In his January blog post entitled “Try a TIPS Mixer in Your Equities Cocktail,” Phillip Murphy described the potential benefits of including Treasury Inflation-Protected Securities (TIPS) in one’s portfolio. In this blog aimed at Millennials, I would like to propose an easy way to build up a 30-year TIPS portfolio for retirement.
Let us assume that Alice, age 25, wants to create her own do-it-yourself TIPS portfolio to be one of her sources of retirement income when she turns 65, 40 years hence. Without a lot of investment decision-making experience, what would be an affordable way for Alice to accomplish her goal?
To begin with, it may help for Alice to read “Risk Less and Prosper: Your Guide to Safer Investing,” by Zvi Bodie and Rachelle Taqqu, in which the authors argue for accumulating TIPS in one’s portfolio, because TIPS provide inflation protection and hedge against interest rate risk. In addition, if the TIPS securities were held to maturity, as would be the case for a laddered portfolio, then there shouldn’t be any risk.
Currently, if Alice has a TreasuryDirect account, she can participate in non-competitive biddings throughout the year. Some key facts about TIPS are as follows:
- TIPS are issued in terms of 5, 10, and 30 years;
- The interest rate on a TIPS is determined at auction,
- TIPS are sold in increments of USD 100, with the minimum purchase at USD 100;
- TIPS are issued in electronic form; and
- TIPS can be held until they mature or, if desired, they can be sold in the secondary market before they mature.
For more details, please visit the TreasuryDirect website at: https://www.treasurydirect.gov/indiv/research/indepth/tips/res_tips.htm.
As described by Wikipedia: “TreasuryDirect is a website run by the Bureau of the Fiscal Service under the United States Department of the Treasury that allows U.S. individual investors to purchase Treasury securities such as T-Bills, TIPS, and others directly from the U.S. government. Its website allows money to be deposited from and withdrawn to personal bank accounts, and allows rolling repurchase of securities as the currently held items mature.”
Thus, for Alice, her TreasuryDirect account would be a cost-effective investment account to accumulate TIPS. From age 25 to 34, at a relatively modest salary, Alice would buy the 10-year TIPS, at USD 5,000 a year. From age 35 to 44, as her compensation grew, she would roll over the maturing 10-year TIPS into 30-year TIPS each year, and she would buy an additional USD 5,000 of the 30-year TIPS. From age 45 to 54, she would buy USD 10,000 each year of the 30-year TIPS. Finally, from age 55 to 64, she would buy USD 10,000 each year of the 30-year TIPS. As she turns 65, she would have built up a 30-year laddered TIPS portfolio, with USD 10,000 of TIPS securities maturing in each of the next 30 years. Since these TIPS securities have coupons and inflation-adjusted principal amounts, the nominal amounts would be much different from the face amount of USD 10,000; but in real terms, meaning on an inflation-adjusted basis, each maturing tranche of the laddered portfolio would provide the same purchasing power of a real USD 10,000.
For Alice, having a 30-year TIPS laddered portfolio of USD 10,000 real income each year would be a nice supplement to her other sources of income from Social Security benefits and defined-contribution retirement savings. If, along the way to her retirement, she could afford to buy more TIPS, then her TIPS nest-egg could be correspondingly larger.
It may not seem like a big deal to have such a USD 10,000 30-year TIPS laddered portfolio available for retirement income when one is ready to retire. However, bear in mind that the maximum social security benefits one may get (in current U.S. dollars) is around USD 2,800 per month, or USD 32,600 a year. In this context, an income of USD 10,000 a year would increase one’s social security income by about one-third.