Gyroscopic Investing

Posted: **Sun Sep 18, 2022 9:14 am**

Excellent new post from David Enna at Tipswatch:

https://tipswatch.com/2022/09/18/this-w ... ious-look/

Enna is always wisely moderate in his claims and recommendations but reading between the lines here there really aren't any meaningful advantages to nominal Treasuries over TIPS going forward unless you believe the Fed will be able to get inflation down to ~2% quickly. IMHO (and Enna's - and Ray Dalio's) sustained 4-6% inflation is much more likely.

If nothing else the 10 year reissue and the upcoming 5 year one he discusses are certainly superior to iBonds due to having both a much higher coupon and no purchase limits. The only "but" of course is that you want to hold TIPS in a tax-deferred account if at all possible.

If you care to really go "down the rabbit hole" with TIPS vs. nominals you can delve into this epic-length thread on Bogleheads:

https://www.bogleheads.org/forum/viewtopic.php?t=382830

The gist of the thread though is in the OP's crystal-clear opening post, which pretty much every knowledgeable subsequent poster agrees with and amplifies:

We've seen a lot of discussion pertaining to the performance of TBM [Total Bond Market] and TIPS over the last year, which is understandable since TBM has experienced its biggest nominal drawdown in its history and inflation is at the highest levels seen in over 40 years. Many investors have chosen to retain their nominal bond holdings, especially TBM, while many others have chosen to (hopefully, permanently) move part or all their fixed income to TIPS.

An aspect of the nominal bond vs. TIPS issue that is often overlooked is the asymmetric risk investors are exposed to with nominal bonds like TBM. Note that this assumes both that an investor's future spending and other liabilities will be in at least roughly real (i.e., inflation-adjusted) dollars and that the CPI used to derive TIPS' yields is a reasonably good measure of inflation. In general, these seem to be fairly reasonable assumptions, and I ask that we do not derail this discussion on questioning them as this is apt to get the thread locked.

My contention that there is asymmetric risk in the decision to allocate one's fixed income in nominal bonds, such as TBM, or inflation-linked bonds, such as TIPS.

With individual TIPS held to maturity, their real return known with precision at the time of purchase. There is no risk to the future buying power of TIPS given the stated assumptions in the first paragraph.

But with nominal Treasuries, their real return unknown with precision at the time of purchase. Only their nominal starting yield is known. They are completely exposed to the risk of unexpected inflation, which has historically been the single biggest risk to fixed income holdings.

Therefore, absent deflation, it is indisputable that nominal Treasuries are riskier than TIPS when it comes to funding future consumption in real dollars. But there's another way to consider this that further demonstrates the same point.

If we assume that inflation is highly unlikely to average below 0% over a given decade, we can assume then that the best possible real returns of 10 year nominal Treasuries is their starting nominal yield of 2.65%. But there is no limit to how low the real returns of 10 year nominal Treasuries can be. In other words, 10 year Treasuries have very long left-tail risk. With TIPS held to maturity, their real return is, again, known with precision at the time of purchase.

Some claim that nominal bonds like 10 year Treasuries, funds like TBM, etc. have a higher expected real return than do TIPS. This is debatable since TIPS have a slight return premium over Treasuries due to their slightly lower liquidity. But in any event, any such higher expected return of nominal Treasuries over TIPS appears to be widely agreed upon to be very small and possibly zero.

Therefore, due to the uncertainty surrounding future inflation, there is uncertainty regarding the future real returns of nominal Treasuries (and nominal bonds, such as TBM), whereas there is no uncertainty regarding the real returns of TIPS as these are known at the time of purchase. Given that the expected benefit of nominal Treasuries compared to TIPS is no more than tiny, I contend that the risks faced by nominal Treasuries (and other nominal bonds) compared to those of TIPS are asymmetric and tilted significantly in favor of TIPS. Nominal Treasuries and other bonds are exposed to significant risks that are absent from TIPS, and those risks are not accompanied by a corresponding expectation of higher returns.

While it's true that nominal Treasuries are preferred in the presence of deflation, TIPS have some, though not as much, protection in that regard also since, upon maturity, the bearer will be paid the greater of their adjusted principal or their original principal. However, given that inflation has been a far bigger historic risk to investors than has deflation, I do not believe the better performance of nominal Treasuries to justify the uncertainty regarding their future inflation-adjusted value."

Posted: **Sun Sep 18, 2022 4:06 pm**

Kevin K. wrote: ↑Sun Sep 18, 2022 9:14 am Excellent new post from David Enna at Tipswatch:

https://tipswatch.com/2022/09/18/this-w ... ious-look/

Enna is always wisely moderate in his claims and recommendations but reading between the lines here there really aren't any meaningful advantages to nominal Treasuries over TIPS going forward unless you believe the Fed will be able to get inflation down to ~2% quickly. IMHO (and Enna's - and Ray Dalio's) sustained 4-6% inflation is much more likely.

If nothing else the 10 year reissue and the upcoming 5 year one he discusses are certainly superior to iBonds due to having both a much higher coupon and no purchase limits. The only "but" of course is that you want to hold TIPS in a tax-deferred account if at all possible.

