Allan Roth has another thought-provoking article called Beat Inflation Handily, and Risk-Free with a very attractive proposition:

Do you want an expected return of nearly 6% annually above inflation but also want to be assured you will beat inflation in a worst-case scenario? Until now, I would have responded “only in your dreams.” But today, that dream is a reality.

Previously, he wrote about a simpler “No Risk” Portfolio that guaranteed your money back in nominal (face value) terms. For example, if you started with $100,000, you’d end up with $100,000 after 10 years. However, inflation would mean that the buying power of your $100,000 would be less after 10 years.

This new & improved “No Risk” portfolio uses individual TIPS to guarantee that even if your stocks go to zero, your total money invested will at least match inflation and maintain buying power. This is because current TIPS guarantees returns of roughly 2.5% above inflation, all by itself.

At current TIPS yields, this can effectively be achieved with roughly 50% stock index ETFs and 50% individual 25-year TIPS. At current yields, every ~$50,000 in 25-year TIPS will end up at a real (inflation-adjusted) $100,000 after 25 years. That means you could throw in ~$50,000 into stocks and every single penny from your stock index ETF returns is gravy on top!

Here’s how the total annualized real (after-inflation) return of your portfolio would look, depending on real (after-inflation) stock returns:

I don’t plan to change my portfolio to this one. Instead, it serves as a useful tool and alternative perspective about asset allocation. There are clear benefits from holding guaranteed bonds, both of the nominal and inflation-linked type. You may think insuring against a total loss from stocks is overkill, and I would tend to agree. But it sure does feel nice to have a floor somewhere, as there have been decades historically where stocks have experienced a negative real return.

Stocks offer some of the highest historical average returns and the highest expected future returns. But if you haven’t experienced a prolonged bear market, your faith hasn’t been truly tested yet. If you’re in your 20s, the stress is different than if you are in your 60s. Imagine the peace of mind from knowing your “worst-case” scenario is still a reasonably-comfortable retirement for you and your loved ones.

I hold close to 50/50 US Treasuries and TIPS for the bond portion of my portfolio. This is an area where my portfolio differs significantly from most “model portfolios” you’ll find from the major fund companies and robo-advisors. While buying more TIPS recently due to their historically high real yields, I decided to run a quick backtest comparing three intermediate-term fund options:

• Vanguard Inflation-Protected Securities Fund (VIPSX)
• Vanguard Intermediate-Term Treasury Fund (VFITX)
• Vanguard Total Bond ETF (BND)

Basically, an intermediate-term fund of TIPS, US Treasuries, or the Total Bond Index that tracks all investment-grade taxable bonds. You will get different results based on the timeframe, but I decided to look back through roughly the last 15 years.

Here is the real yield for 5-year TIPS during the that time period (2008-2023). While there was a brief spike during the 2008 financial crisis, I would guesstimate the average real yield during this entire period as… zero.

Here is the growth of a $10,000 investment starting in January 2008 through September 2023 via Portfolio Visualizer:

Nobody who held bonds over this time period is celebrating in hindsight, but I’m only comparing these three against each other. There is no clear, dominant winner. Visually, sometimes one would be winning slightly, and then another would be winning slightly. If I changed the start and end dates, the winner may be different each time.

However, I would also note that there was no extended bout of high inflation either. Given our current monetary system, high inflation is much more likely than deflation. Historically, high inflation is much more common as well. My opinion is that TIPS offers an insurance component against unexpectedly high inflation, and it appears that even during a period of “normal” to “low” inflation where it only offered a zero real yield, TIPS didn’t really “cost” me anything to hold. Total bond funds usually yield more since they contain corporate bonds, yet TIPS and Treasuries both still kept up.

If you stretch the time period back to 2000, when TIPS offered a higher real yield, you can see it actually did even better on a relative basis. I’m not saying that this will happen again in the future now with high real yields again, but overall I remain satisfied with holding 50/50 TIPS/Treasuries for my bond holdings. I continue to view owning some TIPS as low-cost insurance against unexpectedly high inflation.

When investing in bonds, one of the decisions is how long you want the “term to maturity”, or how much longer the bond will pay interest and then upon maturity repay the principal. The longer the term, the more sensitive the bond price is to interest rates. They are usually broken up into short-term, intermediate-term, and long-term categories. iShares manages a set of popular ETFs that invests in US Treasury bonds of certain maturities:

• iShares 1-3 Year Treasury Bond ETF (SHY)
• iShares 7-10 Year Treasury Bond ETF (IEF)
• iShares 20+ Year Treasury Bond ETF (TLT)

Historically, the longer the term, the higher the return. In exchange for this potential higher return, the longer term leaves you expose to higher interest rate risk. A recent “Chart of the Day” from Abnormal Returns compared the drawdowns of short-term (SHY), intermediate-term (IEF), and long-term (TLT) Treasuries over the last 20 years. I found it a very good visualization of the greater interest rate risk of longer-term bonds in terms of a dropping balance in your brokerage account.

