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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.