The Permanent Portfolio, Investing, Finance and Random Thoughts.
TIPS are a Bad Idea
People sometimes want to know my view on Treasury Inflation Protected Securities (TIPS) vs. Gold for inflation protection. Well, I have boiled my research on this topic down into two simple rules:
Rule #1 – Don’t let the people causing the inflation tell you what the inflation adjustment rate on the investment will be.
Rule #2 – Don’t let the people causing the inflation pay you in the same currency that is being inflated away.
Explanation:
Rule #1 – Governments lie. Yes, that even means your government. When inflation is raging it is the government that will lie about the problem to protect itself. I have studied the financial history on this and it is just what happens in every country. And is it really surprising when you have your population angry that they can’t afford life necessities due to poor management of the paper money supply? Of course the pols are going to lie to protect their necks. Gold though is independent of government spokesmen, incompetent economists and political speeches. The price of gold is going to react to market forces and is not going to be weighed down in govt. policy decisions about true inflation figures, etc. Gold doesn’t care. TIPS however have this huge conflict of interest involved.
Rule #2 – If there is high inflation, then why in the world would you want more of the currency being debased and losing value? You don’t. You wan’t much less of it. In fact, you probably want to hold only the bare minimum to pay for current living expenses and that’s it. Yet, TIPS are paying your inflation adjustments in dollars. If the dollar is falling rapidly under high inflation why would you want more dollars? This only benefits the currency issuer, not you.
Gold has its own quirks and I acknowledge that. However it doesn’t have these very serious drawbacks that TIPS possess. But when it comes to serious inflation protection I believe that TIPS are not the solution. I just don’t know how to say it any clearer. Don’t buy arson insurance from arsonists and don’t buy inflation insurance from inflationists. It’s just a really bad idea.
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#2 written by Jimbo 1 year ago
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It doesn’t worry me because alternatives can be just as bad or worse. The reason for the gold is it is very volatile in the face of inflation. It will go up very strongly in price (especially compared to TIPS). The downgrade of the US has been talked about for ages. It may happen, but we just don’t when. Could be another 20 years or longer for all I know.
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#4 written by Jimbo 1 year ago
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All-
Let’s not forget what risks and opportunities the Harry Browne 4 by 25% Permanent Portfolio addresses:
LT Bonds address the risks associated with Recession. (R)
Gold addresses the risks associated with Inflation. (I)
Stocks provide the opportunity to capitalize on Growth. (G)
Cash/Short Bonds provide the opportunity to offset deflation, and they provide stability. (S)
When you think about it, RIGS addresses the usual 4 phases of the business cycle.
It seems to me that TIPS are just one more “gimmick” investment, and they are redundant to the LT Bond position in the Permanent Portfolio.
Your thoughts?
Marshall Costantino :+>)
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#6 written by Jimbo 1 year ago
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#7 written by MachineGhost 1 year ago
I think the below is more accurate for the HBPP:
Cash: Disinflation
Stocks: Inflation
Bonds: Deflation
Gold: StagflationIt may not matter as to the correct semantics when holding all assets simultaneously, but to perform any kind of strategic or tactical asset allocation successfully, one better know the real world difference between inflation and stagflation.
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#8 written by MachineGhost 1 year ago
Oops, I may now quibble with my use of Disinflation for Tight Money, but that’s what I had in mind for Cash. I can’t recall at theres an “…flation” term for that.
The only real substitute for Treasury Bonds is I-Bonds, yet the lack of nominal principal flunctuations reduces the strategic allocations necessary for the other asset classes, particularly gold.
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#9 written by PPlooker 1 year ago
I’ll just never get the hate for TIPS (well TIPS held in tax advantaged accounts at least) I suppose. It’s as if no one comprehends you can have gold and TIPS at the same time in whatever proportion you feel is most prudent.
To be clear, I don’t think TIPS work in the PP, the “quirks” of gold are part of what make the approach work and TIPS just won’t do, but they can definitely have a place in the VP.
Not to be combative bit it gets tiresome to constantly hear of the shortcomings of the CPI figures, as if though a rational person needs it explained to them more than once or twice why such a measure is inevitably flawed. I understand that and I think most people who care to learn about the CPI figures do too.
The problem is the flaws, although known, are not determinative in whether one should hold TIPS or not. Any way we try to measure inflation is simply going to fall short in either its incompleteness, or it will be too comprehensive, relative to any individual investor.
Can we never get any acknowledgment that an individual could be aware of these problems and yet find utility in TIPS to the extent the rates correlate to that individual’s needs and goals, or must it always be this dogmatic hatred of TIPS?
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PPLooker,
If someone wanted to use very short term TIPS or iBonds for their cash allocation I probably wouldn’t have big issues with it. But I definitely would not use them to replace gold in the portfolio. Also TIPS should ONLY be held in a tax-deferred account. Holding them in a taxable account guarantees you no more than break even at best, or a loss at worst. You have to pay taxes on all the inflation adjustments so the more inflation there is, the more you pay in taxes.
One of my big beefs with TIPS is they are billed constantly as the “safest” investment you can own. Some academics even recommend 100% TIPS portfolios for everyone. This is just insane from a risk control standpoint. I would never advocate anyone put 100% of their money in any investment. I don’t care who is touting it or what the guarantees are.
As for the CPI. I think it is a gross measure of inflation and reasonable at low inflation levels (but I do think it understates many costs such as health care, etc.). However at high inflation levels there is tremendous political pressure to present a lower CPI to deflect public scrutiny about actual inflation. This has happened over and over again in countries that have experienced very high inflation.
Lastly, when you buy an inflation indexed product and the issuer is telling you what the inflation adjustment is you have a serious conflict of interest. I don’t think this issue is easily resolved or can be easily ignored. Just recognize that this is a risk and, like you said, be aware of it.
Thanks for the comments.
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#11 written by MachineGhost 1 year ago
Inflation-indexed bonds are really only useful in the real world during portfolio distribution periods where income is needed which needs to be “protected”. There are a lot of real world issues way beyond “CPI understating inflation” that very few know about when it comes to inflation-indexed products, but I won’t discuss them here (it would scare anyone cold).
In context of the PP though, TIPS really do not make sense because the PP is not about income, but primary real wealth preservation, growth secondary and income dead last. Reducing any allocation to gold with TIPS is not a proper substitute as history shows, especially 2008. Any stance to the contrary is just behavioral psychology issues, probably the normalcy bias.
Technically, the PP is likely to be far from ideal for actual retirement planning purpose. Until the proper software tools are developed, there is just no way to know if 25×4 is good or bad for anyone’s particular situation. But historically, the PP does a better job at mitigating Sovereign Risk than just stocks, bonds, inflation-indexed bonds and cash. Investors in Iceland, Argentina, Germany, Zimbabwe during the past 100 years would have a completely different viewpoint on the 25% into gold than Americans, Canadians, Australians and New Zealanders. However, its hard to overcome the perfectly valid feelings that the gold allocation is “too large” until after that fact.
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Great post. Goverments lie? An understatement if there ever was one.