If you think nothing good came out of our recent bout of inflation, consider Treasury inflation-protected securities, or TIPS. Less than two years ago a 10-year TIPS yielded negative returns. The real yield on the same investment now averages more than 2%—plus inflation.
There’s a way for retirees to get guaranteed cash flow of more than 4% off their retirement portfolio, no matter how the market performs or how much inflation rises: Invest in a 30-year TIPS ladder. Like a conventional bond ladder, an investor can create a staggered portfolio of TIPS that mature at regular intervals. As of Thursday’s close, the real rate of a 30-year TIPS ladder was 2.25%.
Big brokerages can help you construct such a ladder, and there are do-it-yourself type websites like tipsladder.com that outline exactly how much you will need to produce the desired yearly income in your desired time frame.
As real rates have surged, “TIPS rates are more attractive than they’ve been in over a dozen years,” says Allan Roth, a certified public accountant and founder of Wealth Logic in Colorado Springs, Colo.
TIPS are inflation protected bonds issued by the Treasury. The value of a TIPS principal is adjusted higher when the consumer price index rises, resulting in increased coupon payments. The Treasury pays the interest on the adjusted face value of the bond, creating a rising stream of interest payments so long as inflation continues to rise. When the TIPS matures, the investor gets the original face value of the bond plus the sum of all inflation adjustments since the bond was issued.
“Two years ago, you were locking in to underperform inflation [with TIPS], while today, you’re being guaranteed to outperform inflation,” Roth says. “While I don’t know future rates—nominal or TIPS—I do know the 2.4% real rate is a heck of a lot better than the -1.02% it was two years ago. I would not have recommended the TIPS ladder two years ago.”
A TIPS ladder is meant to give you a predictable inflation-adjusted cash flow. “The only thing that matters is real spending power,” says Roth, who wrote about the benefits of TIPS in Barron’s recently.
The total yield on a 10-year TIPS (including the inflation adjustment) was recently 2.13%. The traditional 10-year Treasury note was 4.35% (not adjusted for inflation). So TIPS will perform better than traditional Treasuries if inflation averages more than 2.22% over the next 10 years.
TIPS make the most sense when there’s the possibility of inflation that’s higher than what the market expects. No one can tell you future inflation with any certainty. But given that we are in a period of record-high U.S. deficits, high inflation is certainly possible.
How to build a TIPS ladder?
BlackRock’s
iShares launched a set of defined maturity TIPS ETFs this year, consisting of 10 funds that invest in TIPS with maturities from 2024 to 2033. Roth says this lineup makes it much easier to build a 10-year TIPS ladder, but notes the “biggest risk of higher-than-expected inflation comes after that first decade of compounding.”
Tipsladder.com helps retail investors design a TIPS ladder if you want to go it alone. Input a few pieces of data, including when you want the ladder to begin and end and your desired annual real income, and you can see what your TIPS ladder would look like, year by year, including links to the Treasury’s information page about that specific security.
As an example, Barron’s put in a time frame of 2024-2053, with a desired yearly income of $40,000. The resulting table lays out how many TIPS needed to buy for each year with the corresponding TIPS Cusip number, the cost and the cash flow produced for each year. For our 30-year example, the total cost to buy all the TIPS was $881,363, and the real (inflation-adjusted) cash flow comes to $1,200,343.
You can buy TIPS through TreasuryDirect.gov at auction or on the secondary market through brokers, including Vanguard, Fidelity and Charles Schwab. Investors looking to build a TIPS ladder can, for instance, do so on Fidelity’s site or with the help of a fixed income specialist with a minimum of $1,000.
One complication is that there are no TIPS that mature between 2033 and 2039; the workaround is to buy more TIPS that mature in 2032 and 2040.
Indeed, TIPS are a niche and nuanced market and building a ladder can be confusing, says Collin Martin, fixed income strategist at Charles Schwab. He says it makes sense to work with a professional or brokerage representative when constructing a ladder.
As with any particular investment, a TIPS ladder should be part of a retirement portfolio, not the whole thing. Roth advises clients to limit TIPS to 30% of the bond portion of their portfolios.
“With TIPS you’re sort of making a bet on what inflation will do over that holding period. If you go all TIPS instead of traditional Treasuries, and inflation doesn’t go up as you expect, you might have been giving up some yield with the nominal Treasuries in hindsight,” says Martin.
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