About the intelligent investor
The weekly column of ‘The Intelligent Investor’ by Jason Zweig, has been published in the Wall Street Journal for about a decade and is published exclusively in Globes. According to Zweig: “My goal is to help you distinguish between the good advice and the one that just sounds good”
About Jason Zweig
One of the senior journalists of The Wall Street Journal. Author of the book “Your Money and Your Mind: How Neuroscience Can Help You Get Rich”, and the editor of the updated version of the bestseller “The Intelligent Investor”, described by Warren Buffett as “the best investment book ever written”
If you think this year’s poor returns on stocks and bonds have put a secure retirement out of reach, think again.
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The recent sharp decline in bond prices has made Treasury Inflation Protected Securities, or TIPS, once again a cheap form of insurance for the first time in more than a decade. Buying and holding them in your retirement portfolio can help you ensure a stream of income that will come in throughout your life and not be swallowed up by by the rising cost of living.
TIPS are US government bonds whose underlying value increases (or decreases) at a uniform rate with inflation as measured by the Consumer Price Index.
Also, they pay fixed interest. Like almost all bonds, when market prices for TIPS are high, the yield – the annual interest rate divided by the last price – will be low. When prices go down, the yield goes up.
Unlike Class I bonds, or inflation-protected savings bonds, TIPS can be traded, they are available in large quantities and banks and brokerage firms offer them. They also come packaged with mutual funds and ETFs. These characteristics make TIPS flexible more, especially for wealthy investors.
This flexibility is not always a blessing. TIPS rose about 6% last year, until the return they gave investors above inflation, known as a “real return,” was extremely negative.
The implication of this was that the yield in the future would probably also be negative. Still, investors poured $75.5 billion into TIPS mutual funds and ETFs in 2021, according to Morningstar.
Maturity times are longer than normal bonds
TIPS are not without risk. They protect against inflation – but are hurt just as much as regular bonds when interest rates rise.
This also happens because TIPS pay coupons at a lower interest rate, in part because they have longer maturities on average than regular bonds.
Through Nov. 30 of this year, according to Pimco, TIPS had gained 7.3% inflation-adjusted to the principal price — but their market price had fallen nearly 18%, far worse than the 14% drop in the price of conventional Treasury bonds.
Overall, the return on TIPS was minus 10.9%, not much better than non-inflation-protected Treasury bonds. That puts them on track for the worst year in their 25-year history.
If you hold them until the maturity date – you will get back the original investment, and balances for inflation along the way – none of this should change.
But many of the same people who entered the field when inflation protection was overpriced have fled now that it has become much cheaper. Investors pulled $16.1 billion from TIPS funds through Oct. 31, Morningstar estimates.
However, now that TIPS have collapsed, you can guarantee them a 1.6% return nearly above inflation this week, according to Pimco. A year ago, this yield was minus 1.7%.
If you are looking ahead to the retirement path ahead of you, and not in the rearview mirror, you should be buying TIPS, not selling them.
Withdraw 4% of capital every year for 30 years
At current prices, TIPS investors can lock in the possibility of withdrawing about 4% of their capital each year for about 30 years without running out of money after inflation, said Alan Roth, a financial planner at Wealth Logic in Colorado Springs, Colo.
You probably won’t put all your eggs in TIPS. It’s a defensive strategy designed to ensure you don’t run out of money, after inflation, if you hold them until they mature. But that’s all it is – and it might not be enough. Some of your money should also play offense, hoping to earn a better return in the long run. But inflation-protected Treasury bonds are an excellent addition to a portfolio of stocks and other assets.
“TIPS tend to offer a unique diversification to almost any other type of investment considered by people saving for retirement because of their contractual relationship to inflation,” said Barnsby Wheaton, senior vice president of retirement strategies at Pimco.
can cause a headache in relation to taxation
In terms of taxation, TIPS can cause a headache. Besides the regular interest payments, they also produce these inflationary balances to the base price. Their rising basis value creates what is known as phantom income, which is federally taxable even when it is not received until the TIPS mature or are sold. That’s why many people keep TIPS in a tax-deferred retirement account.
But they are not required to pay local and state taxes. So, if you live in a high-tax state, like California or New York, Roth said, consider holding the TIPS in a taxable account.
Jeffrey Rapp, 63, is a Los Angeles-area physician who retired in 2021. A few years ago, he built a “ladder,” a portfolio of TIPS that mature almost every year from the time he’s 65 until he’s 85.
This will provide him with a stream of income, consisting of a combination of interest and base price payments until maturity, that will maintain a pace consistent with inflation. “It allowed me to not care about the volatility associated with investing in stocks,” he said.