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Subject:  Re: TIPS: To Protect Yourself Date:  12/9/2008  8:30 AM
Author:  Lokicious Number:  25268 of 36037

Concerning how much to allocate, I've read various recommendations. Kenneth Volpert, manager of Vanguard Inflation Protected Securities (VIPSX) suggests that investors/retirees split Treasury holdings between conventional bonds and TIPS. John Brynjolfsson, who ran the granddaddy of TIPS funds, Pimco Real Return Institutional, advises splitting a diversified portfolio into three categories: stocks, bonds and such assets as TIPS, commodities and real estate that help offset rising prices and says, "Bonds protect against deflation. TIPS protect against inflation."

Again, the FAQs on this board are much more complete and unbiased than any advice you will get from investment "professionals," even Vanguard, because we include CDs in the mix, and they deal in the world on bonds and bond funds.

Listing TIPS with commodities and real estate as inflation protection is dangerous thinking: TIPS (not necessarily TIS funds) will get you your original principal back plus some kind of inflation adjusted return, assuming solvency of the US government. The others are far more speculative. Stocks are usually also considered inflation protecting over the long run, and real estate and commodities could be part of an asset allocation plan, but they should definitely not be considered as a substitute for TIPS.

TIPS versus Treasuries versus CDs is how to think of "safe" fixed-income allocation (US Savings Bonds are no longer in the mix, because they aren't competitive, except in rare situations). There are no generalities about allocating between these: it's a matter of choosing the best option when you have money available, depending on what options you have available (i.e., retirement plans may be restrictive, there may be minimums). What we have to go on is: 1) current yields; 2) historical averages for yields and inflation; 3) thoughtful projections for the future. Basically, we can use historical statistics as a rough guide for the future, provided we look at them as an effect not a cause.
My view is that current yields on US government debt and, because of this, FDIC/NCUA insured debt, (and yields for most of the past decade) have been too low for the level of debt (well below historical averages) and that the enormity of the debt burden for the US government (including paying back SS trust fund, with fund surplus already decreasing) will mean either higher interest rates or higher inflation or both in the not too distant future and that's what I plan for.

Regular Treasuries can be a good choice if yields are high enough. They were a good choice in the 80s and early 90s, and would have been a better choice than TIPS if those existed, because inflation was high, but (until inflation receded) "real yields" were low (or negative). So, when inflation got whipped, locking in high Treasury yields turned out to be the winning choice.

Right now Treasuries have very low yields and are even projecting deflation or extremely low inflation for a long time. If you actually want to worry about protecting against deflation for the next 3-5 years, you can do much better with CDs than Treasuries. You can't trade them for a profit if yields continue down from low to almost nothing, as you could with Treasuries. But, if you get them from a bank or credit union (Pen Fed was at 4.75% this month for 5-years last I looked), you can cash in early for a small penalty if inflation takes off and/or yields go up in a couple of years.

Again on bond funds, including TIPS funds, they are not the equivalent of a ladder of TIPS. If you buy Vanguard's TIPS fund now (I don't take seriously funds that claim much higher yields: either artificial or leveraged), and you sell your shares down the road at historical average yields, you would lose about 3% on your shares. If you bought TIPS and held to maturity, you would lose nothing on your original investment. Of course, if we get into a period of high historical real yields (above inflation), due to the enormity of debt, a fund could lose much more.
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