If you care to really go "down the rabbit hole" with TIPS vs. nominals you can delve into this epic-length thread on Bogleheads:

https://www.bogleheads.org/forum/viewtopic.php?t=382830

The gist of the thread though is in the OP's crystal-clear opening post, which pretty much every knowledgeable subsequent poster agrees with and amplifies:

We've seen a lot of discussion pertaining to the performance of TBM [Total Bond Market] and TIPS over the last year, which is understandable since TBM has experienced its biggest nominal drawdown in its history and inflation is at the highest levels seen in over 40 years. Many investors have chosen to retain their nominal bond holdings, especially TBM, while many others have chosen to (hopefully, permanently) move part or all their fixed income to TIPS.

An aspect of the nominal bond vs. TIPS issue that is often overlooked is the asymmetric risk investors are exposed to with nominal bonds like TBM. Note that this assumes both that an investor's future spending and other liabilities will be in at least roughly real (i.e., inflation-adjusted) dollars and that the CPI used to derive TIPS' yields is a reasonably good measure of inflation. In general, these seem to be fairly reasonable assumptions, and I ask that we do not derail this discussion on questioning them as this is apt to get the thread locked.

My contention that there is asymmetric risk in the decision to allocate one's fixed income in nominal bonds, such as TBM, or inflation-linked bonds, such as TIPS.

With individual TIPS held to maturity, their real return known with precision at the time of purchase. There is no risk to the future buying power of TIPS given the stated assumptions in the first paragraph.

But with nominal Treasuries, their real return unknown with precision at the time of purchase. Only their nominal starting yield is known. They are completely exposed to the risk of unexpected inflation, which has historically been the single biggest risk to fixed income holdings.

Therefore, absent deflation, it is indisputable that nominal Treasuries are riskier than TIPS when it comes to funding future consumption in real dollars. But there's another way to consider this that further demonstrates the same point.

If we assume that inflation is highly unlikely to average below 0% over a given decade, we can assume then that the best possible real returns of 10 year nominal Treasuries is their starting nominal yield of 2.65%. But there is no limit to how low the real returns of 10 year nominal Treasuries can be. In other words, 10 year Treasuries have very long left-tail risk. With TIPS held to maturity, their real return is, again, known with precision at the time of purchase.

Some claim that nominal bonds like 10 year Treasuries, funds like TBM, etc. have a higher expected real return than do TIPS. This is debatable since TIPS have a slight return premium over Treasuries due to their slightly lower liquidity. But in any event, any such higher expected return of nominal Treasuries over TIPS appears to be widely agreed upon to be very small and possibly zero.

Therefore, due to the uncertainty surrounding future inflation, there is uncertainty regarding the future real returns of nominal Treasuries (and nominal bonds, such as TBM), whereas there is no uncertainty regarding the real returns of TIPS as these are known at the time of purchase. Given that the expected benefit of nominal Treasuries compared to TIPS is no more than tiny, I contend that the risks faced by nominal Treasuries (and other nominal bonds) compared to those of TIPS are asymmetric and tilted significantly in favor of TIPS. Nominal Treasuries and other bonds are exposed to significant risks that are absent from TIPS, and those risks are not accompanied by a corresponding expectation of higher returns.

While it's true that nominal Treasuries are preferred in the presence of deflation, TIPS have some, though not as much, protection in that regard also since, upon maturity, the bearer will be paid the greater of their adjusted principal or their original principal. However, given that inflation has been a far bigger historic risk to investors than has deflation, I do not believe the better performance of nominal Treasuries to justify the uncertainty regarding their future inflation-adjusted value."

Definitely interesting points, and something for all of us to consider. But I just continue to have a hard time digesting the fact that the market isn't accurately pricing in all known possibilities and delivering up prices that provide us with a '50/50' situation as far as which will perform better, nominal or TIPS. No doubt TIPS will provide a guaranteed real return, if held to maturity, and reduce tail risk (on both the good and bad side).

I also struggle to understand how TIPS prices will change in response to different environments, and how that fits in with the concept of the PP. In a disinflationary environment, and a possible market crash in response to that, will TIPS help the portfolio, or will they crash along with stocks? Who knows. I'm sure someone understands the price movements of TIPS much better than me, but in my experience, they certainly aren't as easy to comprehend as a nominal bond.

Below is a link to a portfoliovisualizer analysis, with portfolio 1 being a PP with 50% intermediate TIPS instead of bond barbell, and portfolio 2 being the traditional PP. End result, balance wise, is almost identical, which would seem to indicate the market 'fairly priced' bonds, perhaps? But the risk adjusted returns are quite a bit higher for the traditional PP, and the correlation to stocks is significantly higher for the TIPS analysis.

https://www.portfoliovisualizer.com/bac ... tion5_2=25

Posted: **Sun Sep 18, 2022 4:23 pm**

That's the big problem with TIPS...I feel it is too correlated with stocks to hold as an open-ended investment.

For giggles, I'm putting 10k/year TIPS for our kid's college expenses. Along with ibonds I consider them part our cash / STT holdings.

Posted: **Sun Sep 18, 2022 6:36 pm**

dockinGA wrote: ↑Sun Sep 18, 2022 4:06 pm
Definitely interesting points, and something for all of us to consider. But I just continue to have a hard time digesting the fact that the market isn't accurately pricing in all known possibilities and delivering up prices that provide us with a '50/50' situation as far as which will perform better, nominal or TIPS. No doubt TIPS will provide a guaranteed real return, if held to maturity, and reduce tail risk (on both the good and bad side).

