Want a Guaranteed Loser? Try TIPS


Newsweek Inflation ImageBond yields are at all time lows, and with Treasury Inflation Protected Securities, or TIPS, you can go even lower.  You can buy now for a guaranteed loss.

What a world we’re living in!

The issue with TIPS is that the yield is keyed to interest rates AND inflation.  And with both at all time lows, buying a TIPS style bond now means you will be in for a losing ride in real (buying power) terms.

The Wall Street Journal published a good article on the topic, HERE, and it’s quoted below

Would you buy an investment that was guaranteed to lose money?

That is the situation investors are embracing today in the market for Treasury inflation-protected securities, or TIPS—bonds issued by the U.S. Treasury whose value is designed to keep up with consumer prices.

The effective interest rates on TIPS have collapsed to record lows. It is mathematically impossible now for investors to earn respectable returns from any of them, and in many cases they are a lock to lose money in real, inflation-adjusted terms.

This doesn’t mean you should dump all of your TIPS at once. But by selling long-term TIPS and holding only short-term ones, you can lock in your biggest gains today and reduce the odds that you will be stuck holding money-losing investments years from now.

TIPS, which have existed since 1997, are a fine idea on paper. The principal adjusts twice-yearly to take account of changes in the consumer-price index. So for the life of the bond, the investor is guaranteed that his investment will keep up with inflation and earn an additional interest rate, known as the “real return.”

Typically, say analysts, these bonds have usually been considered good value when they have offered a real return of 2% or more a year. That has approximated the average historical return, after inflation, of regular bonds.

Yet today’s TIPS yield a fraction of that.

The 30-year TIPS today offers a real return of inflation plus 0.5% a year. For TIPS coming due within the next 10 years, the real return is negative: Your investment is guaranteed to leave you poorer, in real terms, than you are now. A five-year TIPS today locks in an interest rate of inflation minus 1.4% a year. Over the life of the bond, investors will lose 7% in real terms.

Paul Winter, a 20-year veteran of the bond market now working as a fee-only financial adviser in Salt Lake City with $30 million under management, considers all TIPS a poor investment.

Yet they remain popular. FRC, a Boston firm that tracks the mutual-fund industry, says U.S. investors own at least $145 billion worth of TIPS through funds that specialize in them. The amount of TIPS in circulation has risen 50% in five years to $850 billion, according to the U.S. Treasury.

Investors have been buying TIPS in recent years for two reasons, say analysts. Some are looking for a better alternative for their short-term money than cash, which is earning almost 0%—and less than inflation. Others are looking for long-term protection against the risk of surging inflation.

Investors seeking short-term alternatives to cash should stick to short-term TIPS, preferably those that mature within five years.

The Federal Reserve, trying to kick-start the economy, is keeping short-term interest rates at zero and is taking action to drive down long-term rates as well. For savers, this means regular bank deposits, money-market funds and short-term Treasurys effectively lose them money each year. Short-term TIPS, while ugly, might be less so than the alternatives.

There is an argument for using TIPS as a safe-haven alternative to Treasurys. “If I buy nominal Treasurys right now, I can basically earn 0% in a 3%-inflation environment, so I’m losing 3% in real terms per year,” says Carl Friedrich, chief investment officer at Piermont Wealth Management in Woodbury, N.Y., which has $130 million under management.

By comparison, he says, some TIPS don’t look so bad.

Investors seeking longer-term protection against inflation should also stick with short-term TIPS. Even though long-term TIPS might offer higher real rates of return, they are much more volatile, Mr. Friedrich says. If interest rates rise across the economy, he says, those longer-term bonds could fall sharply in price.

“If you’re going to take a position in TIPS,” Mr. Friedrich says, “keep the maturity at the short end, ideally no more than five years.”

Logically, owning long-term TIPS will probably work out well only if the economy plunges into a multidecade deep freeze or bursts into rampant runaway inflation. In either scenario, one can expect plenty of volatility ahead—and many opportunities to earn better rates of return than half a percent a year.

The smart move now is to cash in gains on long-term TIPS.

Bonds are like seesaws: The yield falls as the price rises. TIPS yields have collapsed as their price has risen. The longest-term bonds, which are the most volatile, have risen the most. The February 2040 TIPS has risen 40% in price since it was issued three years ago. Investors are sitting on some hefty capital gains.

