The Superiority of TIPS Ladders

Stefan SharkanskyAdvisor Perspectives welcomes guest contributions. The views presented here do not necessarily represent those of Advisor Perspectives.

Last year on these pages, Laurence B. Siegel wrote in The Dilemma That Isn’t: Bonds versus Bond Funds that an individually managed bond ladder has few economic or practical advantages over a low-expense, professionally managed bond fund. He rested his argument in favor of funds, concluding, "For most investors under most circumstances, the professional wins."

Siegel's reasoning was persuasive, and his conclusion was sound – contingent on the implicit assumption that the bond investor will reinvest coupons and principal repayment back into the bond portfolio. Under this assumption, it is fair for him to dismiss as irrelevant the reassurance that “you get your money back” when a bond matures.

But there are other scenarios under which investors would be better off with a bond ladder than with a fund, specifically when the cashflows are meant to be spent, not reinvested. My only critique of The Dilemma That Isn't is that the author didn't highlight more prominently the crucial assumption that the bond portfolio would be held indefinitely, with all cashflows reinvested. Siegel has argued effectively elsewhere for holding a bond ladder – specifically of Treasury Inflation-Protected Securities (TIPS) – to fund a portion of one's retirement income1. That advice is worth repeating.

When one's goal is to use bonds' cashflows for known future spending, then appropriate bonds will satisfy one's liquidity requirements with a near certainty that a volatile bond fund cannot offer.