Understanding Cash Will Make You a Happier Investor (Tyler)

Discussion of the Cash portion of the Permanent Portfolio

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sophie
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Re: Understanding Cash Will Make You a Happier Investor (Tyler)

Post by sophie » Sat May 27, 2017 9:06 am

Tyler, that's the best summary of TIPS I've heard anywhere. We'd had previous threads about keeping TIPS funds as an extra inflation hedge, but it always looked to me like you had to give up too much in order to get it.

Anyway, it's not really needed. The PP provides consistent enough returns over inflation that you don't really have to worry about it.
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Re: Understanding Cash Will Make You a Happier Investor (Tyler)

Post by eufo » Sat May 27, 2017 10:58 am

Tyler wrote:BTW, several of the people who looked into modeling TIPS left the exercise swearing them off with their own money.
Wow, that is very telling about TIPS. I remember liking the concept of protection against inflation in a bond, but I never really cared for their ultimate performance. Plus, the conspiracy theorist in me suspects the government will always fudge inflation numbers to their own benefit, so how can I trust that I'm going to have any protection against my own perception of real inflation?
Don't agree with me too strongly or I'm going to change my mind
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Tyler
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Re: Understanding Cash Will Make You a Happier Investor (Tyler)

Post by Tyler » Sat May 27, 2017 12:01 pm

grapesofwrath wrote:My naive understanding is the yield might be slightly lower/comparable than that of regular bonds of same duration, but they would offer better protection if there were a substantial rate rise - hence decent alternative to cash.
I definitely wouldn't use TIPS as a substitute for cash. Think about it this way:

Bonds are affected by basically one thing -- interest rates. Values rise when rates fall and fall when they rise, and they pay out the coupon along the way.

TIPS are affected by three things -- interest rates, measurable inflation, and the market guess of expected future inflation. So there are multiple variables involved, and just because TIPS are adjusted for measurable inflation does not mean they track it particularly well. They are harmed by rising rates just like normal bonds, and the market guess for future inflation can be wildly wrong. That's how intermediate TIPS had a real return of -10% in 2013 and how short term TIPS trailed normal short term treasuries three out of the last four years (compare VTIP to VFISX).

All that said, you might want to read books by Swedroe, Swensen, and Israelsen to understand why they like TIPS. While they're not the automatic inflation-protecting vehicles they're made out to be, TIPS are an interesting asset and I think they can be fine in certain portfolios.
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Re: Understanding Cash Will Make You a Happier Investor (Tyler)

Post by grapesofwrath » Sat May 27, 2017 12:52 pm

Tyler wrote:That's how intermediate TIPS had a real return of -10% in 2013
With my limited understanding isn't such a loss just a consequence of selling in a TIPS fund?
What if you hold the Note or TIPS from issue to maturity ? Looking at typical numbers for a 5yr Treasury Note vs 5yr TIPS :
A 5yr Treasury Note currently has a nominal yield of ~1.8% which is pretty much zero real yield with current inflation, so if inflation remains unchanged you get all your money back (in real terms) at end of 5years (ignoring tax). If inflation increases/decreases over the period your 5yr Note will lose/make money (in real terms). i.e. you are not protected against inflation.
Now a 5yr TIPS bond has an interest of ~0.125% (negligible). My understanding this yield is on the principle value, and this underlying principle value of the TIPS bond increases/decreases to track inflation. i.e. the TIPS guarantee to give you a (currently negligible) positive real return at the end of 5years regardless of how inflation moves. i.e. you are protected against inflation.
So if you laddered the TIPS and held them from issue to maturity how would that be a bad substitute for cash or short term fund ? Thanks.
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Tyler
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Re: Understanding Cash Will Make You a Happier Investor (Tyler)

Post by Tyler » Sat May 27, 2017 12:59 pm

Yes, holding TIPS to maturity bypasses the interest rate risk. There's still the future-inflation-guessing risk, though, as normal bonds held to maturity will pay a higher yield and will be a better deal if future inflation is below current expectations. For example, using your numbers it would only make financial sense to prefer a 5-year inflation-adjusted bond paying 0.125% over a non-adjusted alternative paying 1.8% if you expect inflation to average more than 1.675% over the next 5 years. In that context, buying TIPS is just a wager that inflation is currently under-priced. It's a speculative investment.

In any case, I'll amend my previous statement and clarify that I don't think short term TIPS are automatically a poor substitute for cash. Just perhaps unnecessarily complex. Going back to the link in the OP, cash already tracks inflation pretty well on its own without the extra layer of uncertainty.
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Re: Understanding Cash Will Make You a Happier Investor (Tyler)

Post by Tyler » Sat May 27, 2017 2:53 pm

Good point! The treasury market is remarkably efficient in balancing things out.
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