FREE NEWSLETTER
Go to main Forum page »
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.
Mark,
Thanks for replying. I like your “opportunity yield“ phrasing much better than my “coin flip” phrasing…thanks for clarifying.
Interest-rate direction is definitely a tough nut to crack and none of us know what really is going to happen much like the ups and downs of the equity market. I do have a plan, I’m still trying to determine the thoroughness… so still reading and still learning 🤔. TIPS may find their way in my portfolio yet 😉. The HD community is helping me in that regard.
For what it’s worth my portfolio is 45/45/10,
bonds are roughly 1/3 short term, 1/3 short term TIPS. The short term bonds for lower exposure to interest rate hike, TIPS for inflation protection, and intermediate for potential higher returns. All investments are in Vanguard index ETFs for low costs, and easier trading if I need to rebalance during my quarterly portfolio and net worth calculations.
Thanks, David.
My bond investments are also all in Vanguard index funds except for one small position in Vanguard Wellington fund (roughly 65/35% stocks/bonds, int core bonds). That is one of my original investments and in a taxable account. I’m trying to decide whether to leave that alone or rip the band-aid off and sell to further optimize asset location, but that is a discussion for a different time :-).
After reading several investment books before I retired, the only way to reliably beat inflation is to own stocks.
I little while ago I read somewhere, or I might have heard it on WealthTrack, that the return on German equity’s in the 1920’s kept pace with the hyperinflation that happened there.
A question about TIPS: what is the risk that the politicians will grab control of the inflation index and downplay it?
Yes – There have been references that the easiest way for the new Fed Chair to deliver on Trump’s desired low interest rates is to “refine” the definition of CPI? Hmmm. I’ve read this also helps the cost of debt which of course is becoming a very big deal; such that it might not mater who is in office. There has been such a huge retail push for TIPS ladders lately that that in and of itself gives me pause. Too often retail investors get the hard sale by the insiders, selling right before an asset has price issues. Between it’s existing volatility and the wonder of American Financial engineering I just haven’t been able to pull the trigger.
I hope that does not occur. The real risk in my thinking from such actions could could lead to higher real inflation, a higher expectation that inflation is uncontrolled going forward and a concern about the US dollar maintaining its status as the reserve currency of the world.
Exactly
i’ve used treasury direct a lot. can i buy tips there? wouldn’t that be the best source, no middleman…
My decision factor against holding TIPS at Treasury Direct in a taxable account is that if you have an unexpected event before maturity you cannot sell them at Treasury Direct. To sell would have to request transfer to a Broker which typically has a unacceptable time frame.
Yes, you can buy TIPS at TreasuryDirect, but I prefer Fidelity. There is no fee, you get the same deal. And at a broker you can buy in a traditional IRA, the best place for TIPS.
thank you
Yeah, that 2022 collapse was painful. I liquidated my bond funds (sunk cost) and used the proceeds to ladder MYGAs (at roughly 5.5%) to guarantee a rate of return to bridge me from retirement to SS.
Mark excellent article. However, I choose to ditch ALL bonds about 30 years ago and take the Buffett outlook. I switched to 85% Equities and 15% cash to tide me over on the lean years. Overall I have been all Smiles ever since.
William, every now and then I catch myself wondering why I don’t just use high-interest savings accounts instead of bonds. I’ve never really resolved that tension—I just end up going along with conventional wisdom.
Same here. Got out just as they started going down years ago. Now have VG federal MM in my IRA rollover brokerage account. Paying 3.62% now.
Thank you for the article and comments. For a baseball fan, the best way to understand sunk costs is to remember the guy hitting .205 with no power but playing for your team every day because he signed a huge contract 7 years ago!
Thanks for the memorable analogy!
