Another Awful WSJ Personal Finance Article -- This One on TIPS

Advising People to Avoid TIPS When Inflation is High is as, well, Pick your Pejorative.

Photo by Mikael Seegen on Unsplash

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Why Is the WSJ Conveying Terrible Personal Fin Advice?

A month ago, I discussed what I view as an awful WSJ article about when to collect Social Security benefits. The article concocts its own principles of finance, which involves pricing an apple as an orange, actually a crate of oranges. This mis-pricing is not innocent. It implies workers should start collecting their Social Security far too early, potentially leaving tens to hundreds of thousands of dollars in lifetime benefits on the table.

Today’s focus is on an article by Derek Horstmeyer, entitled “Inflation-Protected Bonds Fail a Key Test: They Don’t Help When Inflation Is High.” Professor Horstmeyer is Professor of Finance at Costello College of Business, George Mason University.

Inflation-indexed bonds reference TIPS — Treasury Inflation Protected Securities. These special government bonds provide bi-annual inflation adjustments keeping TIPS coupon and principal payments fixed in real terms. Hence, if inflation rises, whether on an expected or unexpected basis, the purchasing power of what you receive is not watered down by inflation. Hence, saying that TIPS don’t help when inflation is high is akin to claiming that homeowners insurance doesn’t help when your house burns to the ground. Try explaining that to a 10-year old.

The title aside, the article reports that “TIPS perform better when inflation is low.” Professor Horstmeyer also writes that, “Putting TIPS to the test over the past three decades of data, my research assistants (Maha Almoshaddak and Donovan Etienne) and I find that they don’t deliver when inflation is high. In fact, if you are jumping into TIPS when inflation is high, you have already missed the boat and likely will underperform. These findings don’t apply for TIPS that are held to maturity.”

Let’s stick with the homeowners analogy. If you live in an area that’s recently been suffering draught and major fires — an area called Los Angeles, would you expect insurance premiums to be high? Of course. In fact, the cost of LA homeowners insurance policies has risen by one third since 2022, after inflation. This largely reflects last January’s catastrophic Pacific Palisades and Eaton fires.

High inflation is when you need inflation protection. Hence, one would expect the price of inflation-indexed bonds to be bid up and their real yield to fall when inflation is high. This result, which Professor Horstmeyer documents, is just what we’d expect. What we wouldn’t expect is his suggestion that you shouldn’t buy TIPS when inflation is high because “you have already missed the boat.” This sounds like, “Don’t buy homeowners insurance when the probability of losing your house rises because doing so will be expensive.”

Professor Horstmeyer says his findings don’t apply with respect to TIPS held to maturity. This suggest he’s thinking of investors buying TIPS as if they were no different from, say, shares of stock in XYZ corporation. I’m sure he could have found an XYZ whose returns are systematically higher when inflation is lower. Had he done so, he might have suggested selling XYZ when inflation is high. But basic finance says that stocks are priced efficiently. A stock that systematically does poorly when inflation is high will be priced by the market based on this and all its other return features. An efficient portfolio will include this stock just as it will include all other financial assets whose returns aren’t dominated, i.e., whose returns aren’t lower in every state of the world than the returns of some other asset. Stated differently, people will hold XYZ because XYZ performs well in circumstances other than times of high inflation.

From this perspective, Professor Horstmeyer could just have well written an article telling readers to immediately switch their portfolios because they include assets that perform poorly when inflation is at its current level. Would the WSJ have printed such an article? Surely not. It would have realized that all undominated assets are held today because no one knows for sure how they will perform tomorrow and there are states tomorrow is sufficiently high, whatever the state’s probability, to justify its current price.

Every financial assets has its own distribution of future returns. Consider a security that bundleds together a regular bond plus a call option on inflation. If inflation were never be zero, the exercise date were one year, and the option’s strike price were set at zero inflation, we’d be pretty close to manufacturing a one-year TIP. If expected inflation were high, we’d expect the call option to be more expensive. This is simply another way of saying that TIPS provide inflation insurance that’s more valuable when there’s more inflation. I.e., you’ll pay more for the call option when the probability of a high payoff is higher. If you just value this option as a regular bond, i.e., if you ignore its call option component, of course it will look expensive — like a dominated security.

“The Best Way of Doing a Roth Conversion Before Retirement”

Let me turn this column into a twofer. Professor Horstmeyer latest WSJ article bears the above title. The article claims that doing all your Roth conversion immediately is optimal. As I demonstrated a year ago in this article, optimal Roth conversion is a highly non-linear problem. The solution to this problem is generally to go big or go home, i.e., to do significant if not full converting in the short run so as to reap the tax savings over a longer period in the future. But this analysis, based on my company’s economics-based financial planning tool — MaxiFi Planner — never, in my experience of running hundreds of cases, suggests converting everything immediately. The optimum for early retirees is typically to convert over three to five years. But in some cases, the optimum entails converting over a decade or longer. And for workers, the optimum solution may entail waiting until retirement, i.e., possible waiting decades, to begin converting. MaxiFi Planner’s ability to calculate optimal conversion — both the amount to be converted and its timing — was featured in this NY Times column by Peter Coy.

Professor Horstmeyer’s methodology is remarkably primitive relative to that the precision calculations under MaxiFi’s hood. Hence, it’s very hard to know what to say except don’t take his word for it when it comes to either buying TIPS or timing your Roth conversions.

Summary

The WSJ has just recently produced an article suggesting you collect Social Security years too early, you fail to protect yourself against inflation when inflation is high, and that you do all your Roth conversions in one fell swoop. None of this “guidance” is correct, appropriate, scientific, sensible, or safe. And the worst part is that there are innocent LLMs reading this … and passing it on to unsuspecting users.

The moral of the story is simple. Don’t believe everything you read even if it’s in the Wall Street Journal.

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