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INVESTING IS MESSY. Get used to it.
In the financial markets, you’ll typically pay a high price for certainty. That price is paid in lower investment returns, and sometimes also in greater financial hassles. Yet I see investors paying that price again and again.
Consider equity-indexed annuities. Investors imagine they’re getting stock market returns without any downside risk. But in truth, what they’re buying is an overhyped investment that captures only a portion of the stock market’s gain, plus there’s a hefty back-end sales commission if folks cash out early.
Even good investment products that offer some measure of certainty can turn out to be so-so choices. At issue is everything from Series I savings bonds to certificates of deposit (CDs) to holding individual bonds to maturity. None of these is an unreasonable choice for a modest portion of your money. As nervous investors ponder their likely portfolio performance, all three strategies offer the sort of comforting numerical precision that can make investing seem less scary.
Still, while these strategies provide an escape from stock market turbulence, they also all have drawbacks—and the certainty they apparently offer can prove illusory:
That brings me to a retirement-income strategy that’s lately enjoyed some buzz: building a laddered portfolio of Treasury Inflation-Protected Securities, or TIPS, with the bonds maturing gradually over the next 30 years, thereby delivering a guaranteed, inflation-protected income stream. Indeed, there are folks I respect—and consider friends—who have endorsed this strategy.
No doubt about it, there’s a mathematical elegance to the strategy and it offers an appealing degree of performance certainty. I’ve even had readers suggest to me that a TIPS ladder is all a retiree needs and that I’d be a fool not to take advantage, especially given today’s relatively high after-inflation yields offered by TIPS. Am I a fool? I have money in TIPS mutual funds, and I think building a TIPS ladder is a clever strategy.
But I’m still not wildly enthused, for four reasons. First, what happens if you live longer than 30 years? Unlike Social Security or an immediate annuity that pays lifetime income, a TIPS ladder doesn’t offer longevity insurance. What if it’s year 25 of your 30-year TIPS ladder, and death is nowhere in sight? That’s not the sort of conundrum I want to face in my 90s.
Second, building a TIPS ladder is complicated. To see the array of bonds you might need to purchase, try TIPSladder.com. Just one of the problems: There aren’t TIPS maturing every year for the next 30 years. In fact, to construct a TIPS ladder for a client, an advisor I know—who’s an expert on the topic—told me he had to spend 30 minutes on the phone with Vanguard Group’s bond desk, specifying which bonds to buy and in what quantity. And remember, this is a guy who knows what he’s doing.
Third, while keeping up with inflation is often presented as the gold standard for retiree income, those who meet this goal may find themselves feeling shortchanged. How come? The standard of living rises not with inflation, but with per-capita GDP, which has climbed 1.7 percentage points a year faster than inflation over the past 50 years. Suppose your neighbors’ income rises with per-capita GDP, while you merely keep up with inflation. After three decades, your inflation-adjusted income will be the same, but theirs will have climbed 66%—and you may find yourself feeling increasingly poor.
Finally, if you had 10 years or longer to invest, why wouldn’t you own stocks rather than TIPS? Sure, there’s the “if you’ve won the game, stop playing” argument. But owning some stocks may allow your standard of living to keep up with per-capita GDP growth, while also leaving a larger bequest to your children and your favorite causes.
Jonathan Clements is the founder and editor of HumbleDollar. Follow him on X @ClementsMoney and on Facebook, and check out his earlier articles.
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I appreciate your article. A TIPS ladder may have some merits, but I agree it is not the silver bullet for retirement income that we all may want but does not exist.
We went with Prudential Life Vest Annuities in 2009 and they have been great. Not so great is that they are the bulk of our savings for our 70s and the basis for our income stream. That is because taking money out for large expenses, including inflammatory food/heat/ac/ costs, is a difficult decision because it causes downstream issues. We’ve been okay for almost ten years with this plan; this year is the first we have to make a new plan, of sorts. Now, I’m telling everyone to max out those ROTHS.
