EconompicData has a nice, relatively brief post about the relationship between US Treasury bonds, TIPS, and inflation. I would hold either Treasuries or TIPS (or both) because they have the highest credit quality available, and that is a big part of why you should own bonds in the first place. Read the whole thing, but the conclusion below pretty much sums up why I prefer to have TIPS in my investment portfolio.
In normal market environments when inflation is relatively stable, long-term returns tend to be similar for both Treasuries and TIPS. However, TIPS materially outperform in an inflationary environment, while Treasury outperformance is capped by a rate roughly equal to the break-even inflation rate in a deflationary environment. Thus, assuming a view that an inflationary and deflationary scenario are equally likely, the unlimited potential outperformance of TIPS vs. Treasuries in an inflationary environment and limited upside of Treasuries vs. TIPS in a deflation environment would sway an investor towards TIPS.
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Everything you said above sounds good but after reading the following recent blog post I couldn’t come up with any GREAT reasons for ME to own TIPS going forward. I was hoping you could offer some thoughts regarding that post. (Not affiliated in anyway with that author. Just someone I follow on Twitter that offers SOUND advice like you do.)
http://www.basonasset.com/i-dont-really-love-tips/
Thanks for the link, Troy. Sounds like perfectly reasonable points were made there as well. The tax issues do make you really want to put TIPS in tax-sheltered accounts, so I do that. I held TIPS through all the volatility from 2007 onwards and it didn’t really phase me much. Indeed, when there were 3% real yields available I managed to “back my (small!) truck up” and buy some 30-year TIPS with 3% real yields.
What the article doesn’t really offer is a better alternative and why they are better. I’m not in love with TIPS with these sad real yields either but all things considered I am okay buying them. If he’s not in love with TIPS, what is he in love with? Not that much to love in this bond environment.
Thanks for responding. You are correct. He doesn’t say WHAT he LOVES in place of TIPS. I *think* he alluded to just increasing your total bond position but don’t hold me to that.
PS: Long time reader. Many thanks for all the years of sound advice.