Day 200: The Peril of Trusting in Man’s Greatness

Jeremiah 50:29-34“Call together the archers against Babylon,all those who bend the bow.Encamp against her all around.Let none of it escape.Pay her back according to her work.According to all that she has done, do to her;for she has been proud against…

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Two Ways to Look at TIPS

Thinking FrogTreasury Inflation Protected Securities (TIPS) protect investors from inflation by automatically adjusting the original face value of the bond for inflation.  What I have discovered is that this feature is used for different purposes by different people.  I tend to use TIPS as a method of saving principal, but there are those who use TIPS as a “hedge” against inflation within a larger portfolio of riskier investments.

The Saver’s View

I discovered that the way that I look at TIPS is much different than the way investors tend to look at them.  Since I look at TIPS as a way to save money for the future, I’m not very concerned about my returns.  I’m just trying to preserve the returns that I have already received.  I’m also trying to make sure that all of this money is available on a specific date.   I also intend for that money to be adjusted for inflation.

The Investor’s View

When investors use TIPS, they are usually trying to make sure that if there is a downturn in other investments that are sensitive to inflation, that they own something that counteracts inflation.  This allows their portfolio to lose less money or perhaps even gain money as a result.

Very Different Intentions

These two perspectives come from two very different intentions on the part of the bond holder.  One person is trying to preserve and the other is seeking opportunity.  This is why I recommend that you divide your money into two parts as I describe in the article: Stressed about Savings? Divide and Conquer!

The Investor’s Bond Market Focus

When we look at TIPS from the perspective of an investor, we are more concerned with counteracting inflation.  This can be done by trading bonds that are sensitive to inflation.  To TIPS traders, the current market value is more interesting than the adjusted principle.  An investor is less likely to hold a TIPS to maturity.  For TIPS investors, TIPS mutual funds or ETF’s may make sense.  Trading TIPS on the secondary market may also be useful.  Bond market traders are also very interested in Yield to Maturity (YTM).  That’s because they are concerned with the return on investment.  Without a good return, it isn’t a very good opportunity.  This may not be a big deal in some investor’s minds because the inflation protection may be worth a loss in that part of their portfolio, however.

The Saver’s Inflation Protection Focus

When we look at TIPS from the preservation of savings point of view,   we aren’t interested in the market value of TIPS.  We are interested in the adjusted principle.  Since we intend to be getting this principal someday when the bond matures, that’s all we really care about.  We are more interested in seeing how well our savings is being protected, rather than seeing our yield to maturity.  As preservers of principle, we are willing to pay some or even all of our yield to make sure that we have our money when we need it.

Taxes

Taxes are a serious problem for both the investor and the saver.  This is one place where the two views tend to come together.  Taxes can make it difficult for an investor by taking money away during a successful time causing the money to not be there for a time when things aren’t so successful.  This makes swings in income even worse.

For savers, taxes can actually cause us to lose money due to inflation as I explain in the article: “Inflation Protection and Taxes.”  Since we don’t make much interest on a savings style investment, taxation can make our preservation costs unpredictable and threaten our attempts to preserve once again.

Be Careful Not to Mix Views

It can really cause you to become paralyzed as to what to do with your money if you flip back and forth between the investing and savings views of looking at TIPS.  I find that it is wise to make a conscience effort to think one way or the other when choosing what to do.   I tend to use them for savings preservation.  I see very little help out there when it comes to looking at these bonds from this perspective.  By viewing TIPS in a way that matches your needs, you will be able to make more confident decisions with them.

Stressed about Savings? Divide and Conquer!

Piggy Banks

JamesCube (Pixabay)

Trying to decide what to do with the money you have can be stressful.  There are plenty of people willing to “help” you invest your money, but they rarely agree on how.  Just leaving it the bank doesn’t seem right, but neither does losing it all in the market.  I have found that dividing my money into two parts reduces the stress and gives me confidence.

Protection vs. Opportunity

There are two very different points-of-view when it comes to investing money.  It’s possible to look at money as something to protect for some point in the future.  It is also possible to look at it as an opportunity for gain.  Both perspectives have benefits, but they require that we invest in different ways.

When we look at money from a protection point of view, we want to make sure that we don’t lose it.  Our concern is not about future gains, but about having something at a specific time.

When we look at money from an opportunity point of view, we are willing to wait in order to get a big gain.  We’re hoping to use money in order to get significantly more, but we can’t really control the timing of it.

These two points of view, are at odds with one another.  Like the old saying goes, you can’t have your cake and eat it too.  We can’t protect something and risk it at the same time.  When we choose opportunity, we also choose to risk not having our money at a specific point in time.

Many of the professionals in the financial world are more focused on opportunity than they are on protection.  It’s good to keep that in mind when you seek help.  If your intention is to protect, you probably won’t need professional help.  With a little education, you should do just fine on your own.

Insurance vs. Investments

Those who intend to preserve their money are better off thinking about it like they would insurance.  That’s because when you preserve, you are saving what you’ve already earned.   You’re just making sure that it’s there for you when you need it.  A preservation mentality is helpful when you are saving for specific things.  Those things might include maintaining or buying a car.  Other things include buying a house, paying for college or for paying for retirement.  Preservation is good for those things that you already know that you will probably need.

When you want to use your money to take advantage of growth opportunities, insurance doesn’t really make sense.  That’s because you’ve accepted the risk that your money won’t necessarily be there at a specific point in time.

Promise vs. Potential

When we make a decision about where we put our money, we need to decide whether we care more about having a promise that our money will be available, or that we have the potential to gain when opportunity arises.

These kinds of financial arrangements are at odds with each other but they both have their place.  If there was no potential for gain, there wouldn’t be a way to have something to preserve.  If there was no place to save your money, how could you keep what you have gained for a time that you need it?

Determine Your Timing Related Risk Capacity

When I say “timing related risk,” I mean the kind of risk you expose yourself to by not having money when you need to use it.  Considering your timing related risk capacity is a good way to decide whether you should preserve or speculate.

source: nattanan23 (Pixabay)

If you don’t have any savings at all, then you are at risk whenever something doesn’t go right.  You really don’t have any capacity for timing risk.  If you have no extra money and your car’s transmission fails, you would immediately be in financial trouble.  It’s important to have emergency savings and not having it definitely qualifies a timing related risk.

There are other timing related risks you may have.  Retirement is an important one.  You can calculate the amount of time that remains before you plan to retire and the amount of money you might need for the rest of your life from that point.  These projections expose a risk.  If your retirement money isn’t there when you need it, you will probably suffer.  Other things have timing related risk too, like buying a house, paying for college or paying for family vacations.

When we think about risk, we need to consider what we would feel like if our money wasn’t there when we need it.  If the money you are thinking about isn’t going to be needed for a particular time in the future, then opportunity investing is probably a good idea for you.  If you know what the money is intended for, then preservation investing would probably be a better idea.

A Helpful Separation

I have found it helpful to separate my money into two distinct parts.  One is the part I intend to preserve as savings.  That part includes my emergency savings, the part of my retirement savings that would pay for my basic retirement needs and any other amount of money that I would rather preserve than take risks with.  These may include funds I intend to use as an inheritance or a donation.

The other part is for investments that I believe will eventually be profitable.  For these investments, I accept that I don’t know when they will be profitable and I am willing wait.

Less Stress

By taking your savings and setting it aside as something you intend to preserve, you don’t have to worry about how much money it makes.  As long as it keeps up with inflation, it will still be there for you.  The rest you can use to do some investing.  That’s the part you may want to have an investment professional help you with.  If things don’t go quite as well you expected them to go, you can rest assured that your savings is still intact.