TIPS Location/Allocation

[mamaham]

Where are you locating your TIPS?  I know there is some discussion over whether or not to put bonds in tax deferred account or taxable since they are not tax efficient but have low returns.  Does the same difference of opinion apply to TIPS?  As I am building my "ideal" portfolio, just wondering if it is advisable to place these in the 401k (and/or Roth/457b/401a etc) or taxable account.

 

Also, for a 10% bond allocation, does it make sense to do 50% total bond and 50% TIPS?  I know many people have municipal bonds in their taxable as well - then do 33% split between the three?  I am trying to keep it simple and am not sure about adding in muni bonds yet...

 

 

 

 

[Peds]

Why do you think you need TIPS at all?

[mamaham]

Peds wrote:

Why do you think you need TIPS at all?

Click to expand...

good question.  I am not entirely convinced that I do.  I am still researching the different bond funds (as I do want some bonds in my portfolio) (also still researching how to build a diverse portfolio etc) and it seems that the majority go with total index, municipal, and TIPS.  I started reading about them when WCI said "These are bonds whose value is indexed to inflation. This is one of my favorite funds and one I’ve owned for years."

 

I take it you are not a fan of TIPS?

[VagabondMD]

I consider TIPS to be an "optional" asset class, definitely second tier, maybe third tier in terms of importance. I would only place it, and any other taxable bond asset class, in a pre-tax retirement account.

At the level of a 10% allocation to bonds, it probably matters little whether you split it between index and TIPS or just hold the index (or other core) bond fund.

[DMFA]

Honestly I wouldn't bother if you're only 10%.

TIPS are a very tax-inefficient class with both coupon interest and the step-up in principal from inflation being taxed, though they are exempt from state taxes. They also don't earn much, so their best place would probably be in tax-deferred.

[pistolpete]

On a similar note: I'm 31 and have 10% in SCHZ, Schwab's aggregate bond etf in my 457b. Do most of you guys think that it doesn't make much sense holding such a small % in bonds? I plan to retire in 25-30 years, so still have a long way to go. I've only just started my investment journey and haven't lived through a major market downturn yet with any substantial amount of $$$ invested.

[djohnflatfeecfp]

Peds wrote:

Why do you think you need TIPS at all?

Click to expand...

Because we will soon have 6% GDP 

[VagabondMD]

pistolpete wrote:

On a similar note: I’m 31 and have 10% in SCHZ, Schwab’s aggregate bond etf in my 457b. Do most of you guys think that it doesn’t make much sense holding such a small % in bonds? I plan to retire in 25-30 years, so still have a long way to go. I’ve only just started my investment journey and haven’t lived through a major market downturn yet with any substantial amount of $$$ invested.

Click to expand...

I could go either way, and it is not going to make a big difference whether you are 100% equity or 90:10. When the next bear market strikes, you might get some lift with the tracking error and the ability to rebalance back into stocks, but the psychological benefit will be greater than the mathematic benefit, IMO.

[AZdoc68]

DMFA wrote:

Honestly I wouldn’t bother if you’re only 10%.

TIPS are a very tax-inefficient class with both coupon interest and the step-up in principal from inflation being taxed, though they are exempt from state taxes. They also don’t earn much, so their best place would probably be in tax-deferred.

Click to expand...

TIPS funds are really not that tax-inefficient.  They are exempt from state taxes as you mentioned.  The inflation adjustment is nothing more than the inflation premium that's built into all government bonds expressed in a different way--in other words, 10 year TIPS yield less than regular 10 year T-bonds which have inflation expectations already built in.  The only difference is that future unanticipated inflation protection is guaranteed with TIPS.  It isn't with regular government debt.

People stress out about asset location needlessly.  As WCI and others have pointed out, there's really only a few simple rules.  REITs and high-yield debt should be in tax-deferred accounts.  Muni bonds and Foreign stock should be in taxable (if you want you use the foreign tax credit).  The rest matters very little.

Low-yield US government debt doesn't generate much income and therefore much tax liability.  And there's a good case for putting in taxable if it allows higher growth assets to expand your Roth faster for example.

[docnews]

Why not I bonds in taxable / emergency fund? $10k/person/year. After 1 year you can get your money back. After 5 years no penalty withdrawal. You can defer the federal taxes up to 30 years and no state taxes.