As Ive commented here several times, we have owned 10-year TIPs as part of a liability matching strategy in retirement since 2017. We essentially have a hybrid collapsing/going ladder where we buy one TIPs per year and let one mature. The individual TIPs is matched against the projected gap between guaranteed income and all expenses (not just fixed). The individual TIPs are purchased depending on what is doing better at the time, stock or bond funds and factored into rebalancing. Our 40% bond allocation is split about 50/50 between individual TIPs and bond ETFs. Individual TIPs perform a bit differently than a TIPs fund (for example 2022) and holding them to maturity retains the purchasing power. They are not perfect as they have “phantom” income” if held in an after-tax account, which simply means one pays tax as you go prior to maturity. We essentially use them as part of an income floor as individualized alternative to an inflation adjusted annuity. Its not difficult to buy one TIPs per year, whether a new one or one in the after-market. TIPswatch.com is a very good website for learning about TIPs if interested.
Rob – What you are describing is interesting. Would you describe how your ladder was originally structured in 2017?
Rob, my retirement setup is a 50/50 hybrid. I built a collapsing bond ladder before retiring at 58 to act as a low-risk bridge until Social Security kicks in. But since I wasn’t sure which single strategy was best, I also bought a ten-year term annuity to cover the same period. Together, they handle my income needs and, more importantly, eliminate the hassle of managing withdrawals for the first decade of retirement.
I like your above reasoning Mark.
There is also a likely fourth reason. A bond fund held in a taxable account at death gets a step-down in basis (reducing the tax basis to the lower fair market value) if the original cost exceeds the fair market value on the date of death. The potential tax loss likely disappears upon the death of the owner and if you may get a tax benefit from claiming a loss during life by selling the investment then it is often better tax wise to sell the position with the loss during life.
It was unusual to run into people who knew their time living was short that cared about taking tax losses before they died so the moral of the story is to take action now if it matters to you.
William, thanks for adding a fourth reason. I was already stretching my US-specific tax knowledge to its limit just with my own ramblings.
Seems to me you don’t buy a bond fund for price appreciation, you buy it for the dividends. So there’s no need to wait for it to recover unless your crystal ball tells you interest rates are going down. Things aren’t as bad as they seem; if its price has gone down, its yield has gone up, helping your total return.
I’ve gotten rid of most of those pesky bonds in our taxable account, but if I still had a fund, I’d sell it for the tax loss and buy the TIPS in my traditional IRA. (Just bought the new 10-year TIPS for 2.4+% real yield to extend my ladder.)
Randy, I agree you don’t buy bonds for price appreciation, though I don’t hold them for the dividends either. For me, they’re more of a portfolio ballast to smooth out the ride.
Nice lock-in on the 10-year TIPS, by the way.
You are right. The only thing that matters is the price today and how this fits in your AA. What you paid for it is irrelevant to your decision.
Jerry, you summed it up perfectly in just three sentences.
I won’t get into the technical details of bonds and TIPS, because I’m horribly ignorant!
But thinking about the original buy price for any asset isn’t the point, and is at the essence of the “sunk cost” fallacy. The only thing that matters is how to best invest any given dollar today, regardless of what happened in the past.
I get that it feels bad to crystallise a loss, but staying in a sub-optimal asset isn’t going to make it any better.
On that note, we just sold a house that we lost lots of money on (long story with financial and non-financial elements). But we doubted that it was going to better in the near future, and the equity in the house was better put to other uses. So we sucked up the loss and moved on.
Greg, Taking a loss on a house is a tough pill to swallow, but you nailed the principle: keeping capital locked in a sub-optimal asset just to try to ‘get even’ is a classic trap.
As for the bond technicalities, I hear you! That’s why I prefer holding individual bonds to maturity these days. Knowing exactly what cash flow is landing on what date destroys far fewer brain cells than trying to understand fund duration and yield curves.
Mark,
In 2024 I switched from an intermediate to a short term bond fund in my taxable account. I decided it was not worth waiting for the intermediate bond fund to get back to equal. This money was originally put aside in 2019 to pay for new cars over the years, and a porch addition in 2028 so it seemed to make sense at the time. We got one vehicle paid for before the 2022 bond crash. The switch to short term bond fund was because we were much closer to utilizing the money. Now I told my wife she has to keep me alive for 5 more years to get the loss back in it’s entirety (this is another break for affluent investors in the US, we can get our loses back through a annual 3K tax deduction). Now my bonds are evenly split in our portfolio, 1/3 each in intermediate, short term, and short term TIPS.
