Thoughts on TIPS?

[Holocene]

Is anyone investing in Treasury Inflation-Protected Securities (TIPS) these days?

Real rates are positive now so it seems like it could be a good time to lock them in.  Rates are down a bit from a month or two ago but seem to be heading up slightly more recently.  I'm looking at maturities in the 2025-2029 range which are around 1.4-2% real right now.

I'm currently working part-time but not sure how long I'll keep at it.  I just took some extended time off and I'm enjoying the work for now, so I'll probably stay at least through 2023.  I'd like to keep ~5 years of expenses safe(ish) for when I end up leaving the workforce.  Until now, I just used mainly savings/CDs and bond funds.  But bond funds have not felt very safe this year.

So this recent inflation and drop in bond prices has me rethinking my bond position a bit, but I don't want to make any rash moves.  I already have $30k in I bonds and plan to add another $20k early next year.  I plan to keep another $30-40k in short-term cash equivalents, mainly money market funds and a 6 month t-bill ladder now that rates are decent.  A lot of my part-time income will go into tax-sheltered accounts and to insurance/taxes so I may need to live off of this.

My bond allocation is around 15%.  I'm considering moving a good chunk of this to individual TIPS and creating a short 4-5 year ladder.  This way I guarantee beating inflation by at least 1.4%.  Maybe the worst of inflation is behind us, but I'd like to be prepared for if it's not.  I feel like high inflation is one of my biggest risks in early retirement and this is a way to protect against that.  When the TIPS mature, I'll either use them for expenses if I'm not working and stocks are down, or re-invest and keep the ladder rolling.  I basically just want my bonds to be a safe bucket I can pull from rather than stocks if stocks are down.  If stocks are doing well, I'll just withdraw from stocks and re-invest the TIPS.  I figure 5 years expenses should be plenty to ride out any bear markets.  This will all be in a tax-deferred account so I don't have to worry about taxes right now.

My main concern is selling some bond funds while they're still down in order to buy the TIPS.  I hate to lock in losses.  But TIPS rates have risen dramatically too, so those prices are also down.  It's hard to say if it all equals out.

Does this seem like a decent plan?  Anyone else doing anything similar?

[less4success]

Take a look at this article, especially the "Cash Bucket" section:

https://earlyretirementnow.com/2018/05/23/the-ultimate-guide-to-safe-withdrawal-rates-part-25-more-flexibility-myths/

That section discusses using a cash (well, cash-like) chunk of money as "sequence of returns insurance", and I like the strategy.

Edit: oops, I didn’t realize the minimum duration on TIPS was 5 years. My link might not be relevant to your question.

[ChpBstrd]

TIPS failed people spectacularly during this episode of inflation. The fund TIP, as an aggregate example, has had a -10.89% total return YTD. This was during the exact sort of contingency people said they would buy TIP for.
https://www.morningstar.com/etfs/arcx/tip/performance

The culprit was that the fund held something like 7 years' average duration. Interest rates rose so fast that the loss in value due to interest rate changes outpaced the gain in value from the TIPS' principal adjustment. You'd have lost about that much if you held a TIPS bond with 7 years duration on 1/1/22.

So if you think interest rates are going to keep rising significantly, then maybe use an online bond calculator to do the math and see if a TIPS bond at X duration will gain or lose value if interest rates go up by Y%.

TIPS with short durations did well this year because they suffered virtually no interest rate repricing and still got a fat principal adjustment. It was the long durations that got whacked. History could repeat in 2023, OR we could have a big recession that brings interest rates down and flips the script with long-duration TIPS gaining an inordinate amount of value. Good luck guessing which way we'll go.

I'm not saying TIPS are a good or bad deal right now, just maybe don't bet the farm on them. It's far from obvious what the longer durations will do in 2023. If you can pick up some used TIPS at 1-2 years' duration, you could get the next year or two of inflation adjustments while avoiding the interest rate risk.

STIP is a fund of TIPS with a 0.03% ER that has an effective duration of 2.36 years. It's YTD total return was -3.95%. This is a much lower risk alternative to TIP or longer-duration individual TIPS.

[Holocene]

@less4success - Thanks for the link.  I don't think I've read that particular part of the SWR series before.  It's good to hear that the cash bucket strategy did well in backtesting.  It's a bit different than the bucket strategy I had envisioned, where it's more in place of my bond allocation and would be replenished.  But maybe I'll reconsider this alternative.  I think my WR will be low enough that it doesn't really matter and is just for peace of mind.

@ChpBstrd - Yes, intermediate and longer term TIPS got killed this year.  But nominal bonds did even worse.  And of course stocks didn't fare any better.  It seems like there was nowhere to hide in this one, other than I bonds (too bad about the low purchase limits).  Cash was better than most but still lost to inflation.

I've learned a lot about bonds this year.  I sort of regret holding bonds while rates were basically 0 and had nowhere to go but up.  I feel like I should've seen this coming and should've just invested in CDs or more in I bonds in past years instead of bond funds.  But I've lived and learned.  At least I didn't have too much in bonds, and some of it is short-term and didn't lose as much.

Isn't what you say going to be true no matter what bonds I hold?  I'm looking at trading nominals (in a bond fund) for TIPS basically.  The durations will be quite similar overall.  If rates continue to rise, they'll both get hit.  But at least TIPS will protect me if inflation is higher than expected.  And I'm looking to better duration match when I might need the money with individual TIPS, so I can ignore price fluctuations and just know I'll get at least 1.4% + inflation. 