I also struggle to understand how TIPS prices will change in response to different environments, and how that fits in with the concept of the PP. In a disinflationary environment, and a possible market crash in response to that, will TIPS help the portfolio, or will they crash along with stocks? Who knows. I'm sure someone understands the price movements of TIPS much better than me, but in my experience, they certainly aren't as easy to comprehend as a nominal bond.

Below is a link to a portfoliovisualizer analysis, with portfolio 1 being a PP with 50% intermediate TIPS instead of bond barbell, and portfolio 2 being the traditional PP. End result, balance wise, is almost identical, which would seem to indicate the market 'fairly priced' bonds, perhaps? But the risk adjusted returns are quite a bit higher for the traditional PP, and the correlation to stocks is significantly higher for the TIPS analysis.

https://www.portfoliovisualizer.com/bac ... tion5_2=25

Thanks dockinGA for your thoughtful comments. One thing it's important to remember is that TIPS were only introduced in the U.S. in 1997, while the first gold ETF, GLD, started in 1994. So doing backtests on Portfolio Visualizer is dubious at best given how little history there is.

One of the points addressed by far more knowledgeable bond experts than I'll ever bein that long Bogleheads thread is that often when people say we don't know what TIPS will do under X market circumstances they think that we DO know what nominal Treasuries will do - and that's just not the case. Recency bias is huge here: LTT's did great in 2008 while TIPS didn't (thanks largely to a glitch caused by Lehman Brothers, BTW) but LTT's have tanked in unison with equities on other occasions. We in the PP universe tend to take the idea that LTT's will zag when stocks zig as gospel but that's no truer than Browne's utterly incorrect claim that gold is an inflation hedge.

The question about deflation is also addressed by the OP in the Bogleheads thread and in more detail later on in the conversation there, but perhaps more importantly it was addressed by William Bernstein in his book "Deep Risk." Here's an excerpt from Jason Zweig's review of it that addresses the relevant points here:

"Deflation, the persistent drop in the value of assets, is extremely rare in modern history, Mr. Bernstein says. It has hit Japan but almost nowhere else in the past century, thanks to central banks that print money to drive up prices.

The best insurance against deflation is long-term government bonds. Diversifying your portfolio into international stocks also helps, since deflation often doesn’t hit all nations at once.

While bonds protect you from deflation, they expose you to inflation — far and away the likeliest source of deep risk. Mr. Bernstein notes that inflation can destroy at least 80% of the purchasing power of a bond portfolio over periods as long as 40 years.

That is deep risk at its deepest — a hole so profound most investors can’t get out of it in a lifetime. That happened in, among other places, France, Italy and Japan from 1940 through 1979, Mr. Bernstein says.
The best insurance against inflation, he says, is a globally diversified stock portfolio with an extra pinch of gold-mining and natural-resource companies. Treasury inflation-protected securities, U.S. bonds whose value rises with the cost of living, also can help."

So here we get to one of Bernstein's key criticisms of the PP (and bear in mind he admires Browne and in fact the whole "Deep Risk" book came out of his reading of Browne and long discussions with the co-founder of this forum, Craig Rowland). It makes no sense to allocate equal percentages of a portfolio that are nowhere near being equally likely to occur - especially when the cost of insurance also varies widely. Case in point: sustained deflation is both highly unlikely and expensive to insure against; inflation is very likely and relatively cheap to insure against. Prosperity is by far the most-likely long-term scenario - which is why the Golden Butterfly tilts to it by increasing the stock allocation while diversifying it away from the handful of tech stocks that determine the results of today's TSM funds.

People monkey with the PP all the time of course and at what point said monkeying makes one a heretic surely is open to debate. One doesn't have to go all-in on TIPS obviously - what about using iBonds for part or all of the "deep cash" allocation, or using a mixture of regular nominal intermediate Treasuries via an ETF like VGIT along with short-term TIPS in VTIP or a slug of the 5 or 10 year TIPS coming up at auction that Enna discusses?

Posted: **Sun Sep 18, 2022 7:16 pm**

Kevin K. wrote: ↑Sun Sep 18, 2022 6:36 pm

Thanks dockinGA for your thoughtful comments. One thing it's important to remember is that TIPS were only introduced in the U.S. in 1997, while the first gold ETF, GLD, started in 1994. So doing backtests on Portfolio Visualizer is dubious at best given how little history there is.

One of the points addressed by far more knowledgeable bond experts than I'll ever bein that long Bogleheads thread is that often when people say we don't know what TIPS will do under X market circumstances they think that we DO know what nominal Treasuries will do - and that's just not the case. Recency bias is huge here: LTT's did great in 2008 while TIPS didn't (thanks largely to a glitch caused by Lehman Brothers, BTW) but LTT's have tanked in unison with equities on other occasions. We in the PP universe tend to take the idea that LTT's will zag when stocks zig as gospel but that's no truer than Browne's utterly incorrect claim that gold is an inflation hedge.

The question about deflation is also addressed by the OP in the Bogleheads thread and in more detail later on in the conversation there, but perhaps more importantly it was addressed by William Bernstein in his book "Deep Risk." Here's an excerpt from Jason Zweig's review of it that addresses the relevant points here:

"Deflation, the persistent drop in the value of assets, is extremely rare in modern history, Mr. Bernstein says. It has hit Japan but almost nowhere else in the past century, thanks to central banks that print money to drive up prices.

