Beat Inflation Handily, and Risk-Free: Allan Roth

Beat Inflation Handily, and Risk-Free: Allan Roth

With TIPS and a stock fund, investors can earn 6% above inflation.

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Reviewed by: etf.com Staff
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Edited by: Mark Nacinovich

Do you want an expected return of nearly 6% annually above inflation but also want to be guaranteed to beat inflation in a worst-case scenario? Until now, I would have responded “only in your dreams.” But today, that dream is a reality. Here’s how.  

Inflation and Spending Power 

I’ve written before on how investors can invest risk free by using a combination of a long-term bond or CD and one or two low-cost stock index funds. While a valid strategy, this guarantees at least a zero nominal return. Historically, over a 10-year period, inflation has taken over 60% of one’s spending power and, over 20 years, over 80%. That is according to research by Edward McQuarrie, a professor emeritus at Santa Clara University. Inflation surged last year and is particularly scary now. 

Morningstar’s John Rekenthaler wrote a report entitled, “High TIPS Yields Are a Retiree’s Best Friend.” It’s quite true—as of Oct. 23, a 30-year ladder of Treasury Inflation Protected Securities, or TIPS, yielded an inflation adjusted 4.75% withdrawal rate. Yet these high real yields are also an investor’s best friend as I’ll explain. 

TIPS Plus a Stock Fund 

By using a combination of one single maturity TIPS and a stock fund, you can construct such a portfolio. As an example, say someone has a long-term investment horizon of 25 years and a $100,000 portfolio. The closest individual TIPS to that 25-year period is a TIPS that matures on Feb. 15, 2049. 

It’s yielding 2.581% plus inflation as of Oct. 23, 2023. That’s nowhere near the 6% annualized expected return I previously mentioned. But one could put part of the portfolio in that one TIPS bond and the rest in one or two low-cost diversified index funds.  

For a U.S. stock fund, one could use the iShares Core S&P Total US Stock Market ETF (ITOT) or Vanguard Total Stock Market ETF (VTI). For international, good options include the iShares Core MSCI Total International Stock ETF (IXUS) or the Vanguard Total International Stock ETF (VXUS).  

Here’s how the math works out: 

  • 25-year TIPS $52,884 (52.9%) 
  • Stock index funds $47,116 (47.1%) 

The 25-year TIPS will mature at a real, inflation adjusted $100,000 and the remainder in the stock index fund is additional return as follows depending upon the real (inflation-adjusted return) return on stocks.

Actual Real Stock ReturnAnnualized Return
Complete Loss0.00%
50% Loss0.85%
0% / year1.56%
4% / year3.31%
8% / year5.94%
12% / year9.19%


If the stock market earns a real 8% annually as it has earned over the past 40 years, one earns inflation plus 5.94% annually on the total. Admittedly, that seems optimistic to me, but even in an awful scenario where stocks lose half of their real value, one still beats inflation by 0.85% annually, which increases spending power by 24%.  

Though I could explain the math, DepositAccounts.com has an online risk-reduction calculator that will allow you to use your own assumptions such as how long you want to use this strategy. While it was designed for nominal returns, I confirmed with DepositAccounts.com founder Ken Tumin that it works for real returns as well. One must just use the real return for both TIPS and stocks. 

As of Oct. 23, I estimated the following. 

Total Annualized Real Return Depending on the Real Return of Stocks

% Stock Index

YearsTIPS YieldFunds0%4%8%12%

5

2.45%11.4%2.2%2.6%3.2%3.7%

10

2.43%21.4%2.0%2.8%3.9%5.2%

16

2.57%33.3%1.8%3.1%4.9%7.2%

20

2.62%40.3%1.7%3.2%5.4%8.3%

25

2.58%47.1%1.6%3.3%5.9%9.2%

29

2.51%51.2%1.4%3.4%6.2%9.7%


Note that the longer the maturity and the higher the TIPS yield, the more one can put in the stock index fund. Again, one must hold the TIPS purchased until maturity and leave the stock index fund alone. While this may be a simple strategy, it may not be easy. TIPS and stock funds can be volatile, and it’s imperative that the investor have the courage to do nothing with this money until the TIPS mature.  

A Few Caveats 

Though these numbers are relatively accurate, they’re not precise. For example, the 25-year TIPS actually matures in about 25 years and three months, and so the actual returns would be a tad higher if stocks earned more than the TIPS yield. 

It also makes the assumption that the TIPS interest could be reinvested. This assumption is true for the inflation component (added to the principal), but, for example, this particular bond has a 1% coupon that is paid out in cash. That would have to be reinvested and could pay more or less than the current real yield. Some TIPS have coupon yields as low as 0.125% which minimizes the reinvestment risk. 

Finally, the TIPS throw off some phantom income on the CPI-U inflation adjustment added to the principal but that also increases the cost basis of the TIPS. It’s a timing issue rather than paying higher taxes. That issue could be easily addressed by holding the TIPS in tax-deferred or even a tax-free Roth account. 

Bottom Line 

TIPS aren’t just for retirees. Buying individual TIPS and holding to maturity guarantees a positive real return that is known when purchased. TIPS ETFs don’t provide such certainty, with the exception of the new BlackRock Defined Maturity ETFs, which extend to only 10 years. But combining an individual TIPS with stock index funds now provide guaranteed attractive real returns with the potential of much higher real returns. It seems too good to be true, and yet the math proves otherwise.  

Of course, the tax laws could change, and your inflation may not be the same as the CPI-U. And taxes will eventually have to be paid unless this is done in a Roth account. 

Though, as they say, “investing involves risk,” this strategy along with the current high TIPS yields provide the best way I know to get much of the stock market return without taking on much risk in the way of future spending power. 

Allan Roth is founder of Wealth Logic, an hourly based financial planning and investment advisory firm. He also benchmarks portfolio performance for foundations and other business concerns. Roth's website is www.DareToBeDull.com. You can reach him at [email protected] or follow him on Twitter at Allan Roth (@Dull_Investing) · Twitter