Our FA has built us a rolling 10-year TIPs ladder which he started implementing 7 years when we engaged him. Its about 20-25% of our investable assets. It works great in our strategy. Maturing bonds are liability matched against the gap between projected income and expenses. TIPs are one of the few assets one can buy where the purchasing power is guaranteed to be there when the bond matures. Now to the objections raised: 1-for us the 30 year TIPs ladder is irrelevant as ours is a rolling ladder and new bonds are fed from bond funds. The concern about longevity insurance is not relevant for us as we are not using it for the purpose and we are delaying SS for that purpose. 2. The point about buying TIPs being complicated has been raised previously and is still wrong. My FA gets on the Vanguard site and buys TIPs in a few minutes. I have no idea why the guy Jonathan knows needs to get on the phone with Vanguard. 3. The inflation protection argument is a good one-as I said, we buy TIPs to maintain purchasing power and I agree that is to the extent possible. As our portfolio is 50% stocks for use >10 years out, hopefully that will help. The gap in TIPs years frequently get mentioned but that also can be managed by buying TIPs on the secondary market. The yields now are enticing but I do agree they are not a reason to jump unless one has a long term strategy. For us, TIPs are nice piece of of overall moderate and balanced strategy.
Great article. While working I had 100% in equities. Later I got some short term bond ETF’s at Vanguard. As interest rates started rising a few years ago, even the shortest bond ETF lost value. I quickly got out (covid hit) and went to money markets because the bonds were my stable portfolio. Mm rates were still very low then, but now the VG core MM is over 5%. I’m happy with that, and still have 65% in equity ETFs. The fixed portion of my account is for short term needs, if needed. No pension but SS (wife’s and mine) and dividends cover all our fixed expenses.
When I started working in 1972, the typical retirement investment strategy was to shift equities to bonds in order to lock in a fixed, secure retirment income stream. Unfortunately, inflation, longevity and better health care have all made the retirment investment calculus more complicated. Add in the fact that may investment portfolios will live on after their owners deaths, providing returns for children and grandchildren, and it makes a very strong argument why equities should always be part of lifetime investment strategy.
Bill Bernstein’s insights struck me, particularly his advocacy for constructing a 25-year TIPS liability matching portfolio tailored for residual living expenses. That now has me dividing my investment landscape into two distinct territories: one for risk, and one for riskless endeavors.
I count myself fortunate to possess a healthy cache of equity index funds in my risk portfolio. But delving into the nuts and bolts of building a TIPS ladder revealed a process far less daunting than anticipated.
Reflecting on why this approach resonated with me, it dawned on me that my entire investing journey unfolded against the backdrop of a declining interest rate environment. Those were the years when globalization propelled assets of all kinds to unprecedented heights. But as retirement beckons, uncertainty creeps in. How will I respond to new financial realities: sequence of returns, deglobalization, rising interest rates? I wasn’t so sure even though all the Monte Carlo simulations, articles, and industry publications tell me to keep things simple. I felt a liability matching portfolio is a beacon of stability amidst the unknown. Once I learnt the math, it wasn’t complicated.
I’m another advocate of keeping things simple and just use an intermediate bond fund for my fixed income. An ongoing monthly distribution to spend, rebalance with cash and equities annually and done. I can’t imagine any of these alternative strategies produce significantly better long term results but I do know for sure my needs are met and I’m happy. Hope all are reaching that goal with whatever they are doing.
Good article. TIPS ladders give me a headache just thinking about the complexities!. KISS has more and more merit as I think of implementation, performance and estate planning implications. As I grow older, and more experienced, an increasingly good attribute of a financial plan seems to be keeping it simple.
side for child beneficiaries, that potentially is a 25 year horizon for equity investing.
As always, I appreciate the diversity of comments about stocks, bonds, conservative versus aggressiveness investing in retirement. We keep our portfolio simple.
