For several years now, one of the topics on my list of research topics has been to evaluate the potential of several “new” Vanguard index mutual funds for inclusion to my investing portfolio.
Of course, these funds are not necessarily new (several have been around for multiple years now), but they are NEW to me. Listed below are the current Vanguard mutual funds I use to make up my investing strategy:
1. Cash – Various online high yield savings accounts
2. Vanguard Short Term Bond Index (MUTF:VBISX)
3. Vanguard Inflation-Protected Secs (MUTF:VIPSX)
4. Vanguard Total Intl Stock Index (MUTF:VGTSX)
5. Vanguard Emerging Mkts Stock Idx (MUTF:VEIEX)
6. Vanguard Total Stock Mkt Idx (MUTF:VTSMX)
7. Vanguard Small Cap Index (MUTF:NAESX)
8. Vanguard Small Cap Value Index (MUTF:VISVX)
9. Vanguard Value Index (MUTF:VIVAX)
10.Vanguard REIT Index (MUTF:VGSIX)
The first Vanguard fund on my list to evaluate is a shorter maturity version of the regular-maturity TIPS fund I currently invest in (Vanguard Inflation-Protected Secs (MUTF:VIPSX)). Mike from Oblivious Investor gives a good description of the short-term fund and the differences between the regular TIPS option.
Listed below are a few key features/details of the Short-Term Fund:
Maturity/Risk
This fund, the Vanguard Short-Term Inflation-Protected Securities Fund, has been around since October of 2012. It features an average maturity of around 2.4 years, much shorter than the regular TIPS fund, which features ~ 9 year average maturity. As you would expect, the short-term TIPS fund carries much lower risk, and also lower return, than the regular TIPS fund.
Cost/Fees
With a low 0.20% expense ratio and no purchase or redemption fee, the expenses of this fund can be considered approximately equivalent to the regular TIPS fund (which also has a 0.20% expense ratio).
Inflation Protection
According to a Vanguard white paper and also several commenting threads in the Bogleheads forums, the consensus is that the Short-Term TIPS fund provides better tracking/protection against inflation. This is due to the fact that the shorter-term TIPS have less interest rate fluctuations.
Should The Short-Term TIPS Fund Be Incorporated in To Your Portfolio?
Overall, in researching this question, the answers have been quite mixed.
The general consensus is that this is a “small potatoes” decision, meaning that you will likely be just fine in either a regular maturity or short-term TIPS fund. Accordingly, I have come across good reasons to utilize the short-term TIPS fund, and good reasons to stay put in the regular TIPS fund.
Convincing Reasons to Switch to the Short-Term TIPS Fund
- If your primary goal of holding TIPS is to protect against pure inflation risk, than as mentioned above, the Short-Term TIPS fund will do this better for you.
- If you are older and don’t want to take on very much risk.
- For example, if you’re close to retirement, and you want to hold TIPS as part of your fixed income holdings, but prefer to have less fluctuation.
Non-Convincing Reasons to Switch to the Short-Term TIPS Fund
- Shortly after the short-term TIPS fund came out, Vanguard replaced its regular TIPS holdings in Target Retirement Funds with the short-term equivalent. “And if Vanguard does it, you should do it too!” 🙂
- To me, Vanguard making this switch is definitely a good reason to consider its inclusion in to a portfolio, but it’s not a good enough reason to blindly make the switch.
- You are trying to “time” and/or predict interest rates and inflation levels in the future.
- To me, many studies have shown that even highly trained economists are not very good at all at predicting the future.
- You invest in short-term bonds for the other portion of your fixed income allocation. And therefore, you should match the short-term duration accordingly with TIPS.
- This might make sense if you were closer to retirement. However, as mentioned in this Bogleheads thread, regular TIPS may actually have less overall risk than equivalent-maturity (~9 years) government bonds.
- Because of this, it seems logical for folks further from retirement to use regular TIPS, even if they use short-term bonds for the rest of their portfolio.
- For example, Rick Ferri recommends that folks saving for retirement use regular TIPS.
What is The Purpose of TIPS In Your Portfolio, Specifically?
So, having heard the reasons for and against the use of short-term TIPS, it seems like the most efficient path forward to determine what is right for you is to ask yourself, “Why did you add TIPS to your portfolio in the first place, and what is their specific purpose?”
As described in a previous post where I performed a historical backtest (using a regular-maturity TIPS price data set) to help determine the most efficient asset allocation to TIPS, I invest 25% of my fixed income asset allocation in TIPS. The rest is in short-term bond index funds and cash accounts. This 25% level was determined because it gave me the most diversification benefit, and highest return/risk ratio.
Sure, having protection against inflation is great, but it was almost a secondary purpose. Since I am ~35 years from retirement, I am able to take on a significant amount of risk, as shown by my overall asset allocation of 70% equity / 30% fixed income.
Typically, when asked what the purpose of my fixed income allocation is, I say that it’s primary purpose is to provide stability/security. That is why 75% of this fixed income allocation is made up of very low yield/low risk short-term bonds and cash accounts. Because of this, it doesn’t make me as concerned about the remaining 25% fixed income allocation being invested in a regular TIPS fund, with slightly higher risk, vs. a short-term TIPS fund, with lower risk.
Further, I also make it a policy to have my investing decisions made by life changes and/or data. Since short-term TIPS are a newer phenomena, I haven’t been able to find a long-term historical backtesting data set (similar to this one by Bogleheads) in order to get a quantitative feel for the differences in risk and return between short and regular term TIPS.
Therefore, with all of the unknowns, mixed opinions, and lack of strong current evidence for a change, I am planning to stay put being invested in the Vanguard Inflation-Protected Secs (MUTF:VIPSX).
How about you all? Do you currently invest in a TIPS mutual fund? Is it a regular maturity fund, or shorter-term?
Share your experiences by commenting below!
***Photo courtesy of https://www.flickr.com/photos/lendingmemo/11697736305/in/