The best insurance against deflation is long-term government bonds. Diversifying your portfolio into international stocks also helps, since deflation often doesn’t hit all nations at once.

While bonds protect you from deflation, they expose you to inflation — far and away the likeliest source of deep risk. Mr. Bernstein notes that inflation can destroy at least 80% of the purchasing power of a bond portfolio over periods as long as 40 years.

That is deep risk at its deepest — a hole so profound most investors can’t get out of it in a lifetime. That happened in, among other places, France, Italy and Japan from 1940 through 1979, Mr. Bernstein says.
The best insurance against inflation, he says, is a globally diversified stock portfolio with an extra pinch of gold-mining and natural-resource companies. Treasury inflation-protected securities, U.S. bonds whose value rises with the cost of living, also can help."

So here we get to one of Bernstein's key criticisms of the PP (and bear in mind he admires Browne and in fact the whole "Deep Risk" book came out of his reading of Browne and long discussions with the co-founder of this forum, Craig Rowland). It makes no sense to allocate equal percentages of a portfolio that are nowhere near being equally likely to occur - especially when the cost of insurance also varies widely. Case in point: sustained deflation is both highly unlikely and expensive to insure against; inflation is very likely and relatively cheap to insure against. Prosperity is by far the most-likely long-term scenario - which is why the Golden Butterfly tilts to it by increasing the stock allocation while diversifying it away from the handful of tech stocks that determine the results of today's TSM funds.

People monkey with the PP all the time of course and at what point said monkeying makes one a heretic surely is open to debate. One doesn't have to go all-in on TIPS obviously - what about using iBonds for part or all of the "deep cash" allocation, or using a mixture of regular nominal intermediate Treasuries via an ETF like VGIT along with short-term TIPS in VTIP or a slug of the 5 or 10 year TIPS coming up at auction that Enna discusses?

Completely agree on the backtests. I just ran the numbers for what was available on portfoliovisualizer, and thought there were interesting results in how close the overall final values were, but also that the TIPS didn't provide the same diversification benefit as nominals did, at least for the data set available. Will that hold true in the future, I have no idea.

For the record, I am not exactly a PP purist. I have some accounts with a PP, others with a GB, none of which are 'pure' and include all manner of I-bonds, savings accounts, longer term bonds for cash, money market funds, individual long bonds, LTT ETF's, little bits of some energy ETF's, a smidgen of international stocks, paper gold, etc., so I'll be the last one to complain of someone being a 'heretic' for recommending tinkering around the margins of the original PP. In no way am I suggesting that adding some TIPS would be an issue, or even that 100% TIPS would be a big problem.
But, what I've yet to find is a better portfolio 'framework' that provides a reasonably agnostic "philosophy" that prepares the portfolio for all future outcomes, and has a relatively long track record of providing good risk-adjusted returns, than the PP/GB. It's never going to be the best performing portfolio, but it's never going to be the worst either, and it has a reasonably long track record of providing extremely consistent rolling returns. So, until I find something better, I personally have been hesitant to make any big, wholesale changes to the basic portfolio structure that might 'break it'.

Posted: **Sun Sep 18, 2022 7:19 pm**

I think the better PV tool for thinking about TIPS on is the asset correlation tool (this link is goes back to 2000 so it covers two recessions).
https://www.portfoliovisualizer.com/ass ... &months=60

In a risk parity style portfolio, the cash and bonds can be expected to zag a little when things go wrong with stocks, but TIPS tend to follow stocks. Not nearly as much as corporate bonds, but it still performs to corporate bonds than LTT's or cash.
https://www.portfoliovisualizer.com/ass ... &months=60

That's why TIPS make sense if you are shooting for a specific maturity date (or ladder) for cash on hand at the appropriate time(s). If I retire early, I could see creating a TIPS ladder to cover health care and living expenses until SSN and Medicare kicks in.

But it's not an appropriate diversifier from stocks if as a general long term holding investment tool. It's not a rebalancing tool like LTT's.

Posted: **Sun Sep 18, 2022 7:39 pm**

dockinGA wrote: ↑Sun Sep 18, 2022 7:16 pm [
Completely agree on the backtests. I just ran the numbers for what was available on portfoliovisualizer, and thought there were interesting results in how close the overall final values were, but also that the TIPS didn't provide the same diversification benefit as nominals did, at least for the data set available. Will that hold true in the future, I have no idea.

For the record, I am not exactly a PP purist. I have some accounts with a PP, others with a GB, none of which are 'pure' and include all manner of I-bonds, savings accounts, longer term bonds for cash, money market funds, individual long bonds, LTT ETF's, little bits of some energy ETF's, a smidgen of international stocks, paper gold, etc., so I'll be the last one to complain of someone being a 'heretic' for recommending tinkering around the margins of the original PP. In no way am I suggesting that adding some TIPS would be an issue, or even that 100% TIPS would be a big problem.
But, what I've yet to find is a better portfolio 'framework' that provides a reasonably agnostic "philosophy" that prepares the portfolio for all future outcomes, and has a relatively long track record of providing good risk-adjusted returns, than the PP/GB. It's never going to be the best performing portfolio, but it's never going to be the worst either, and it has a reasonably long track record of providing extremely consistent rolling returns. So, until I find something better, I personally have been hesitant to make any big, wholesale changes to the basic portfolio structure that might 'break it'.

