CPI Plus 2.72%?

There's been a lot of attention lately to real yields on TIPS approaching 3%. These yields that Copilot found are probably stale by a few days but current enough for this post. 

We've talked more about the concept of real yields/return a few times lately. Generically, a real yield of 2% is considered a benchmark or sort of minimum standard. Real yields have been heading in the right direction from the perspective of investors for the last few years based on the UTEN ETF, which is not a TIPS product, but haven't been attractive.

This relates to recent posts where we've talked about foundations often seeking CPI plus 5% for an entire portfolio, the context of this is CPI plus almost 3% for a sleeve of the portfolio. The ten year and further out TIPS are still duration. If interest rates go meaningfully higher without a big step up in headline inflation then the prices of TIPS bought at 5.11% nominal/2.72% real will still go down a lot in price. If rates move higher along with noticeably higher price inflation, then the par value will be reset but it's sort of sequence thing for how much prices might drop as par increases teeter totter with interest rate sensitivities. 

Before going any further, if this sort of real yield appeals to you enough to allocate to TIPS, buy individual TIPS not ETFs or mutual funds. 

TIPS aren't my favorite. We can build a portfolio with a higher real yield that is far less volatile. I built this study;

I included TIP but there's not much information there, the duration is just under seven years. The real yield from the first table for a 20 year TIPS is 2.72%. The volatility of a 20 year TIPS should be similar to a 20 year regular bond and you can see the volatility of TLH which tracks 10-20 years. 

The specifics of the portfolio I built aren't important but a couple of details, 50% of it is FLOT which not a high yielding fund. It currently shows 4.53% on Yahoo Finance. The other half is split between 7 funds which each have 6-8% weightings to dilute the risk a bit. There is some volatility in the yield numbers flowing from the portfolio. 

In the context of CPI plus 5%, despite our result with the above income portfolio that has no equity exposure, you'd need a growth component (equities) to have a reasonable chance for CPI plus 5% for a longer period. 

Maybe you don't need that but if you do, even 20% equities should nudge up the plus X% number.

Adding 20% to equities and reducing the income positions proportionately had a total return for the period study of 11.27% and while that sounds good to me, it compounded 500 basis points less than a simple 60/40 portfolio. 

The information, analysis and opinions expressed herein reflect our judgment and opinions as of the date of writing and are subject to change at any time without notice. They are not intended to constitute legal, tax, securities or investment advice or a recommended course of action in any given situation.