In my prior post about Portfolio Types, I discussed some popular “lazy portfolios”.

However, a few of the portfolios used TIPS and REITs. I wanted to take the time to explain what those are today. Should be a short post today.

What is a TIPS?

TIPS is an acronym which stands for: Treasury Inflation Protected Securities

Essentially, they occupy the same risk class as bonds, but with a few advantages and disadvantages. The major difference is that TIPS offer an “after-inflation” return. Basically, you buy TIPS at the real rate, which is lower than what the Treasuries would consider “break-even”. This will be somewhat oversimplified, but bear with me:

You buy a TIPS at a certain face value, let’s say 0.5%. Inflation is 2.0%. Since you are protected from inflation, your yield is 2.5%.

Now let’s say instead you bought a 10 year nominal treasury bond which yields 2.6%

Well simple math shows your normal 10 year nominal treasury bond won out. (2.6% > 2.5%)

However, in the event that your nominal treasury bond was 2.4%, then the TIPS won out. (2.5% > 2.4%)

Long story short, if you believe that inflation will be high enough over the next 10, 20, or 30 years to do better than the current bond rate, then TIPS are a better bet.

If you really want to learn more, Vanguard has an excellent piece about what TIPS are: Vanguard on TIPS

FULL DISCLOSURE:

I respect Scott Burn’s and Andrew Tobia’s portfolio, which uses TIPS.

However, I am a simple man and I try to keep things as simple as possible. My whole philosophy is to remove my own choices from the equation because I am not a smart man. Utilizing TIPS may provide a better overall return if you are able to predict how inflation will fare over 10, 20 or 30 years. However, I don’t think I can… so why risk it? I’ll just get my nominal return and not worry about collecting things.

Now, for those of you who want to try to eek out the most from your investment, TIPS aren’t a bad option. For the most part, the risk/reward isn’t horrible.

What is an REIT?

REIT is an acronym which stands for: Real Estate Investment Trust

Essentially, a bunch of shareholders pool their money for real estate ventures they would not be able to afford alone. REITs must maintain dividend payout ratios of 90%, but many allow you to reinvest your dividends called Dividend Reinvestment Plans (DRIPs).

The three types or equity, mortgage, or hybrid. Think of equity as leasing/renting your property and mortgage as getting the interest from their loan. Hybrid is a combination of both.

The major advantage to REITs is that they do not correlate with stocks/bonds at all really, so it helps diversify your portfolio.

FULL DISCLOSURE:

I don’t use REITs because I never really understood them all that well. However, the more I look at them, the more I like Rick Ferri’s Core Four portfolio which uses a small % of REIT, 6 or 8% depending on whether you want a 60/40 or 80/20 allocation respectively. For the purposes of the Stock/Bond allocation convention, REITs are considered as “stocks”.

I may revisit REITs in the future to diversify my wife’s portfolio a bit. I have the Thrift Savings Plan (TSP), so both TIPS and REIT aren’t really an option for me.

Wait a second… don’t you have TSP? Then how do you follow Taylor Larimore’s portfolio?

I do… and I can’t.

However, I approximate it with the funds TSP does offer. Approximations can be found here: Three fund portfolios

Instead of:

Vanguard Total Stock Market Index Fund — VTSMX (.17%) VTSAX (.05%) VTI (.05%)
Vanguard Total International Stock Index Fund  — VGTSX (.22%) VTIAX (.14%) VXUS (.14%)
Vanguard Total Bond Market Index Fund — VBMFX (.20%) VBTLX (.07%) BND (.07%)

I use:

C fund
I fund
G fund

Comparison chart here

However, I do use Taylor Larimore’s portfolio for my wife’s Vanguard account, as well as its variations in other accounts.

The funds available to you may not allow you to approximate exactly the asset allocation you want. However, you should now have enough tools to somewhat approximate it. Next week I will go over a friend of mine’s available funds to help him approximate a “three fund portfolio”. However, the end result isn’t what we expected.

TL;DR

TIPS ~ bonds class. TIPS win out if inflation is higher than expected over a certain time period.

REITS ~ stocks class. Shareholders pool money to buy property and earn money from rent, mortgage, or both

I don’t use TIPS or REITs… however, I may rebalance my wife’s portfolio to include a little REIT after looking at them again.

-Sensei

Agree? Disagree? Questions, Comments and Suggestions are welcome.

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