The 50 thousand dollar question

[kv968]

TIPS is an acronym for Treasury Inflation-Protected Securities. Basically bonds that are indexed to the rate of inflation so, as I understand it, if the maturity value of the bond is, say 3%, and inflation at maturity was calculated at 4% then your redemption value would be principal + 3% + 4% (or principal + 7%).

I don't know what you mean by the "maturity value of the bond". If you mean it's "fixed rate", that wouldn't be added to the principal value of the bond. That would just be the ongoing interest payment. The inflation adjusted part of the principal, if there is one, would be part of the redemption value like you said.

[JoeP]

Maybe a few small donations to charities?

Besides the advice already given, do you have or do you plan to have kids? College is expensive!

[dontgopoor]

If the $70k is not an EF (or you only want $20k in the EF), you may want to consider paying down the mortgage. You will lock in a 3.75% before tax return, which looks great compared to bonds and is not bad compared to equities in the current environment. If your time horizon is truly very long and you won't need to tap the $ for anything, then equities would make more sense.

[jpg7n16]

TIPS is an acronym for Treasury Inflation-Protected Securities. Basically bonds that are indexed to the rate of inflation so, as I understand it, if the maturity value of the bond is, say 3%, and inflation at maturity was calculated at 4% then your redemption value would be principal + 3% + 4% (or principal + 7%).

I don't know what you mean by the "maturity value of the bond". If you mean it's "fixed rate", that wouldn't be added to the principal value of the bond. That would just be the ongoing interest payment. The inflation adjusted part of the principal, if there is one, would be part of the redemption value like you said.

The inflation adjustment adjusts the principal value of the bond. The interest coupon payment (if any) is paid out based on that principal value.

Example: 3% coupon TIPS
Initial principal value: $1000; Interest Yr 1: $300*
After 10 years of 3% average annual inflation: $1,343.92; Interest Yr 10: $403.17*

*simplified for the example, it would actually be a bit higher due to inflation adjustments throughout the year. The inflation adjustment is made daily.

See more info about these straight from the Treasury website:

https://www.treasurydirect.gov/indiv/products/prod_tips_glance.htm

But also worth noting, these do not always trade at their principal value. Sometimes much higher, but potentially lower if interest rates start to climb. So if you're building an EF with TIPS and rates start to climb, you risk your EF dropping and not being able to cover an emergency.

You will lock in a 3.75% before tax return, which looks great compared to bonds and is not bad compared to equities in the current environment.

After considering the tax advantage, that 3.75% likely saves 15-30% taxes, so could be reduced to anywhere 2.6%-3.18% after tax.

When I compare that to equities which are expected to average 7-11% over long periods of time, that IS bad compared to equities in the current environment. Only people living in fear think the market will average less than 3% long term from here on out.

If short term, equities shouldn't be considered anyways, because they're too volatile. But that's less than half of what you can expect long term, and after you account for compounding, it's much much worse than equities.

On a $50k investment, you would have:
3.75% over 25 years: $125,508.36
7% over 25 years: $271,371.63
11% over 25 years: $679,273.19

If your time horizon is truly very long and you won't need to tap the $ for anything, then equities would make more sense.

Agreed.

[kv968]

TIPS is an acronym for Treasury Inflation-Protected Securities. Basically bonds that are indexed to the rate of inflation so, as I understand it, if the maturity value of the bond is, say 3%, and inflation at maturity was calculated at 4% then your redemption value would be principal + 3% + 4% (or principal + 7%).

I don't know what you mean by the "maturity value of the bond". If you mean it's "fixed rate", that wouldn't be added to the principal value of the bond. That would just be the ongoing interest payment. The inflation adjusted part of the principal, if there is one, would be part of the redemption value like you said.

The inflation adjustment adjusts the principal value of the bond. The interest coupon payment (if any) is paid out based on that principal value.

Example: 3% coupon TIPS
Initial principal value: $1000; Interest Yr 1: $300*
After 10 years of 3% average annual inflation: $1,343.92; Interest Yr 10: $403.17*

*simplified for the example, it would actually be a bit higher due to inflation adjustments throughout the year. The inflation adjustment is made daily.

