From: Tad Borek 
Newsgroups: misc.invest.financial-plan
Subject: Re: Idea short/medium term portfolio
Date: Mon, 26 Jan 2004 18:09:08 CST
	iQBVAwUAQBWsJPl/I4+O31e5AQHLggH/QOGHnV93r60qsajCE0o19hGu21tF8Zj4
	yLLbjBiWt7H9n7apTnMaAmpI2eVwqNU/GniNX+ysT8vOc+/PnziWDw==
	=auuo

[sorry if repost, NNTP probs...]
Michael Grinnell wrote:
 > So, the rather large deficits the US is running (and seems likely to
 > run into the future) will likely push up interest rates.  This would
 > theoretically push up the NAV on a TIPS fund.  But, the inflation part
 > of this is unknown and may not be favorable.



Yes, I think that a continued deficit will end up pushing up bond yields 
as the US gov't borrows more cash (from overseas, incidentally). The CPI 
might not be going up at the same time, or at the same rate, so I can 
envision a period where Treasuries returned more than "old" TIPS.

Still I should emphasize that TIPS (& I-bonds) are a very interesting 
kind of investment with different/lower risks than regular Treasury 
bonds. If you buy & hold you're guaranteed a real return that is very 
close to the original fixed rate. That's an unusual kind of bond, and it 
reduces what is one of the main risks of long-term bonds...that we'll 
get hit with 12% inflation and you'll end up with very low real returns. 
("real return" means after factoring in inflation)

 > In sum, it seems that both intermediate and TIPS funds are not
 > particularly recommendable in the current climate (with interest rates
 > going nowhere but up, seemingly).


I think the OP is about a short-term goal and the more conservative 
route is to match your investment with your goal...ie short-term bonds 
and cash-like investments. Going to intermediates or TIPS adds some risk.

The TIPS have the advantage of increasing rates as inflation drifts 
upwards; normal intermediate-term bonds would simply fall in value. So 
between the two I see TIPS as less risky.

One piece of info that may be helpful: when you look at the long-term 
historical returns of short, intermediate, and long-term bonds, you see 
a big leveling off in returns, and a big increase in volatility of 
returns, once you go out beyond 5-year bonds. The finance speak for this 
is "unrewarded risk." The source of this is the risk introduced by 
future changes in interest rates. It has only a minor effect on a 
short-term bond, but it's noticeable on the longer issues, and a huge 
factor on truly long-term bonds (20 years+). You can use this risk to an 
advantage, but not when we're at historically low yields.

So generally speaking it's questionable why you'd ever hold long-term 
bonds, and even intermediates arguably provide so little extra returns 
that they might not be worth it.

TIPS are hard to fit into this, though, because a lot of the risks of 
normal longer-term bonds are offset by that inflation adjustment. Again, 
I can envision a period where TIPS and Treasuries deviated in rates, 
with the TIPS not catching up because CPI hadn't increased yet. A 
longer-term investor probably wouldn't be too concerned with that, but 
with a short-term goal it strikes me as a risk with a TIPS fund. I-bonds 
would avoid that risk.


 > The current climate seems very difficult for someone to find a decent
 > 3-5 year investment other than money market or CDs.  There just seems
 > to be a real lack of direction in where the economy and interest rates
 > are going.  Every time I think that interest rates just have to go up,
 > they don't.  Now, I see forecasts pushing interest rates up in May or
 > during the summer.


But I don't think that's any reason to try to eke out some additional 
return from your cash. You keep money in cash so you can get your hands 
on it, and perhaps so you have something to invest when your other 
investments take a dive. Seeking out additional returns is doing 
something different; if you do it when MM funds are yielding 1% and 
inflation is 1%, you should equally well consider it when MM funds are 
yielding 5% and inflation is 4.1%. Really those are much the same, it's 
just that now the low real return is easy to see.

I think it's perfectly acceptable to "do nothing" and wait until the low 
yields pass - they will, and if it doesn't happen in 3-5 years you 
haven't really lost much in returns. Consider a portfolio as a 
whole...it wasn't such a bad year after all, was it? While MMs were 
ticking along at 1% or less, stock investments put on 25-30% or more. 
Even if that represented 10% of the portfolio, it added more to the 
bottom line than the other 90% (this was an example of how stocks are 
said to reduce risk, as compared to an all-cash portfolio). So who cares 
really about cash yields? A year, two years, whatever from now there 
won't be any talk on this board about "how can I get more than 2% from 
my cash?"

-Tad