Agreed on all points. Other than using TIPS for most of the bond position and some iBonds for cash I just stick with the GB.

Posted: **Sun Sep 18, 2022 7:55 pm**

joypog wrote: ↑Sun Sep 18, 2022 7:19 pm I think the better PV tool for thinking about TIPS on is the asset correlation tool (this link is goes back to 2000 so it covers two recessions).
https://www.portfoliovisualizer.com/ass ... &months=60

In a risk parity style portfolio, the cash and bonds can be expected to zag a little when things go wrong with stocks, but TIPS tend to follow stocks. Not nearly as much as corporate bonds, but it still performs to corporate bonds than LTT's or cash.
https://www.portfoliovisualizer.com/ass ... &months=60

That's why TIPS make sense if you are shooting for a specific maturity date (or ladder) for cash on hand at the appropriate time(s). If I retire early, I could see creating a TIPS ladder to cover health care and living expenses until SSN and Medicare kicks in.

But it's not an appropriate diversifier from stocks if as a general long term holding investment tool. It's not a rebalancing tool like LTT's.

I disagree with the statement that TIPS aren't an appropriate diversifier from stocks or rebalancing tool but LTT's are. This reflects recency bias, as shown in this chart from Nisiprius on Bogleheads:

https://www.bogleheads.org/forum/viewto ... 6#p6350456

As I mentioned earlier, the idea that LTT's will invariably save the portfolio during stock market crashes came about right about the time that the PP attracted widespread attention: during and immediately after the 2008 market crash. And while we know from the 90+ years of data in the Nisiprius table that LTT's don't invariably help during stock market crashes, the assertion that "TIPS tend to follow stocks" is based on a mere two decades. It's akin to making blanket statements about the behavior of paper gold when the oldest such ETF has been around for less than 20 years. Just my 2 cents worth - who knows what the future holds?

Posted: **Sun Sep 18, 2022 10:16 pm**

Interesting graph. That graph is a darn good argument to not rely on any bonds at all for negative correlation against the stock market.

However, since TIPS have been more prone to follow stocks for the entire life of this investment product....its a bigger stretch to say it's a good alternative to LTT's if your goal is to diversify away from stocks. After all, while LTT's helped saved portfolios in 2008, TIPS pointedly did not.

For sure, the (uncertain) proof we have is that LTT's is more likely to be negatively correlated to Stocks than TIPS. I'd rather bet on the next 20 years being closer to last 20 years being, than betting on a flip in market dynamics altogether.

But as you say, who knows?! Like DockingGA, I'm not a PP purist so I could totally see a long term 50/50 TIPS/Treasury split if one felt the need for inflation insurance (though given the general skepticism of "TEH GOVERNMENT" on this board I sense an ideological contradiction here). Given that I mentally treat TIPS as "cash in the future such", such a 50/50 split would basically just follow the HBPP bond mix, just updated to the 21st century.

On my end, I plan on betting on a 40-50% stocks allocation + Time Specific TIPS purchases + SSN inflation increase + the capped inflation increases in my pension to cover inflation in retirement.

Posted: **Mon Sep 19, 2022 9:44 am**

I appreciate your insightful comments joypog!

I do want to point out though that the main reason TIPS didn't perform as well as LTT's during the 2008 market crash was Lehman Brothers. This post from Adam and Movement Capital tells the sordid story:

https://seekingalpha.com/article/427835 ... ps-in-2008

In defense of your concerns however, Lehman Brothers aside, the much smaller size of the TIPS market vs. conventional Treasuries certainly does mean there's far less liquidity for them during market crises. Bottom line is we won't know how they perform long-term until there's long-term data to parse. But IMHO their advantages over nominal Treasuries now and for the foreseeable future should make them the default choice for many investors, given the asymmetrical risks detailed in the post from Bogleheads I shared earlier on in this thread..

One last thing on TIPS that I only learned many pages later in that thread is that the only reason TIPS aren't widely used in the popular target-date retirement funds that are the mainstay of typical corporate 401(K) programs is that the TIPS market simply isn't large enough for that to be feasible given the amount of money the giant brokerages need to invest. Vanguard uses short-term TIPS (VTIP) as a small slice of a couple of its most conservative retirement income funds but that's it. Interestingly the one exception to this rule is DFA, which to the best of my knowledge is the only mutual fund company that takes a liability-matching approach to retirement. Their income fund is mostly comprised of TIPS, for the very sane reason that they know that for most retirees the chief concern is having enough income to meet essential needs, not the potential size of the portfolio left to heirs. Here's the link for anyone interested in exploring this further:

https://us.dimensional.com/funds/dimens ... ncome-fund

Posted: **Mon Sep 19, 2022 10:19 am**

Great thread on BH for sure.

Some things are simple (not counting taxation)…a tips with a real rate of return is a always and categorically superior to an ibond.

Throwing in taxes, then it becomes a matter of where to put them.

Posted: **Tue Sep 27, 2022 2:33 pm**

Kevin K. wrote: ↑Sun Sep 18, 2022 9:14 am My contention that there is asymmetric risk in the decision to allocate one's fixed income in nominal bonds, such as TBM, or inflation-linked bonds, such as TIPS.

With individual TIPS held to maturity, their real return known with precision at the time of purchase. There is no risk to the future buying power of TIPS given the stated assumptions in the first paragraph.