That's why I'm asking what elessar meant by "maturity value of the bond". You really don't know until the bond matures since the principal will be dependent on the inflation adjustments. I was just wondering what that 3% was that elessar was mentioning. I was assuming it was the fixed rate and if that was the case it wouldn't be added to the redemption value of the bond when it matures.

[dontgopoor]

When I compare that to equities which are expected to average 7-11% over long periods of time.

The conventional wisdom that all equities will average 10% (or 7-11%) needs to be questioned and positioned with regard to your needs and plans. And it's not a matter of "fear" (and when you hear that term, ask yourself whether it's being used as a marketing technique to sell financial products).

First, define long term? 5 years? 10? 20? 50? 100? How you define long term makes a huge difference. Here's one article that has various returns - Observations: Average Stock Market Return Since 19xx. (I have no affiliation with the blogger; I just googled long-term stock returns). Note the link "Best & Worst Returns for 1-100 Year Holding Periods" - lots of variation depending on starting and ending years for the same holding periods. And I believe these stats reflect just US equities.

With today's global markets, domicile of the equity should be considered - US, European, Asian, Emerging Market. The levels of debt, inflation, and currency stability will greatly impact real returns.

I recently read from a reputable source that some emerging markets have equities that are offering returns several points higher than European equities and with a less debt laden economic environment. Something that I'm researching a bit more.

Could equities return 10% within your definition of long term? Sure. But they could not. (yes, dollar cost averaging helps).

Bottom line: Hope for 10% but plan for half that amount.

[jpg7n16]

The conventional wisdom that all equities will average 10% (or 7-11%) needs to be questioned and positioned with regard to your needs and plans. And it's not a matter of "fear" (and when you hear that term, ask yourself whether it's being used as a marketing technique to sell financial products).

No it doesn't. And it's just the facts of the stock market. 30 year periods average 9.4%, with a standard dev of 2.3, meaning the majority of historical returns fall between 7.1-11.7%. Therefore I think it's perfectly reasonable to assume that long term periods should continue to average around 9%.

No it's not a marketing tactic to advise people to avoid fear and stay invested. The advice given here is free of charge to anyone. Who would benefit? We get no commissions from you taking our advice. But it helps to keep realistic expectation. 9% is realistic, and I'd say plan on 7%+.

This is planning, not prophecy. Start somewhere realistic. Err slightly on the conservative side. Monitor progress and adjust savings rate as needed.

First, define long term? 5 years? 10? 20? 50? 100? How you define long term makes a huge difference. Here's one article that has various returns - Observations: Average Stock Market Return Since 19xx. (I have no affiliation with the blogger; I just googled long-term stock returns). Note the link "Best & Worst Returns for 1-100 Year Holding Periods" - lots of variation depending on starting and ending years for the same holding periods. And I believe these stats reflect just US equities.

I generally start long term returns around 30 years. But long term is usually anything 5-10+ years. That blog is hard to follow.

Here are all the returns since 1871: CAGR of the Stock Market: Annualized Returns of the S&P 500

Doing the math with compounding, there have only been 4 10-year periods out of the 132 possible 10-years that lost money on average. (Highest loss, of 1.47% in the period ending 2008). That's pretty good odds for a 10 year investment horizon.

There has never in history been a 15+ year period where stocks lost money. Retiring at 65, and need money to at least age 80? That's 15 years. Should include stocks. Saving for retirement at age 35, desiring a certain sum by age 65? That's 30 years. Should include stocks.

With today's global markets, domicile of the equity should be considered - US, European, Asian, Emerging Market. The levels of debt, inflation, and currency stability will greatly impact real returns.

Not really. Just focus on overall asset allocation. Companies are increasingly global. Coke is based in America, has tons of revenue overseas. 3M gets over half it's revenues internationally. Domicile would ignore that.

Could equities return 10% within your definition of long term? Sure. But they could not. (yes, dollar cost averaging helps).

Well duh. That's the definition of an average. Some are above, some are below. Plan around the average, and err on the conservative side (7%+)