With both my wife and I having pensions along with our social security checks covering nearly 100% of our expenses, we have enough cash to cover three years of expenses, we have $260k in IRA’s divided evenly in VTI and VUG.
Is there any reason that I should have any bonds in our portfolio? I always appreciate input that agrees with or challenges my thought process.
You already effectively own two huge bonds — your pension and Social Security — and it seems those bonds cover almost all your expenses, so I’m not sure you need any actual bonds.
I definitely think bond funds are the way to go in accumulation mode, but once you’re retired and drawing down funds, I can make a case for using individual bonds since you can match the duration to the time frame that you will need cash. To that point, as a recent retiree, I’ve put together a small TIPs ladder. It’s only 10 years long and it only covers a portion of my expected spending–at that level it certainly seems like a reasonable component of my retirement plan.
The majority of my portfolio is still in stock and bond funds, with another five years or so of spending (not covered by the TIPs ladder) in cash. That said, I agree with the other comments here that a TIPS ladder lacks simplicity, which is a definite downside.
It’s amazing how much our personal experience, risk tolerance, and unique needs shape our financial choices. Much of what you’re railing at here may not be strictly rational, but could be reasonable from a certain point of view.
One example: I bought I Bonds long before the recent inflation spike because I wanted an inflation-adjusted place to keep savings for future healthcare needs in retirement. At the time I was consistently paying taxes in the highest bracket, even after maxing 401K and HSA savings and deferring as much income as I could. The fact that I Bond tax liability isn’t incurred until selling was appealing, and I had zero chance of selling prematurely.
Perhaps your main point here is this: before investing, know your goals, your time horizon, and yourself. So much damage is done when we take cues from others who have different needs, goals, risk tolerance, or time horizon than our own.
Just wondering if commenter, Ray Giese, is the same person I used to enjoy working with many years ago? – Bill Goodykoontz
As always, terrific insights. I suggest people start with the the large picture – a bucket approach, with a portion of assets devoted to cash and equivalents (usually 2-3 years of base expenses), a portion to low/moderate risk (short term-intermendiate bonds, fixed annuities, etc.) to cover an additional 3-5 years of base expenses, and the remaining portion to growth (take your pick, but I choose dividend growth stocks to growth of the income stream, plus moderate capital appreciation). I sweep monthly interest and dividend income into my checking account to create the cash flow I need.
The percent representing each “portion” or bucket depends upon your base expenses – how much you need to devote to each bucket to cover the base expenses as outlined above, but 1/3rd in each bucket is a good place to start.
A combination of annuities, delaying social security, and growth of dividend income over the years serves as my insurance for longevity risk – and I have some to consider since my parents achieved life into their late 90’s (and my Mom is doing well while approaching age 99 in May!).
Let’s not forget the other side of the equation though – expenses. Begin “retirement” with a well understood base of expenses, and keep an eagle eye as the years go on. Expect a few large unplanned expenses to pop up, but with the bucket approach you should be able to manage it well.
Finally, begin your portfolio repositioning before you anticipate stepping away from full time employment – I suggest five years. Derisk your portfolio during that time so that upon your retirement you have eliminated the “sequence of returns risk” – in other words, the market crashes the day of your retirement.
Let’s talk simple math. Bond funds make no sense when rates are low.
As for stocks, the stock market does not have to go up.
As for cash, I do have one worry, that extremist federal politicians will cause the US to default which could devalue the dollar catastrophically. Otherwise, what’s so wrong about treading water in CDs or money market funds?
When I read a reply you made to someone else’s comment, it appears this is how you actually operate:
“My current plan is to keep five years of required portfolio withdrawals in cash investments once I’m fully retired.”
I’m not sure what point you’re trying to make in your comment’s final snarky paragraph. Perhaps you could elaborate.
To give Mr Cammer the benefit of the doubt, maybe he was saying that putting money in CDs or money market funds is consistent with keeping five years of required portfolio withdrawals in case investments once you retire?
