In this Ask The Expert With Larry Swedroe article, Randy is shying away from the stock market and wondering if he should invest his money in Treasury Inflation Protected Securities (TIPS), or in Certificates of Deposit (CDs). Here’s the question from Randy:
Hi Larry…..seeing that the 5 year TIPS auction in January (reissue) offered a nice real return (as it was sold under the coupon par, I am looking to buy either the 5 or 10 year TIPS in the upcoming April auction. Since deflation is predicted to hang around for a few years, is it wise to buy the 5 or 10 year TIPS in April?
Lastly, since I also have some cash to invest, and am shying from the market, am I better off investing in TIPS with cash also in April, or better off going with CD’s. Maybe you can reiterate how the tax situation works with TIPS if you feel that going with TIPS is a good option with cash. Thanks!! p.s.- I am in the 25% tax bracket
Randy, I would ignore all economic forecasts such as the one you mention about deflation. There are no good economic forecasters. The historical evidence demonstrates that they have no better track records than the proverbial “monkey throwing darts.” If you are interested in the subject, I suggest you read a wonderful book by William Sherden, The Fortune Sellers: The Big Business of Buying and Selling Predictions.
You should never invest in anything you don’t fully understand. Thus I urge you to learn more about TIPS before you buy any. There is a chapter on them in my new book, The Only Guide to Alternative Investments You’ll Ever Need. That book provides you with tables to help you decide on which TIPS to buy.
It is perfectly fine to buy TIPS at the auctions — that saves any bid-offer spread you will pay in the secondary market. However, the secondary market for existing TIPS typically offers better values for buy and hold investors. One reason is that the older TIPS (called off the run bonds) are less liquid than the new TIPS (called on the run bonds). Thus you get paid a liquidity premium.
Additionally, most of the older TIPS have an inflation factor built in which does create some incremental price risk over a new TIPS. However, unless you believe that there will be cumulative deflation over the full remaining life of the TIPS then you are getting an extra return. In my view, while that risk exists with TIPS of more than just a few years that risk is minimal. Since the Great Depression we have never had a period of even two years of cumulative deflation and the very easy monetary policy we have now means that the far greater risk is inflation.
In general, TIPS should be held only in tax exempt accounts, unless you are in the lowest tax bracket. At your tax bracket I would recommend intermediate term AAA rated municipal bonds (not too long because of the inflation risk). My own municipal bond portfolio has maturity of under 5 years. (note the muni curve is typically steeper than the Treasury curve so you get paid more to take the price risk of longer bonds).
Personally, I just bought some of the January 2016 TIPS with a yield to maturity of 2.47 percent. I hope that is helpful.