When nearing retirement, there’s one ladder that proves valuable to climb while interest rates stay elevated.
A TIPS ladder involves strategically assembling a collection of Treasury Inflation-Protected Securities so that you can generate an approximate annual return of 4.6% over three decades as your investment portfolio gradually depletes. The income derived from this approach adjusts upward each year according to inflation rates, ensuring that your standard of living remains stable even amidst rising costs. To illustrate, investing $1 million would provide you with roughly a $46,000 inflation-adjusted annuity every year throughout your retirement.
“Given how high the interest rates currently are, it becomes simpler to achieve your objectives,” explains Wade Pfau, who authored the Retirement Planning Guidebook. “It may be wise to secure these terms now and eliminate that element of risk.” (During early 2022, with lower rates, such a strategy would have yielded only around 3.3% per year instead.)
Building a TIPS ladder without external assistance could lead to significant headaches due to all the necessary computations. Fortunately, several online resources can assist you in figuring out which bonds to acquire and how much to invest in each. Numerous brokerage firms offer online platforms or dedicated fixed-income teams to aid investors in purchasing these bonds directly.
With a standard bond ladder strategy, you buy financial instruments that come due annually across a series of years. In contrast to a bond fund whose worth changes as interest rates shift, holding onto each individual bond within your ladder until they reach their maturity date shields you from decreases in capital value. Consequently, you'll receive the complete face value of these bonds upon reaching their respective maturity dates.
The challenge with a TIPS ladder is that there are no TIPS bonds available between the years 2036 and 2039. To address this gap, TIPS ladders usually invest more heavily in TIPS maturing before 2035 or after 2040.
Before you start constructing a ladder, you need to decide how much money to put into it. Even with today’s favorable rates, Allan Roth , a financial advisor In Colorado Springs, Colo., it is advised that you allocate no more than one-fourth of your fixed-income portfolio to TIPS.
Why not more? Even a TIPS ladder has risks. If you are forced to sell any of the rungs more before they mature—say you have a medical emergency or need a new roof—you would still take a loss if interest rates have risen. Roth says Most of your fixed-income investments should consist of short- to medium-term, high-grade bonds.
Pfau agrees with this view. "When constructing a bond ladder for retirement purposes, it’s essential to keep each segment until it reaches maturity," Pfau explains.
LADDERS of Treasury Inflation-Protected Securities (TIPS), similar to many fixed-income investments, typically work better within tax-deferred accounts. However, Roth points out that in high-tax states such as California or New York, TIPS could also be useful in taxable accounts due to their exemption from state and local taxes—like all other Treasuries. Nonetheless, you'll still be liable for paying federal taxes on these securities.
When it’s time to construct the ladder, clarity regarding your objectives is essential. Certain bond ladders aim to generate ongoing income without touching the initial capital. That’s not the case here. With a 30-year Treasury Inflation-Protected Securities (TIPS) ladder, you will gradually use up your entire investment while safeguarding against inflation. On the other hand, if your priority was maintaining an inflation-adjusted principal, a TIPS bond ladder could currently provide returns at 2.19% over inflation each year, as stated by Roth.
There is an available web-based resource for free. tipsladder.com , that tells you how to construct a TIPS ladder. You click the Generate button to construct a TIPS ladder over a chosen number of years and learn what yield it will deliver. Then you click the Purchase button to find out which bonds you need to buy in which quantities. In the case of a 30-year ladder, you would buy TIPS starting in 2026 and ending in 2055.
Your stockbroker or money manager It can also be useful. For instance, Fidelity offers an online tool that enables you to create a bond ladder. Should you decide to use Treasury securities such as TIPS for this ladder, purchasing the bonds directly doesn’t incur any costs.
If this seems overwhelming, consider asking your brokerage’s fixed-income department to build a TIPS ladder for you. Keep in mind that this service probably isn’t free. As an illustration, Fidelity charges $19.50 per bond type purchased. Therefore, constructing a 30-year ladder—which includes several non-TIPS maturity years—would cost approximately $500.
Roth mentions that for big clients, brokerages often eliminate these charges. However, you'll still encounter the bid/ask spread on bonds. According to Roth’s estimation, this could add an additional $500 to the expense of a $1 million TIPS ladder.
It may appear more complex compared to just buying a TIPS mutual fund. However, after establishing your TIPS ladder, very little maintenance is required. Every year, one segment of the ladder will mature regardless of any additional actions taken.
According to financial writer and asset manager Bill Bernstein, this strategy serves as an ideal investment for retirees concerned about potential cognitive declines in the future. "A significant amount of effort is required initially" when using a bond ladder approach, explains Bernstein, who authored the updated Second Edition of 'The Four Pillars of Investing.' However, he adds that after setting it up, each subsequent year becomes simpler since assets will mature annually without further action needed.
Send your correspondence to Neal Templin. neal.templin@barrons.com
Post a Comment