So it makes sense to cash those in. As an added bonus, the gains, assuming the bonds have been held for more than a year, will be taxed at a maximum rate of 23.8%. The annual income from the bonds, if held, will be taxed higher as ordinary income.

Investors still looking for long-term protection against the risks of high inflation in the future might find better value in real estate, such as in investment properties, and in commodities, both of which look cheap compared with their long-term averages.

Junk Bonds’ Fire Is Poised To Fade

Junk Bond Yields Peaked

See Full Image At WS Journal

Is this a sign of peak low rates? Junk Bonds, the highest risk/ highest yield segment of the bond market, has been on a tear over the last year, and those gains (price increase/ yield decrease) roared on in the first days of 2013.

Bond yields have been marching steadily down- the chart on the left shows the prices rising up up up.

One has to ask, in this marketplace of compressed yield and increased frothiness, why jump into a junk credit yielding 5% when you can lock in a 5+% yield from  the likes of Met Life, NY Life, or Allstate?

These are companies with rock solid credit ratings, hundreds of years of operating history, massive reserves, and solid operations…

If you’re a buyer of junk bonds, you are either buying with an intent to hold to maturity, or you’re buying in full knowledge that you will likely loose money when you go to sell.  If you’re not aware of these two distinct possibilities, then perhaps the junk market is not the right place to be now?

Take another at the high yield but SAFE investment in the form of Secondary Market Annuities – a great fixed income alternative.

Of course, if you’re interested, give us a call.

The original WSJ article is here.


A Happy New Year? Not For Bonds


WSJ bond prices chartA recent Wall Street Journal article highlighted the Russian Roulette investors are playing in the bond markets.  The slightest upward tweaks in interest rates sends bond prices falling… and when prices fall, you lose money if you have to sell.  Bond buyers nowadays need to be making a ‘yield to maturity’ play, and plan on holding whatever they buy for the duration.

Case in point:

In the first two days of the year, prices for the benchmark 10-year Treasury have tumbled, sending the yield above 1.9% intraday Thursday, the highest level in eight months.

The article continues along with this intriguing piece:

The sudden moves have put investors and analysts on guard. Some are beginning to question whether Treasury yields, which have been stuck between about 1.60% and 1.80% for the past six months, may kick higher. Some wonder if they may even soon surpass 2%, a level they haven’t breached since last April. Many investors have been reluctant to bet against long-term Treasurys, in large part because the Fed has been such a big buyer of the debt and because intermittent shocks over the past few years—from worries about the U.S. economy to Europe’s debt crisis and troubles in the Middle East—have consistently sent investors scurrying to Treasurys for safety.

That has helped propel the bull market in Treasurys into a third decade.

Read that carefully- the FED is the largest buyer of the Treasury debt, keeping the rates artificially low and stable, and propelling a bull market in treasuries into a third decade.

Snake, eating its own tail?  How long can the charade last?

In a totally unrelated section of the paper, Rich Karlgaard, an excellent write at Forbes, had a WSJ editorial about Ponzi schemes.  He focused on Herbalife, but I suspect his keen and penetrating intellect could rip the Fed/Treasury farce apart.  We might not like what he has to say however.

Read Rich’s article here- it’s good.
A Short Seller Takes on a Vitamin Vendor


No Easy Money in Muni Bonds


Jason Zweig is usually a surly and negative financial commentator.   I can’t recall the last time one of his columns said much positive about any financial marketplace.  This week is no exception as he takes aim at Muni  bonds, which many of our clients considering Secondary Market Annuities also hold.

I guess his position makes sense for someone  going IN to Munis in this marketplace… yields are so low that you must plan on holding to maturity (at 1-2%…), as any uptick in rates will result in a loss of principal.

But for those holding good munis with an attractive yield not threatened by maturity or a call provision, just hold tight.

This may sound  funny coming from someone selling financial products that compete with Munis.  But the truth is, a good yield on a tax free asset is just worth keeping.  Without question.

But What About Secondary Market Annuities?

Now that said, some of our clients are invested in Munis that have good yields, but the bonds are coming due, or are callable.  For those situations, Secondary Market Annuities are a great  alternative or re position investment.