Right now, you might look at this chart and question why anyone would have wanted to own long-term Treasury bonds if you could experience a drawdown of 41%! And from “100% safe government bonds” no less! 😡

Well, lots of people were quite happy with their long-term bonds up until recently. Here is a Morningstar chart that tracks the growth of $10,000 first invested 10 years ago (2013) in the long-term Treasury ETF TLT. During the initial COVID response, your $10,000 investment would have been worth nearly $17,000 when interest rates were dropping. But as of today, you are basically back to only $10,000 again after a long 10 years.

The Growth of 10k chart for the intermediate-term Treasury ETF IEF is similar, but a bit downsized. The peak value in 2020 was about $13,000 before coming back to close to $10,000 again as well. (Focus on blue line only.)

Finally, the Growth of 10k chart for the short-term Treasury ETF SHY was much more ho-hum. Notice how the vertical axes increase in much smaller increments. The peak value in 2020 was only about $11,000 before ending just slightly lower at ~$10,700. (Focus on blue line only.)

In fact, if you compare all three ETFs, the short-term ETF SHY had the highest ending value (and highest total return) over the last 10 years. Term risk showed up, and you could have had both a calm ride and more money in the end.

This is not a recommendation to only buy short-term bonds. Interest rates have been rising recently at one of the fastest rates in history, and that may stop or reverse at any time. Many people still choose to purchase longer-term Treasury bonds as a protection against deflation and/or dropping interest rates. Mostly, these charts help illustrate how these different types of bond terms respond to volatile interest rates. You may wish for a quieter ride (and less downside potential), even if you give up some upside potential. Or not.

As part of its “Portfolio Basics” series, Morningstar has an educational article on taxable bonds, including corporate bonds, US government bonds, and foreign government bonds, along with their different credit grades and maturity lengths.

Over the last 20 years, things have played out pretty much as the traditional theory would have predicted. The higher the “risk”, the higher the return. High-yield “junk”-rated corporate bonds have had the highest return, but also the bumpiest ride due to their higher credit risk and higher interest rate risk (they are usually of longer maturity). Short-term US Treasury bills (“cash”) has had the lowest return but the lowest credit risk and lowest interest rate risk. Personally, I see this chart and am satisfied with my holdings of intermediate-term US Treasury bonds (green line) that keeps the highest credit risk but with effectively a ladder out to a longer average maturity.

But hey, those high-yield bonds still returned a lot more money over the last 20 years instead. Why not just hold those instead? First, don’t forget to step back and look at the bigger picture:

If you’re going to accept big swings, you might prefer one of the highest returning assets in the top-right corner. (I have no idea which one will be the absolute highest in the next 20 years, but I don’t think it’s an accident that all the stocks are grouped together in that top-right corner.) If you can hold on through the scary periods, the gap between stocks and bonds over the long run (~100 years below) is huge:

This is why many will advise you to own more stocks if you want an overall higher risk/potentially higher return profile, as opposed to riskier bonds. But before you get carried away, read this book excerpt Courage Required from William Bernstein. Bleak times will come again. Safe things have value beyond the rate of return.

Every asset class has its energetic supporters, from rental properties to altcoins to gold. Listening to each group, you may feel that you need to own every asset class in order to be “diversified”. However, sometimes less is more, and it can be useful to read about why many seasoned veterans consciously avoid certain corners of the investment world. I find it a refreshingly different perspective, even if I may or may not agree. Everyone’s needs are different, and I own several of the things below myself. Here are a few lists along with supporting arguments.

William Bernstein – MD, author and wealth manager. I compiled this list while listening to the linked interview.

• Commodities Futures
• Individual Stocks
• Corporate bonds
• Long-term bonds
• Fixed annuities

Jonathan Clements – financial author and long-time WSJ columnist

• Savings bonds.
• Long-term bonds.
• High-yield “junk” bonds.
• Municipal bonds.
• International bonds.
• Individual stocks.
• Immediate fixed annuities (but he does plan to buy some eventually).
• Deferred income annuities.
• Gold
• Commodities
• Real Estate Investment Trusts (REITs)
• Rental properties.
• Long-term-care insurance.
• Life insurance.
• Disability insurance.
• Flood insurance.

Amy Arnott – CFA, portfolio strategist for Morningstar Research

• Actively Managed Funds
• Real Estate Investment Trusts (REITs)
• Sector Funds
• Alternative Investments
• I Bonds
• High-Yield Bonds
• Gold

Let me know if you come across any other “What I Don’t Own” lists.

[Image credit: Amazon]