How and Why to Build a TIPS Ladder in Retirement
As retirees seek to maintain their purchasing power during retirement, particularly in an era defined by economic uncertainty and fluctuating inflation rates, building a TIPS (Treasury Inflation-Protected Securities) ladder can be a prudent investment strategy. This article explores the "how" and "why" of creating a TIPS ladder and the benefits it can provide for retirees.
Understanding TIPS
TIPS are a type of U.S. government bond specifically designed to protect against inflation. Unlike traditional bonds that offer fixed interest rates, TIPS guarantee that the principal amount will rise with inflation, measured by the Consumer Price Index (CPI). This means that as inflation increases, so does the interest payment, providing a cushion for retirees against rising living costs.
Why Build a TIPS Ladder?
1. Inflation Protection
One of the most compelling reasons to build a TIPS ladder is to guard against inflation. Over longer periods, inflation can erode the purchasing power of fixed income streams. A TIPS ladder allows retirees to offset this risk by ensuring that their investment grows with inflation, helping to maintain their standard of living throughout retirement.
2. Predictable Income Stream
A well-structured TIPS ladder provides a predictable and reliable stream of income. By staggering the maturities of TIPS (for instance, investing in TIPS that mature in 5, 10, and 20 years), retirees can receive regular interest payments and access to principal without having to rely on a single lump-sum payment.
3. Diversification
Incorporating TIPS into a retirement portfolio adds diversification, which is crucial for risk management. Depending solely on equities or other fixed-income products can expose retirees to market volatility and changing interest rates. Including TIPS can help stabilize a portfolio and reduce overall risk.
4. Lower Correlation with Stock Market
TIPS often exhibit a low correlation with equities, making them an effective hedge during market downturns. This can be especially important for retirees, who may rely on their investments for living expenses and cannot afford significant capital losses.
How to Build a TIPS Ladder
Step 1: Assess Your Needs
Before building a TIPS ladder, it’s essential to assess your cash flow needs in retirement. Consider your expected expenses, any income sources (like Social Security or pensions), and how long you anticipate needing these funds.
Step 2: Determine Ladder Structure
A typical TIPS ladder consists of bonds with staggered maturities. A common approach is to select TIPS that mature in intervals such as 5, 10, and 20 years. This staggered structure provides regular access to principal as each bond matures, thus allowing the retiree to reinvest or use the cash as needed.
Step 3: Invest Strategically
Investing in TIPS can be done through various avenues, including direct purchases from the U.S. Treasury or through mutual funds and exchange-traded funds (ETFs) that specialize in TIPS. Consideration of costs, management fees, and liquidity is crucial when selecting investment vehicles.
Step 4: Monitor and Adjust
Once the TIPS ladder is established, it’s essential to regularly monitor your investments and adjust as necessary. Changes in inflation rates, interest rates, and personal financial situations may require adjustments to your ladder structure or rebalancing of your overall investment portfolio.
Conclusion
Building a TIPS ladder is a strategic approach to securing a reliable income stream while protecting against inflation. For retirees navigating the complexities of post-retirement finances, it offers numerous benefits, including predictable income, inflation protection, improved diversification, and a safety net against market downturns. By carefully assessing individual needs, deciding on ladder structure, and monitoring investments, retirees can enjoy a more secure and stable financial future. Investing in TIPS not only provides peace of mind but also allows retirees to focus on enjoying their retirement years to the fullest.
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The problem with iShares iBonds ETFs is the expense ratio of about 0.2%. When you build your ladder using TIPs Treasury bonds, it has no expense ratio. If the real yield is say 2.46%, you are giving away about 10% of that to expenses with iShares. That 0.2% is a higher expense ratio than a stock index fund from Vanguard, and a stock index fund is expected to have four times the return as the real yield on the current 10-year TIPs fund.
As an Australian using our equivalent of TIPS (eTIBs), I think tax might not be as bad as people make out.
1. You're only taxed on the inflation adjustment, not on the un-adjusted cash component
2. By claiming a tax loss on assets that declined in value (e.g. stocks) you can reduce your taxable income
3. If you live a modest lifestyle, closer to the tax-free threshold, you can minimise tax to around 7-8%
4. If you live a modest lifestyle, you're probably less exposed to inflation
It's true that TIPS are not tax efficient, but that doesn't mean they can't function as a decent hedge against stock losses.
Hi Rob, great info and your ability to convey the subject matter is excellent. Since the specific year Blackrock ibond ETF's are fairly new products they appear to be very thinly traded (low daily volume) which results in wider bid / ask spreads, and the potential to trade away from their NAV. Until these ETF's gain more popularity it may be worth a person's time to buy the specific bond through TreasuryDirect or their brokerage account. Thanks for all you do!
Thanks Rob for teaching me new information.
Does it makes sense to build a 20 year TIPS ladder (secondary market) by dollar cost averaging since interests rates are varying?
Since stocks usually beat inflation, why not make things a whole lot simpler and just invest your $1,000,000 or, better, $2,000,000 in a dividend stock fund like SCHD with a 3.4% annual yield. The value of the underlying stocks grows 8% on average, and your annual dividend payments go up every year as a result, even though the yield remains stable at 3.4%. AND, at the end of twenty years you have a huge pot of money as the underlying dividend stocks have appreciated considerably in value, vs nothing left at the end of the TIPS bond ladder.
Thank you for this video. I've been a 100% S&P 500 guy for the past 26 years and am now approaching early retirement and want another vehicle for a steadier income stream. This video has given me something to think about and figure out what my transition to retirement will look like.
What about a TIPS ETF ? Same principles? Same taxes in a taxable account? I'm looking to protect down payment money from inflation….
I am revisiting this lesson. Still confused. Could you do a new video on tip ladder with 30 year ladder, step by step? I have 500k and age 76.
Really great video. Very informative! Thanks!
Per your comment at 24:18 … it appears that blackrock has now added TIPS to their tool. 😉 Way to go giving them the suggestion.
Man… if only an insurance company would sell me a variable annuity tracking a TIPS ladder like this! Then I’d have my inflation hedge and my longevity hedge in the same financial product!
@RobBerger can you purchase tips by qusi number on fidelity?
Despite the fact that TIPS are backed by the full faith and credit of the United States Government, is SIPC ever necessary if purchased through a brokerage firm?
Official Inflation is never going back to 2%. The infinite spending mentality of democrats has doomed us to a mega-inflation future. And "official" inflation is a hopeless joke – consumer expenses are increasing closer to 20% per year, not 2% or 3%
No you shouldn’t