FREE NEWSLETTER
We all remember the 2022 bond collapse, triggered by rising interest rates. Most of us were caught out, a supposedly safe asset class posting double-digit losses. Some of those bond funds are still slightly underwater four years later. Which brings me to a question worth thinking about.
Right now, Treasury Inflation-Protected Securities (TIPS) are offering guaranteed real returns of roughly 2-3% above inflation. That’s a compelling, ultra-safe option for liability matching in retirement, and I think most people would do well to look into it. The catch: none of us have unlimited capital. For many, the money to fund that TIPS allocation would have to come from selling bond funds that are still sitting at a loss.
So the real question is this: does it make sense to realize a loss now in order to lock in today’s TIPS environment?
My personal opinion, for what it’s worth: don’t anchor to the purchase price. What you paid for those bond funds in 2021 is gone, and it has zero bearing on whether today’s decision is a good one. The only question that matters is forward-looking: is this capital better off in TIPS than in what you’re currently holding?
Framed that way, the “loss” stops being a loss at all. You’re not losing money by selling, you already lost it when rates rose in 2022. The price already reflects that. What you’re actually doing now is trading an uncertain, drifting recovery for a locked-in, inflation-protected return.
To my way of thinking, that’s not giving something up. It’s possibly an upgrade.
There’s a second reason this makes sense beyond the psychology: compare current yields, not prices. Your bond fund’s price already adjusted to the higher-rate world, so the real comparison isn’t “I’m down X%, do I cut my losses.” It’s “what yield is this fund actually offering me now, versus what TIPS are offering.” Once you strip out the emotional weight of the purchase price, it’s just a straightforward yield comparison.
Often, that comparison favors moving.
If you’re holding in a taxable account, there’s a possible third reason to act now rather than later: realizing that loss can offset gains elsewhere. The tax code is quite literally rewarding you for doing the thing your instincts are resisting. The sunk cost fallacy is fighting you at exactly the moment the numbers are on your side.
So what do you think of my reasoning, does it make sense or am I missing something obvious? I’m not a financial advisor but it seems to me getting hung up on any bond losses shouldn’t be the driver of your decision making.
Delving into TIPS and TIPS ladders I stumbled upon Allan Roth’s personal experiment building a TIPS 30 year ladder about 4 years ago. It is a good read. But it highlights the volatility IF purchasing 30 year TIPS – duration can still hurt. While he bought when Yields to Maturity were high they have continued to rise in the long end. I think most would prefer not to have such volatility especially as there is no end in sight for the deficits. And in my 60’s thirty year bonds aren’t that appealing anyway!
Mark,
Thanks for another great article and keeping the TIPS discussion going. I hadn’t heard much about TIPS until post COVID and the recent 2022 bond crash, inflation, etc. “The Bond bull market is over and the Bond bear market is here to stay” seems to be the way the wind is blowing these days.
It certainly has sparked much discussion on HD, and many other podcasts, blogs, and YouTube Channels.
I follow Jesse Cramer and I had included his podcast on the subject in another HD TIPS article. Also, Rob Berger has expressed his bond investing philosophy to invest in 50% core bonds and 50% TIPS, similar to others in the comments thread (e.g., Rob Jennings). Many other financial experts are providing similar advice, saying it’s prudent to add TIPS in your fixed income portion of your portfolio. They typically offer 25-50% of your bond allocation…but I never hear 100%. And of course, William Dorner has expressed his preference in avoiding bonds all together and instead opting for S&P 500 and cash.
Add TIPS? How much?
For me I’m still mulling it over.
I currently am investing my fixed income portion of the portfolio in a mix of U.S. treasuries and corporate bonds: 2/3 short, 1/3 intermediate; 2/3 treasury, 1/3 corporate — all high quality investment grade. My cash is primarily in VUSXX (by choice) and VMFXX (sweep accounts). I want my fixed income to earn me something but I want it to be mostly low volatility. TIPS, to me is another coin flip on is inflation going up or is it going down. Most folks say “up!” I am staying away from long duration bonds. But I’m not investing in TIPS. Is this a contradiction in strategy or is it still a sound approach?
The TIPS choice stems from wanting to match spending liabilities and hedging for inflation. Currently, I’m choosing to implement an asset allocation, total return & rebalancing strategy in my upcoming retirement. I am selecting the fixed income portion to cover N number of years of expenses that I feel comfortable with (to cover near-term expenses and buffer for a market downturn) and using the equity portion for growth and an inflation hedge. Again, right now, I’m choosing to not include TIPS.
Choosing TIPS may be the right choice for some, but to me it still feels the TIPS bet could be “right” if inflation goes higher than the TIPS rate, or it could be “wrong” if inflation goes down. I am choosing to cover that inflation risk in the portfolio with my well-diversified (I think) equity allocation.
Personal finance is *personal* as they say, so we all have our personal approach…but I’m all ears if someone would like to offer any advice.
Andy, you seem to have a thorough plan for how you want your portfolio to operate.
I have one observation on your “coin flip” thinking about TIPS. To my mind, holding individual TIPS to maturity isn’t a coin flip on inflation direction—it is an absolute lock on purchasing power. The only thing “at risk” relative to nominal bonds is opportunity yield if inflation turns out to be unexpectedly dormant. But even in that scenario, your real purchasing power is still fully protected and increased.
My position might seem slightly ironic considering I built a 10-year nominal bond ladder rather than an inflation-adjusted one, but that was down to the practical and structural difficulties of doing so over here in the UK.