Take a Muni yielding 5% tax free- it might have been issued 5 or 10 years ago, and if you  hold such a gem, you bought it a long time ago.  Your friends though you were weird settling for such a super low return then…. but you look like a genius now as it’s that’s a GREAT  tax free yield.

But then say your bonds mature in 2013.  You know you have liquidation coming soon, and you have to replace the investment.  What can compete?

We have clients in this exact situation… and they are choosing Secondary Market Annuities with yields in the 5-6% range.

They are replacing the yield on their Muni portfolio, selling their bonds that have short maturities, and re positioning in the best way they can find now.

And I think it’s a great strategy.


Read Mr Zweig’s dour assessment of Munis here if you want.  As with most of his work, he’s negative and arrogant at the same time, but does make some good points.

How to Beat Bonds Using Social Security


Knowing when to take Social Security can be a real chore.  We frequently work with clients to determine the optimal time to take the benefits.  There are different ways to calculate the benefits of waiting, and this recent WSJournal article equates the return to a bond investment, with a surprisingly high payoff.

Consider an unmarried man in average health, age 62—the youngest age for starting retirement benefits. His payoff for waiting until age 67 to collect is the equivalent of buying a long-term bond that pays 3.2% a year. For a woman, all else held equal, it’s a 4% yearly return, according to Mr. Shoven and his research partner, Sita Slavov at Occidental College.

Here’s the whopper: For married couples, if the higher-earning spouse delays payments from age 62 to 70, but at age 66 begins collecting spousal benefits from the lower-earner’s plan (as Social Security allows), the return is like owning a 7% bond.

Not just any bond, either. The fictional alternative would have to be government-guaranteed and provide periodic inflation adjustments. And the income would have to be tax-free for most recipients.

The closest real-world investments are Treasury inflation-protected securities, or TIPS. They’re government-backed and inflation-adjusted, but they’re subject to federal (but not state and local) tax. Ten-year TIPS on Thursday paid minus-0.21%. That’s not a misprint; bond rates are so low that investors are paying to own TIPS just to get the inflation adjustment.

Put differently, a 7% annual return for delaying Social Security payments is for many investors better than a bank certificate of deposit that pays more than 10%, considering the inflation adjustment and tax advantages.

But beware- making any long term plans based on politics is bound to disappoint.

Some retirees find advice on when to start Social Security benefits confusing. That’s because even a ballpark calculation must consider not only factors like gender, marital status, income and health, but also long-term changes to life expectancies and short-term changes to interest rates.

For now, the deal remains sweet. The plan’s trustees say there is enough cash to pay full benefits through 2036 and three-quarters of benefits thereafter, and Mr. Goss says such deadlines historically have served as a call to action for Congress.

Members of both parties are considering legislation to rein in costs. “We clearly have to make changes to things like the retirement age to keep the program affordable,” says Sen. Tom Coburn (R., Okla.), the ranking member of the Finance Subcommittee on Social Security, Pensions and Family Policy.

If you’re making plans based on maximizing Social Security, be sure you have a fallback or contingency scenario in case benefits change during your waiting period.

Are You a Stock or a Bond? A Moshe Milevsky Analysis


The title of my post this week comes from Professor Moshe Milevsky for the second time.  I’m giving you all a break from reading and including a link to this video where the good professor talks again about the difference between personal and financial capital.

Moshe Milevsky Annuities Analysis

Mr. Milevsky makes is very apparent that the amount of risk a person takes with financial assets should be inversely related to the type of risk associated with an individual’s personal capital.

If your income is unstable, your invested assets should be allocated conservatively.  Also, as your number of earning years decreases so should the level of risk on your financial assets.

Milevsky and I share these beliefs and I enjoy seeing someone of his stature provide evidence of the need for conservative retirement planning.

Annuities work well within this planning framework.  Each of you here understands that to a certain degree, which is why I am working to clarify the need for and use of annuities in retirement income planning.

Revisit the available reports and feel free to call or email at your convenience with specific questions you may have.

If you are not a member, sign up now for all the free information that will make the process of retirement income planning much more simple.

Please follow this link to see Dr. Milevsky’s video.