But with nominal Treasuries, their real return unknown with precision at the time of purchase. Only their nominal starting yield is known. They are completely exposed to the risk of unexpected inflation, which has historically been the single biggest risk to fixed income holdings.

Therefore, absent deflation, it is indisputable that nominal Treasuries are riskier than TIPS when it comes to funding future consumption in real dollars.

Thanks for the interesting post and also for the pointer to the Bogleheads discussion. Great stuff.

The one thing I think is important to point out is that the above premise is based on the bolded assumption that bonds are always held to maturity and never sold on the secondary market. Because once you account for capital appreciation/depreciation in the open market, the idea that TIPS are clearly safer than nominal treasuries or even that they reliably keep up with inflation in the way people expect is very much disputable.

This inspired me to write a long post about it:

All About Tips: Real Returns and Inflated Expectations

Again, nothing I write disproves the Bogleheads post because he very clearly is talking about TIPS held to maturity. But I do think that the full story is a lot more complicated than that idealized assumption implies.

Posted: **Tue Sep 27, 2022 2:53 pm**

Tyler wrote: ↑Tue Sep 27, 2022 2:33 pm …
…
This inspired me to write a long post about it:

All About Tips: Real Returns and Inflated Expectations
…

Tyler, where’s the best place to alert you to typos? I found one at Looking Deeper -

Going back to the TIPS mechanics we discussed, if you hold a bond to maturity then you get the full original principal pack

Posted: **Tue Sep 27, 2022 3:01 pm**

Tyler wrote: ↑Tue Sep 27, 2022 2:33 pm
Kevin K. wrote: ↑Sun Sep 18, 2022 9:14 am My contention that there is asymmetric risk in the decision to allocate one's fixed income in nominal bonds, such as TBM, or inflation-linked bonds, such as TIPS.

With individual TIPS held to maturity, their real return known with precision at the time of purchase. There is no risk to the future buying power of TIPS given the stated assumptions in the first paragraph.

But with nominal Treasuries, their real return unknown with precision at the time of purchase. Only their nominal starting yield is known. They are completely exposed to the risk of unexpected inflation, which has historically been the single biggest risk to fixed income holdings.

Therefore, absent deflation, it is indisputable that nominal Treasuries are riskier than TIPS when it comes to funding future consumption in real dollars.
Thanks for the interesting post and also for the pointer to the Bogleheads discussion. Great stuff.

The one thing I think is important to point out is that the above premise is based on the bolded assumption that bonds are always held to maturity and never sold on the secondary market. Because once you account for capital appreciation/depreciation in the open market, the idea that TIPS are clearly safer than nominal treasuries or even that they reliably keep up with inflation in the way people expect is very much disputable.

This inspired me to write a long post about it:

All About Tips: Real Returns and Inflated Expectations

Again, nothing I write disproves the Bogleheads post because he very clearly is talking about TIPS held to maturity. But I do think that the full story is a lot more complicated than that idealized assumption implies.

Thanks very much for your comments Tyler - and for your brilliant and timely new post on this topic on Portfolio Charts. willthrill81 on Bogleheads, the OP for that long thread on TIPS, is a big fan of yours and of Portfolio Charts - as I suppose is needless to say. Great minds and all that.

What you point out is indeed very crucial: TIPS only really come into their own when one buys a specific duration bond to meet a known future need. My go-to source for all things TIPS-related, David Enna at Tipswatch.com, only buys individual TIPS and has never sold one prior to maturity.

But what I didn't fully appreciate until reading your new post is just how thoroughly TIPS in a typical TIPS fund can fail an investor just when inflation protection is most needed. As you show in an earlier article on your site, cash can often be more useful in such situations - as we're currently seeing with short-term TBills. "No free lunch" indeed. Thanks so much for your work.

Posted: **Tue Sep 27, 2022 3:06 pm**

dualstow wrote: ↑Tue Sep 27, 2022 2:53 pm Tyler, where’s the best place to alert you to typos? I found one at Looking Deeper -
Going back to the TIPS mechanics we discussed, if you hold a bond to maturity then you get the full original principal pack

Crowdsourced editing FTW. Thanks!

Kevin K. wrote: ↑Tue Sep 27, 2022 3:01 pm But what I didn't fully appreciate until reading your new post is just how thoroughly TIPS in a typical TIPS fund can fail an investor just when inflation protection is most needed. As you show in an earlier article on your site, cash can often be more useful in such situations - as we're currently seeing with short-term TBills. "No free lunch" indeed. Thanks so much for your work.

I think the thing that surprised me the most was when I looked up the YTD performance of TIP. Yikes! If TIPS don't really help now, then when?

And I always enjoy both your and Willthrill's posts here, on Bogleheads, or wherever. I mean liking Portfolio Charts is great.

But I appreciate smart discussions even more.

Posted: **Tue Oct 04, 2022 11:44 am**

Tyler wrote: ↑Tue Sep 27, 2022 2:33 pm

The one thing I think is important to point out is that the above premise is based on the bolded assumption that bonds are always held to maturity and never sold on the secondary market. Because once you account for capital appreciation/depreciation in the open market, the idea that TIPS are clearly safer than nominal treasuries or even that they reliably keep up with inflation in the way people expect is very much disputable.

This inspired me to write a long post about it:

All About Tips: Real Returns and Inflated Expectations

Again, nothing I write disproves the Bogleheads post because he very clearly is talking about TIPS held to maturity. But I do think that the full story is a lot more complicated than that idealized assumption implies.