Reads like robo-troll spam.
Thanks very much Mr. Clements for this wise and timely piece. I have to confess to being among the many who was seriously considering going all-in on a TIPS ladder after seeing them extolled as THE retirement solution by the likes of William Bernstein and Allan Roth, but after watching my wife’s eyes glaze over when I explained how she’d manage such a portfolio in the likely event of me dying first I realized that our current simple portfolio is plenty to deal with – for both of us.
I’m most grateful to you for your consistent championing of intelligent minimalism, which has led me to a “four fund” portfolio (half each short-term bond funds in the form of VTIP and VGSH (plus a Treasury money market fund with 3 years of residual living expenses), along with half globally-diversified equities in VTI and VEU) that I feel confident we can both live with and manage for whatever time is left to us. If nothing else, the 50:50 split between equities and fixed income along with equal amounts of nominal and inflation-protected bonds makes me feel like we’re acknowledging that the future is unknown and positioned to survive most scenarios.
As one ages I think simplicity trumps more complex strategies, especially since the result is not guaranteed to be any better. Also, maybe this does not apply here, but I have a friend who is the executor of an estate and the outstanding bonds created a real problem in settling the estate (some could not be closed before maturity). Regardless, for yourself, someone managing your accounts later in life when you can’t, and ultimately your executor – keep it simple….
I always wonder what happens to any kind of fancy footwork if the person managing the money expires and the person left behind has no skill or interest in continuing with managing the investments. We have just a couple of Vanguard mutual funds and those can continue as-is if I (the person managing the money) gets hit by the proverbial Mack Truck. Any extra investment return we might gain from fancy footwork won’t really affect our 15-to-20-year retirement. Just starting out with 60 or 70 years ahead of you, the extra return can make a real difference.
SLK…great comment! My bride of 40 years also has eyes that glaze over when discussing finances. For that reason, I have 100% of my non-annuity dollars invested with Vanguard, and I use their PAS advisor services, for 30 basis points a year.
My advisor is in his young 30’s vs. me being 73 and my wife 69. He will be here, or someone like him, should I predecease my wife. Vanguard’s advisors are salaried employees, so conflicts of interest like churning are simply not a concern. Neither are the other unethical activities common in financial services.
The annuities we own are all joint life and have guaranteed income riders. We do not need the dollars presently and they are all in deferred status, increasing by 8.25% annually. My wife was my office manager for a number of years in the late 90’s and early 2000’s, when I owned a Nationwide Insurance & Financial Services Agency, and she was series 63 and 6 licensed, so she has understands the basics of insurance & investing. My Annuity rep is in his early 50’s so, God willing, he will be alive when I am gone as well.
I love the idea of TIPS Ladders, but they are too complicated for non investors to understand and manage. Then again, that’s only my opinion. And while TIPS Ladders are great for handling Inflation related risk, laddering annuities can accomplish similar goals.
I think your discussion of how the standard of living increases at a faster rate than inflation is a powerful argument for owning stocks in our retirement years. You have previously indicated a personal preference for keeping 5-7 years worth of future withdrawals in cash and short term bonds when retired, with the balance in equities. I suppose many of us follow a similar logic with the main difference being the number of years worth of withdrawals we prefer to hold in safe assets. Do you anticipate increasing that number beyond 5-7 years while the CAPE is rising to higher levels, or would you just ride it out?
Following the stock market for four decades has taught me that it’s all but impossible to predict market performance by looking at valuation yardsticks, so the CAPE and other measures don’t influence my asset allocation. My current plan is to keep five years of required portfolio withdrawals in cash investments once I’m fully retired.
Thank you Jonathan!
From your comment, I assume you are not a fan of John Hussman, PhD, who uses market valuation metrics as (one of) his major decision factors.
