large savings in government outlays.  The whole concept of TIPS is so bizarre that I can't believe anyone would spend a dime on them.  It's like buying fire insurance from a known arsonist.

[KevinW]

I guess my point is that a faith in the Fed's monetary policy working out as advertised, seems to be deeply ingrained in the Boglehead philosophy.  If someone trusts that system, it's not surprising that they also trust the TIPS system.  They have a similar flavor.

[MediumTex]

I guess my point is that a faith in the Fed's monetary policy working out as advertised, seems to be deeply ingrained in the Boglehead philosophy.  If someone trusts that system, it's not surprising that they also trust the TIPS system.  They have a similar flavor.

One of the realizations I have made as I have matured as a person is how many beliefs people have that have utterly no basis in reality (or at least "reality" as I understand it).

I have also learned that disturbing those beliefs can cause a lot of trouble for both the person you are trying to enlighten as well as yourself.  In many cases people really like their beliefs, and the person bearing the truth is often the one blamed for the confusion that follows the introduction of a disruptive truth into a popular system of beliefs.

I believe that the truth is like water, and it has a way of penetrating virtually any set of false beliefs, but it often takes time for this process to unfold (sometimes a LONG time).

Although the idea that faith in the Fed would be rewarded with inflation-adjusted investment returns seems absurd to me, people are going to believe what they need to believe to give their world a sense of coherence and meaning, and the "truth" of these beliefs is often a minor consideration.  OTOH, many people would say that "truth" is whatever makes them feel good about things at the moment, and that's why the fortune tellers and seers of society always have a ready supply of new customers.  One should never underestimate the amount of time that a skilled storyteller can maintain his position in society, even if every single thing he says is false.

[TripleB]

One of the realizations I have made as I have matured as a person is how many beliefs people have that have utterly no basis in reality (or at least "reality" as I understand it).

Put your jacket on before you go outside or you'll catch a cold! The virus (cold) shares the name with the weather (cold) so they are linked!

[moda0306]

TripleB,

Being from MN, you absolutely increase your chances of "activating" the cold virus by being out in the cold for too long.

[yankees60]

There have already been several reports that any deficit reduction package will include new standards for indexing inflation which are designed to produce large savings in government outlays.  The whole concept of TIPS is so bizarre that I can't believe anyone would spend a dime on them.  It's like buying fire insurance from a known arsonist.

Have these "new standard" ever been included in any way?

Vinny

[yankees60]

TripleB,

Being from MN, you absolutely increase your chances of "activating" the cold virus by being out in the cold for too long.

This seems to go counter to my 9th grade biology teacher telling us (55 years ago) that experiments were conducted with "people soaking wet, stark naked, in front of fans" and they did not catch colds or get sick at any greater frequency. Have subsequent experiments refuted this?

Vinny