Just read it.

As usual, superb, Tyler!

I don't know how it is possible but you continue to outdo yourself each time!

You ARE the Luka Dončić of the investing world! We are so fortunate to have you among us.

(And, is it any coincidence that the Dallas Maverick have not one but two Tyler's on THEIR roster??!!)

Posted: **Thu Oct 06, 2022 4:18 am**

In the book. Investing equanimity, which is all about the permanent portfolio , the author eric deslauriers had the following to say about tips

Numbers in a spreadsheet do not tell you about political risk that often comes with high inflation. You have to use some intuition and historical extrapolation to guess what results from high inflation and why you don't want to use TIPS.

1) High inflation is a political problem in almost every case. The people causing the inflation know they are doing it.
2) Because high inflation is unpopular with the masses, the people in charge are always going to lie about it as long as possible to deflect blame.
3) Then when lying doesn't work, they will implement policies like price controls to make it look like they are doing something. This always makes it worse.
4) Along the way, they will manipulate economic numbers to try to trick the markets. However the markets are much smarter than the typical politician, who is usually an idiot based on my experience.

But these things are not going to show up in Excel. There is no ("IDIOT POLITICIAN ) function you can call. There is no way for you to anticipate what actions they will take to lie about the situation. And, there is no way for you to know how the markets are going to react to the mess.

I will only suggest that the markets will figure out the right thing to do and that right thing usually is not relying on government numbers about inflation.

so tips are like buying fire insurance from an arsonist

Or you can simply go back and read Nixon's, Ford's and Carter's speeches about inflation in the 1970s. It was lie after lie after lie. A decade of lies.

“.

Posted: **Thu Oct 06, 2022 8:21 am**

mathjak107 wrote: ↑Thu Oct 06, 2022 4:18 am
In the book. Investing equanimity, which is all about the permanent portfolio , the author eric deslauriers had the following to say about tips

Eric is among us and has recently been active in this forum.

I bought the above mentioned book the day it came out and read it at one sitting. I characterized it as a "spiritual" Permanent Portfolio book.

Posted: **Thu Oct 06, 2022 9:26 am**

If we're going to blame politicians for inflation we should also blame them for every other economic condition, since their decisions precipitate them. Singling inflation out doesn't make sense, and neither does the "buying inflation from the arsonist" dig against TIPS, which of course applies just as much to nominal Treasuries. Case in point of both of the above situations being at work is politicians (always from one party, BTW) using the debt ceiling as a cudgel and flirting with (and causing, once so far - with more to come this year?) with causing the credit rating of Treasuries as a whole to be downgraded.

Anyway, there's a good new thread on Bogleheads about TIPS in retirement portfolios at the moment:

https://www.bogleheads.org/forum/viewto ... f193d8dbb0

The most knowledgeable poster about bonds altogether over there seems to be vineviz, and I thought this comment of his in response to the OP was really worthwhile:

Some investors might not need any TIPS and others might be best served by having 100% of their fixed income in TIPS.

"The three key variables are these:

1) What percent of your core retirement expense will be covered by Social Security and/or and inflation-indexed pension? The higher that percentage, the less necessary it will be to hold any TIPS.

2) What will your portfolio withdrawal rate be in retirement? The lower that rate, the less necessary it will be to hold any TIPS.

3) What percent of the portfolio is allocated to stocks? The higher that allocation, the less necessary it will be to hold any TIPS.

Someone with a high ratio of Social Security to expenses and with a low withdrawal rate (say, less than 3%) will likely have very little need for TIPS, especially with a high equity allocation.

Someone whose Social Security benefit is small relative to expenses and who has a high withdrawal rate (say, more than 4%) will probably benefit from having most or all their fixed income in TIPS, especially with a low equity allocation.

There's no magic answer for people in the middle."

Obviously the answers to questions 1 and 2 above will vary greatly among individual PP'ers but #3 is pretty straightforward: 25% in equities is very low and as the market is reminding us again this year gold doesn't help with inflation.

Posted: **Thu Oct 06, 2022 9:39 am**

mathjak107 wrote: ↑Thu Oct 06, 2022 4:18 am so tips are like buying fire insurance from an arsonist

As are standard treasuries...but somehow that fact escapes some.

The real difference is the terms and conditions of the TIPS variety bond vs a nominal treasury which is set by the USG and the bonds' prices which are set by the market.

The breakeven inflation rate is the precise interest rate value at which buying a TIPS on that day is going to be a good bet or a bad one based on how well you can prognosticate the future of inflation.

The factors that cause the markets to reprice nominals are the same that are used to reprice TIPS...that's why they generally go up and down together. If the market perceives one to be a better value than the other based on available information the market will reprice them to be equivalents as modified by their terms and conditions and the market's best guess about the future...this is known by another name as the law of arbitrage.

If one wants to be against holding government debt, go for it. There are good and bad arguments for holding that view. But to say TIPS vs. nominal treasuries are better or worse than one another demonstrates nothing but a lack of understanding.

The only thing that matters if you are going to go down the government debt route is which terms and conditions best suit your financial needs and risk profile.

If one thinks through the actual logic of the argument being made it falls on its face.