I'm trying not to bet on where interest rates will go from here and just lock in what is right now an acceptable rate to me for this small part of my portfolio.  If I hold it to maturity, I don't have to care what rates or prices do in the meantime.  I know what I'll get at maturity.  That's why individual TIPS are more appealing to me than a TIPS fund.  Individual TIPS prices will still fluctuate, and if I need to sell early, I might have to realize losses if rates have gone up.  But I'm pretty confident I'll have enough other safe money to last me 2023 and 2024 and will have TIPS start to mature in 2025.  So I don't anticipate needing to sell early.  Of course, anything could happen.  But I don't think I'll be considerably worse off with TIPS maturing in 2025-2029 than with an intermediate-term total bond fund or nominal bonds of the same duration. 

Nominals will win in the case of lower than expected inflation or especially deflation.  TIPS will win in the case of higher than expected inflation.  If I bet on TIPS and inflation is low or there is deflation, I can still buy everything I need.  Because I'm still earning 1.4% over inflation.  If I bet on nominals and inflation is high, I'm a lot worse off.  Now I maybe can't afford everything.  Obviously if my own personal inflation varies a lot from the official CPI, this might not hold.  But I think it's close enough.  So it seems like a no-brainer to go with TIPS.  If TIPS were still negative or just barely above 0, I'd feel differently.  But rates above 1% real for a 3-7 year duration seem reasonable to me.

I appreciate your comments.  I'm just not sure that any of what you mentioned is particular to TIPS vs bonds in general.  I understand rates may rise further and bond prices will go down more.  But it feels kind of too late to get out of bonds altogether.  So it's really a question of nominal vs. inflation-adjusted.  I will likely keep at least some nominal bonds as I have a mortgage at 3% that I'll need to cover.  I just think TIPS might make sense for the rest.

[ChpBstrd]

I suggest investing on the premise that things are about to change radically. Either (or both at different times) of the following could happen:

1) The Fed wimps out on rate hikes like in the early 1970s and inflation comes roaring back with the next commodities cycle.
2) A severe recession (current odds = 100% according to the yield curves) sends us back into deflation.

If 1) occurs, intermediate and long duration TIPS might tread water because their principal adjustments will be offset by losses due to duration like in 2022, but this is still probably an acceptable outcome compared to other investments. If 2) occurs, you will have locked in long term returns lower than a bank CD might have paid, but at least you'll be in treasuries rather than risky assets. The game would be to exit treasuries as the SHTF and get into risky assets (also known as rebalancing).

If you owned STIP, in contrast, you'd in theory get the next couple of years' principal adjustments while suffering a minimal amount of damage due to duration effects in a rising-rates environment.

I don't see the point of aligning individual TIPS' durations with your spending because a) individual TIPS are fairly liquid, and b) a fund like STIP can be sold off in very small increments as needed for spending or rebalancing. I suggest paying attention to duration as a risk management tactic, rather than as a spending plan.

[Holocene]

I would think the TIPS I'm considering (short to intermediate term) would do ok in either scenario. 

I think #1 would be a best case scenario for TIPS.  No more rate hikes to bring down TIPS prices as yields increase, but lots of inflation which the TIPS would keep up with and probably beat most other investments.  This is basically the scenario I want to protect against and TIPS seem like the best option right now to do so.

For #2, TIPS would not be the ideal choice and could actually lose nominal value if deflation occurs.  But then, stuff would be cheaper to buy too.  So my TIPS would theoretically still have the same purchasing power.  And I'd still have some short-term cash and some nominal bonds and I bonds too. 

If the odds of recession/deflation was really 100%, then moving to TIPS is stupid.  But I'm not so convinced.  And I still feel like I'm better off with TIPS in #2 than without TIPS in #1.

STIP is a short-term 0-5 year fund that currently holds almost equal amounts of TIPS for each year 2023-2027, with a bit more concentrated on the middle years.  So I'm not really planning on TIPS of terms much longer than STIP right now, maybe 1-2 years.  I'm not looking at 20-30 year TIPS.  STIP is certainly an option and is probably the only TIPS fund I'd consider now (well maybe VTIP).

In my mind, the benefit of individual TIPS would be that I have a known real amount of money at a certain date with basically no risk.  I can basically insure against SORR by keeping my first few years of expenses safe.  I'm ok with little growth on that money and with it potentially losing to other alternatives.  With STIP, the fund value will fluctuate and could potentially be down when I need the money and return less than I had planned on, thus increasing my risk.  STIP would be a shorter duration than I need right now and a longer duration than I need when withdrawing.  So if I know when I need the money, and it's easy enough to buy individual TIPS, why would I not create my own short ladder?  I don't understand why I shouldn't use my spending plan to match the duration of my bonds.

I don't intend to rebalance with these TIPS, so that's not really a consideration for me.  I might not rebalance at all.  I think I just want to keep a fixed inflation-adjusted dollar amount in cash/bonds and the rest in stocks.  But that's probably a topic for another time...

In any case, I'll keep mulling over this like I have been for the last few weeks.  We'll see what the Fed has to say tomorrow.  This was a lot easier when I just had my head in the sand and was shoveling all my money into stocks!