David, nothing motivates longevity quite like spreading out a tax loss deduction over five years! I’m surprised I’ve missed this strategy in my financial readings lol
Actually my investment loss was 21K, so it is spread over a total of 7 years, as the IRS only allows one to claim a maximum 3K annually when filing. 2 down 5 to go. Long live the king?
😂
That strategy of tax loss harvesting and locking in losses intentionally can seem counter intuitive, but you are basically having the government subsidize your move from one equity which is under water or no longer suitable to a different one and using those losses to offset gains or even up to $3000 of ordinary income each year. I sued to think , I will just wait for it to come back… that is no longer my stance, if it is under water and there are better options, I sell at a loss, book the offset and move on. Waiting for the investment to even get back to par is a losing proposition in most cases.
Prior to moving our IRAs to Fidelity, I had primarily been using a balanced fund, so never had to give any thought to allocations, other than 60/40 vs 70/30. When deciding on ETFs at Fidelity, I looked at the total bond ETFs and thought, yikes, these things still haven’t recovered to their 2021 levels. So, partially based on the opinions of my fellow HumbleDollar nerds, I made Vanguard’s VTIP my main bond position. I also have a five year CD ladder, which all by itself can protect me from a lost decade.
Just for fun, I have a small stake in Fidelity’s FAGIX, which is a high yield play. It probably has a higher correlation with equities, so I don’t really consider this a defensive device.
And who’s to say those bond funds won’t take another nasty hit in the future. So, yes, I’d eat the loss and switch to TIPs.
Dan, does your 5 year CD ladder reflect increasing yield in each year CD? In other words, is it based on an upwards sloping yield curve? Unless you got your CDs through a brokerage search, I’ve found most banks are paying more for shorter term CDs than 5 year CDs. I did my fixed income ladder using Target Date bond ETFs which all seem to have the traditional upward sloping yield in each increasing year with my 5 year ETF at around 5%. The investments are all in investment grade bonds and virtually eliminate interest risk if held to the target date. This gives me more of the traditional advantage of always getting the most yield out of my longest year ETF. My overall yield is around 4.75% and will gradually increase assuming interest rates don’t change and I reinvest each maturing ETF in a 5 year target date.
Steve, I’m going to put my ignorance on display. I was unaware of target date bond funds (until now). They actually have a fixed expiration date! Your yield is nearly 1% better than my CD LADDER. Amazing.
Dan, I’m not far behind you on this one. I only learned about the product recently, through a comment on another forum article — unfortunately, my memory’s like a goldfish, so I can’t recall who posted the comment or who wrote the original article.
Mark, thanks so much for making me feel less like a dolt! Seriously, Steve’s reply is another great example of things that make HumbleDollar a great place to hang out.
Dan, Sounds like we think alike. As you might recall, I have a 10-year nominal ladder setup for the exact same peace of mind. Mine is structured as a collapsing ladder specifically to cover living expenses until Social Security kicks in
I’m not convinced that selling a bond fund in a taxable account and replacing it with a TIPS is a good idea. The taxation of individual TIPS in a taxable account involves paying taxes on phantom income. In other words, there is no current cash flow for this income. If you are speaking about a TIPS bond fund, you could have the same issues of the fund declining in value as rates rise. TIPs generally belong in tax deferred or tax paid accounts.
I used to think that way and put 5 and 10 year tips in my IRA & Roth but once could make the case that it makes some sense in a brokerage. 1.) You spread out the income taxes over the life of the bond and avoid a tax bomb. Those of us with ibonds will know what I mean. 2.) In many states, treasury income is tax free while income from retirement accounts comes out as regular income for the state. Depending on your income, that way also be tax free but the ceiling in NJ for that is not all that high. My point is there is no perfect way to avoid the tax man, I now buy tips is all accounts-gotta be right some of the time..
Good point, Harold. Tax implications are always the wild card here. To clarify, I was picturing selling the fund at a loss specifically to construct a ladder of individual bonds to maturity—locking in that real yield directly rather than holding a fund with no fixed end date. But you’re right: in a taxable account, the tax treatment of the inflation adjustment definitely eats into the net math.