So ponder the premise being made...the government cooks the books on inflation, therefore the government is ripping you off if you buy TIPS because the adjustments are manipulated via the inflation measure/CPI. Ok maybe the government DOES do that...but then what does every other USD denominated bond on the planet use for inflation expectations pricing/repricing? No doubt there are bond hedge funds out there that have their own private measurements, but then how do they apply their measure to both nominals and TIPS and would they apply a different private CPI to the two different bonds?

Here is what we know about TIPS that is quantitative and are facts of the terms and conditions of the bond.

Fact 1: Either bond is going to give you a minimum of $1000 when it matures
- For nominals this is both a ceiling and a floor
- For TIPS this is only a floor
- When converted/discounted to in a present value calculation...the floor is the same and can be summed into a single number

Fact 2: Either bond is going to provide an unchanging coupon rate
- These coupon rates can be changed into present value cash flows and summed up into a single number

Fact 3: Both bonds' value will fluctuate based on market conditions (supply/demand)
- TIPS will also be adjusted according to the CPI calculation

To summarize facts 1-3, this is a straight math exercise. The only variable, which no one really knows, is what future CPI adjustments are going to be. The market takes a shot at estimating that delta via the breakeven inflation rate which really makes this whole thing entirely rational for you to make a decision upon. Here's how that works; do you personally believe future inflation will be higher than the BER? If yes, buy TIPS. If you are right you have "won" the game. If you believe future inflation will be less than the BER buy nominals. If you are right, you will also "win" the game. (This is the same point Tyler was making on BH.)

Last critique...one has to assume global bond traders and financial institutions are uniformly stupid on bond basics when they decide what price they are going to buy/sell a bond for. They maybe stupid on some things, but they are not stupid on bond basics.

Posted: **Thu Oct 06, 2022 12:01 pm**

yankees60 wrote: ↑Thu Oct 06, 2022 8:21 am
mathjak107 wrote: ↑Thu Oct 06, 2022 4:18 am In the book. Investing equanimity, which is all about the permanent portfolio , the author eric deslauriers had the following to say about tips

Eric is among us and has recently been active in this forum.

I bought the above mentioned book the day it came out and read it at one sitting. I characterized it as a "spiritual" Permanent Portfolio book.

You are right ..it is more a spiritual book about the pp than a financial one

Posted: **Thu Oct 06, 2022 4:07 pm**

There's no substance to the inflation-linked bond market here in Canada. In some sense I'm grateful for that because it makes the bond choice easier for us here. No hand wringing over nominals vs TIPS.

Posted: **Fri Oct 28, 2022 1:10 pm**

Kevin K. wrote: ↑Sun Sep 18, 2022 6:36 pm
The best insurance against inflation, he says, is a globally diversified stock portfolio with an extra pinch of gold-mining and natural-resource companies.

It certainly has not helped this year! You would have been much better off in cash/cds this year.

Posted: **Sun Nov 20, 2022 10:56 am**

Kbg wrote: ↑Thu Oct 06, 2022 9:39 am Last critique...one has to assume global bond traders and financial institutions are uniformly stupid on bond basics when they decide what price they are going to buy/sell a bond for. They maybe stupid on some things, but they are not stupid on bond basics.

But there are buyers that “act” dumb, like the FED, insurance companies, and other big institutional pensions and endowments that will buy up large amounts of government bonds at any price. In the case of insurance companies and pensions, they only have nominal payout obligations and thus don’t really care if the bonds they are buying are priced at negative real rates. All these “big fish” heavily distort the bond market.

Currently, with QT, we may be seeing some “positive” distortion as the FED offloads their balance sheet. For example, TIPS are attractively priced with maturities 15-20yr out.

Gyroscopic Investing

TIPS vs. the PP Barbell or iBonds: No Contest

TIPS vs. the PP Barbell or iBonds: No Contest

Re: TIPS vs. the PP Barbell or iBonds: No Contest

Re: TIPS vs. the PP Barbell or iBonds: No Contest

Re: TIPS vs. the PP Barbell or iBonds: No Contest

Re: TIPS vs. the PP Barbell or iBonds: No Contest

Re: TIPS vs. the PP Barbell or iBonds: No Contest

Re: TIPS vs. the PP Barbell or iBonds: No Contest

Re: TIPS vs. the PP Barbell or iBonds: No Contest

Re: TIPS vs. the PP Barbell or iBonds: No Contest

Re: TIPS vs. the PP Barbell or iBonds: No Contest

Re: TIPS vs. the PP Barbell or iBonds: No Contest

Re: TIPS vs. the PP Barbell or iBonds: No Contest

Re: TIPS vs. the PP Barbell or iBonds: No Contest

Re: TIPS vs. the PP Barbell or iBonds: No Contest

Re: TIPS vs. the PP Barbell or iBonds: No Contest

Re: TIPS vs. the PP Barbell or iBonds: No Contest

Re: TIPS vs. the PP Barbell or iBonds: No Contest

Re: TIPS vs. the PP Barbell or iBonds: No Contest

Re: TIPS vs. the PP Barbell or iBonds: No Contest

Re: TIPS vs. the PP Barbell or iBonds: No Contest

Re: TIPS vs. the PP Barbell or iBonds: No Contest

Re: TIPS vs. the PP Barbell or iBonds: No Contest

Re: TIPS vs. the PP Barbell or iBonds: No Contest

Re: TIPS vs. the PP Barbell or iBonds: No Contest