Treasury Inflation Protected Securities (TIPS) Are Today’s Most Underrated Asset Class

It takes a long time for InvestoWorld to wake up to new realities. Treasury Inflation Protected Securities are an amazing asset class. In most circumstances, they are better than bonds. In many circumstances, they are even better than stocks.

TIPS

Reason #1 Why Treasury Inflation Protected Securities (TIPS) Are Today’s Most Underrated Asset Class — TIPS Are the Perfect Remedy for Overvaluation

I have been arguing the merits of TIPS for a long time. I took my money out of stocks in 1996 because of concerns re stock overvaluation and went looking for an asset class that promised to preserve capital while not failing to keep up with inflation (the big downside of certificates of deposit). I was thrilled when Treasury Inflation Protected Securities came along. Unfortunately, it was hard to persuade investors of their merit for so long as stock prices remained high. But I have seen more interest in alternatives to stocks since the price crash (this article was posted in March 2010).

I doubt there has ever in history been another time when an asset class that comes with a government guaranty offered as much of an edge over stocks as Treasury Inflation Protected Securities offered over stocks in January 2000. The Stock-Return Predictor tells us that the most likely annualized 10-year return for stocks purchased at the prices that prevailed at that time was a negative 1 percent real. TIPS were paying 4 percent real. That’s a differential of 5 full percentage points of return! Every year! For 10 years running!

Do the math and you learn that buying TIPS at a time when 90 percent of the “experts” were recommending a high-percentage stock portfolio put you ahead by 50 percent of your initial portfolio amount at the end of 10 years. Those with $100,000 saved were likely to be ahead by about $50,000 ten years later. Those with $500,000 were likely to be ahead by $250,000. Near-retirees who enjoyed $1,000.000 of accumulated wealth in January 2000 were able to put themselves ahead by $500,000 just by making a decision to buck the experts from The Stock-Selling Industry and invest in Treasury Inflation Protected Securities instead.

And then there’s compounding. Those who are ahead today by $50,000 or $250,000 or $500,000 will move even farther ahead over the years as the earnings differential for investing in the non-stock asset class grows and grows.

Stocks are not as overvalued today as they were then, to be sure. So the differential going forward is not likely to be as great. But the historical data shows that, every time stock prices have risen to twice fair value, they have fallen to one-half fair value in the huge bear market that inevitably followed. That’s a price drop of over 60 percent from where we are today. So a good case can still be made for the asset class that is my favorite at times of dangerous overvaluation.

Reason #2 Why Treasury Inflation Protected Securities (TIPS) Are Today’s Most Underrated Asset Class — They Are the Perfect Counter to Stocks

TIPS are a better alternative to stocks than are corporate bonds. The conventional investing wisdom is that the money you don’t put into stocks you should put into corporate bonds and the money you don’t put into corporate bonds you should put into stocks. But why? This wisdom was developed at a time when Treasury Inflation Protected Securities did not exist. We need to rethink it. When we do, I think we will see that TIPS do the better job of serving as the alternative to stocks.

Treasury Inflation-Protected Securities

Diversification offers the proverbial free lunch. Diversify effectively and you obtain higher returns without taking on added risk. Bonds and stocks have long been pushed as the perfect combo of investment classes for diversification purposes. But I don’t see it.

The downside of stocks is that prices are prone to crash at times of high valuation. What asset class performs in an opposite way and thereby provides great diversification? It’s not corporate bonds. Bonds sometimes do poorly at the same time as stocks are doing poorly; bad economic times can cause trouble both for those holding stocks and for those holding bonds. The magic of Treasury Inflation Protected Securities is that they are the precise opposite of stocks. Stocks offer high growth and high price volatility. TIPS offer limited growth and perfect stability; you know what your long-term, inflation-adjusted return will be on TIPS on the day you purchase them. That’s diversification!

When I am seeking growth in an investment class, I go with stocks. Bonds just are not as strong in the growth department. But when I am seeking stability of return, I go with Treasury Inflation Protected Securities. Bonds are not only not as growth-oriented as stocks, they are also not as stable as TIPS. My view is — Go with stocks when valuations are moderate or low and the long-term value proposition of stocks is strong and go with Treasury Inflation Protected Securities when buying a stable asset class makes more sense.

Reason #3 Why Treasury Inflation Protected Securities (TIPS) Are Today’s Most Underrated Asset Class — They Are the Easiest Asset Class to Understand

There is a crying need today for simple investment strategies. Middle-class workers must invest effectively if they are to build successful retirement plans. But millions of today’s investors do not have the interest or background or experience needed to become experts on scores of different investment topics. We need “good enough” investment options that can be fully comprehended with minimal effort (the biggest investment risks come from making choices that you don’t fully understand).

You want simple? Go with Treasury Inflation Protected Securities. Go to the Treasury Department site explaining what Treasury Inflation Protected Securities are about and all your questions can be answered in an hour or two of study. You put your money in. You get the return promised. It really is as simple as that. TIPS are the perfect investment class for today’s middle-class investor.

Reason #4 Why Treasury Inflation Protected Securities Are Today’s Most Underrated Investment Class — They Earn Higher Returns Than You Think

The Stock Selling Industry sells stocks. Hard. Surprise! Surprise!

We have all been subject to so much marketing (disguised as “expertise”) on behalf of stocks that we have come to believe that stocks always offer the highest returns. Um — not so. The proper way to identify the long-term return of an asset class is to look not at the return provided on paper but to look at the return provided to real live investors. In the case of Treasury Inflation Protected Securities, there can be big differences.

Safe Investing

If you are buying TIPS because you want a portion of your portfolio to be in a rock-solid safe investment class, you really will earn only the return stated. With TIPS, that can be a low number, perhaps 2 percent real or so. But another option with TIPS is to hold them at times when stock valuations are high and the long-term value proposition of stocks is poor and then to shift the money held in TIPS to stocks when stocks return to moderate or low valuation levels and the likely long-term return on stocks goes sky-high.

Again, The Stock-Return Predictor (see link above) tells the story. If stock valuations drop to one-half fair value in coming years (as they did on the three earlier occasions when we permitted valuations to go to insanely dangerous levels), the likely annualized long-term return for stocks will rise to 15 percent real. If you hold money in Treasury Inflation Protected Securities earning 2 percent real for five years and then shift it for five years to low-priced stocks likely to provide a long-term return of 15 percent real, is your 10-year return 2 percent or something a good bit higher than that? It seems to me that it is something a good bit higher than that.

Treasury Inflation Protected Securities are a wonderful asset class for the investor pursuing Valuation-Informed Indexing, the strategy advocated at this web site. TIPS came along just in time!