FAQ: How Do I Build a TIPS Ladder to Try to Secure My Base Living Standard in Upside Investing?
Upside Investing keeps things simple. It assumes you can earn a safe return, after inflation, on all (regular and retirement account) assets not invested in the stock market, specifically the S&P 500. You specify this safe return under Settings and Assumptions by setting an inflation rate and the nominal rate of return on your regular and retirement-account assets that aren't now and won't in the future be invested in stocks. The difference between the nominal rate of return on safe assets and the inflation rate is the real (post-inflation) return used by MaxiFi in building your base living standard floor and well as raising your floor based on your drawdown of stocks (whose value is determined in our Monte Carlo simulations) once you start converting your stock holdings to safe assets.
TIPS (Treasury Inflation Protected Securities) are, arguably, the safest or one of the safest assets in which one can invest. These are bonds of different maturities issued by the U.S. Treasury. They are protected against inflation due to the adjustment of their coupon and principal values to inflation. If inflation is negative (If there is deflation), the nominal coupon payment is reduced. But your terminal principal payment will never be less than the bond's original principal amount. In adjusting the coupon for inflation or deflation, the Treasury multiplies the inflation-adjusted principal by the initial interest rate of the bond. The Treasury's TIPS website provides a helpful description of this coupon-payment adjustment.
TIPS are not fully safe for three reasons. First, the inflation adjustment you receive is subject to taxation even though your real return is no higher. Second, tax rates may be raised, which means the inflation component of the TIPS return will be taxed at a higher rate. And third, it's possible, if unlikely, that the U.S. government would default on its debt. Given this risk, you should consult a qualified financial adviser before deciding how to invest safely. Economic Security Planning, Inc. does not provide investment advice. Upside Investing lets you explore a particular investment and spending strategy as part of MaxiFi's purely educational service.
If you do decide to invest in TIPS, you can purchase newly issued TIPS directly from the U.S. Treasury at Treasury Direct (treasurydirect.gov). Or you use the secondary market to buy TIPS issued in the past. The real yield on TIPS depends on the security's remaining maturity. As of the typing of this FAQ on July 17, 2022, 30-year TIPS were yielding .86 percent real (after inflation) on an annual basis. In contrast, 5-year TIPS were yielding 0.46 percent real.
You can also purchase I-Bonds. I-Bonds are very similar to TIPS, but come with some advantages relative to TIPS that are discussed here. The amount of I-Bonds you can purchase in a given year is limited.
Were you to buy TIPS to try to secure your living standard you could follow these steps.
1. Specify a highly conservative safe real rate -- one below or substantially below, the average real yield you will receive on the TIPS ladder (a bundle of maturity-dated TIPS securities) you will purchase. This will protect you against the tax-based inflation risk mentioned, although not against default. It will also protect you against the possibility that TIPS that you purchase in the future, including those you may buy with TIPS coupons will have a lower real yield than currently prevails.
2. Run MaxiFi in Upside Investing mode. Click on Floor Details from the menu at the top of the screen. Click on the Annual Savings and Withdrawal report from the menu on the right.
3. Use your current regular assets that are not in your reserve fund or are otherwise being held for emergencies to purchase TIPS whose principal payments will be used to cover future regular asset withdrawals -- the amounts shown in red.
4. Through time, invest annual TIPS coupons and the amounts of additional saving shown in black to purchase additional TIPS to cover withdrawals in future years shown in red.
5. Rerun your Upside Report at least annually and update your inflation and nominal rate of return assumptions as well as all other inputs to your plan.