Don’t know anything about the guy. But why would I be a fan?
https://www.morningstar.com/funds/xnas/hsgfx/performance
I have lost money on bonds that failed and on bond funds that did poorly over the past years. I have, however, followed Johnathan’s advice to keep bonds as a part of my portfolio over the past twenty years without regret.
Of all your great insights over the years on personal finance issues, this article offers the most helpful information at my personal stage of investment decision making and as I enter retirement fairly soon. The first such insights gleaned from your writing were WSJ articles in 1999 and 2000, when you wrote on the advantages of low cost index funds and their new counterpart, ETFs. Those articles led me to buy QQQ after it dropped 50% in 2000, and 75% in 2001. I still hold 90% of those shares today, bolstered by the incredible performance of the Magnificent Seven. Much thanks for valuable investing insights on both ends of these 25 years.
Investors have to face reality: markets and the economy are constantly changing.
Index-investing theory states that you don’t have to know anything, that the market itself will guide you, and you can make good money just by doing what everyone else is doing.
Now just because a particular theory works for a while, doesn’t mean it will work forever. Yes, S&P 500 investors have made money in the past 20 years, but past performance guarantees nothing.
The TIPs ladder, the equity-indexed annuity – those are pretty much the same sort of thing. It’s automatic, you don’t have to know anything, it’s guaranteed to work.
As some people know, I am active investor. I follow the economic, demographic, and market trends. What worked in the past may not work any more. Even with a conservative retiree portfolio, you have to follow your investments and constantly make changes. Otherwise, over a 30-year retirement, you may fall behind. There is simply no magic formula, no way to avoid study and making hard choices.
I’m a bit puzzled by your response. You state that the past performance the S&P 500 doesn’t guarantee that investors will enjoy the same 20-year performance going forward. That’s true, but it’s also true for all stock market investors, passive and active alike.
I wouldn’t characterize index investors as not knowing anything. They indeed do know that a fund like Vanguard’s Total Stock Market Index fund (VTSAX) guarantees that it will match the performance of the US stock market. And the performance of the US stock market is the aggregate result of all active investors doing their homework. In any given year, however, half of all active investors will underperform the market. And, no doubt, many of those underperformers were also following economic, demographic and market trends.
Tracking the market and economy, and adjusting your portfolio accordingly, is an acceptable alternative to indexing, but it’s no guarantee of outperformance. It’s also important to acknowledge that shifts in market sentiment can sometimes occur so suddenly that active investors can find themselves playing catch up. Since indexes reflect these shifts in sentiment, index investors won’t need to play catch up.
Consider the recent meteoric rise in the price of Nvidia stock, presumably due to the potential of artificial intelligence. It is now the third most heavily weighted holding in VTSAX. Personally, I never had any inkling that Nvidia would become such a successful investment, yet I indirectly own some of its shares “not knowing anything.”
I can’t see any reason why I would sell a broad market fund like VTSAX and replace it with something else based on my forecasts of the future.
many points here that I had never considered ! Thanks.
Individual muni bonds have their place in states with high tax rates and low inventories of bonds such as the one in which I live. The only muni fund available for my state charges exorbitant fees. So instead I buy individual bonds and have the satisfaction of a predictable income stream and of knowing the specific projects — the schools, water systems, sewers, low income housing — I am helping to finance. Never in 30 years have I held a bond that has defaulted or stopped payment, though of course that remains a risk.
Or you could just hold taxable bond funds in tax deferred accounts.
I agree with your points. Thanks, Jonathan!
Great article on bonds, and I think your advice for investing money for the longer term is spot on. To me, the risk/reward calculus tips in favor of holding money I won’t need for 10 years or longer in a diversified, low cost, stock fund. If history is a reasonable guide, over long periods the overall stock market should provide returns that exceed the returns from bonds and exceed inflation by a good margin. The added benefit is that the tax rate on stock gains will be lower than the tax rate for bond income. There are no guarantees, but over long investment horizons it seems to me that the downside risk of a broadly diversified stock portfolio is far outweighed by the upside potential.