The authors make the case for investing in inflation adjusted, government protected I Bonds and TIPS (Treasury Inflation-Indexed Securities also called Treasury Inflation Protected Securities). Focusing on the major goals of saving for retirement and providing for college education costs, Bodie and Clowes show how much an investor needs to save today. If the calculations seem a bit heady, readers are referred to the book's companion web site 'calculator'. At the heart of worry-free investing as defined by the authors is the defense of an individual's future buying power rather than the building of incremental wealth.
Stocks have been widely touted as the only reliable hedge to inflation. However, during the 1970's sustained inflation ravaged stock market returns on an (inflation) adjusted basis. Had TIPS and I Bonds existed, they would have outperformed a diversified basket of stocks. Indeed, most investors today should use TIPS and I Bonds alone, we are boldly told. And all investors should invest at least some of their retirement assets in these two investment tools. Unfortunately for those inclined to follow this last advice, it is not clear if many (or any) company sponsored retirement plans (401(K)'s etc.) offer these products.
The author's focus on inflation at a time when it is barely detectable may seem problematic, but a recovering economy, growing budget deficits, and a weakening dollar carry their own consequences. In the end, Bodie and Clowes overplay their case for I Bonds and TIPS. Not all products and services in the economy adjust in lockstep as do these bonds with Bureau of Labor Statistics measures of inflation. As a consequence a near exclusive reliance on these bonds may prove comforting but ultimately ineffective to reach a desired goal. Still, the understanding and use of these investment tools could prove important in a balanced portfolio in the years ahead. Now is the time to look at the issue.
"It seems somewhat ridiculous that the government is not recommending these," Bodie told the 401kWire.com. "The simplest way would be for the government to mandate that one of the core options under 404(c) to be TIPs."
So far he reports that his recommendations have fallen on deaf ears in Washington (no members of Congress have contacted him and he has not contacted the Department of Labor). That should reassure industry insiders. What should catch your attention though is that Bodie's ideas have a small chance of catching on inside the US Treasury.
"There was a call by the Treasury department for ideas on how to stimulate the demand for TIPs," explained Bodie. In response he shared his ideas with Peter Fisher who manages the national debt issued by the Treasury. He also landed an opinion piece on the topic in the Financial Times of London.
Bodie first started working on the concept for JP Morgan. The New York City based firm engaged Bodie to explore ways to add the instruments to the 401(k) plan that it offers to its own employees. Bodie told the 401kWire.com that his understanding was that the product would eventually have been rolled out to other JP Morgan defined contribution clients. The engagement ended when JP Morgan merged with Chase.
Undeterred, Bodie is still pursuing the concept even without government fiat. He is now forming a new company in partnership with Harvard's Nobel Prize Winner Bob Merton and an unnamed but "senior level and experienced Wall Street executive" to pursue the concept of offering TIPs to 401(k) investors. "There will be a press release in the next couple of weeks" detailing the effort, he said.
"Everyone who we have mentioned this to responds quite enthusiastically," said Bodie.
Bodie's idea is theoretically simple. "Participants in 401k plans are not made aware of the risks of investing in their own employers stock. And they are not made aware of the risk of even investing in diversified equity funds," explained Bodie. "People say that if you invest in equities for the long-term that you do not have risk -- that is wrong."
That idea is buttressed by the fact that the price for options rises as the maturity of the instrument lengthens. If the risk of equities decreased over longer holding periods that price should be falling instead of rising. He adds that none of the investments in 401(k) plans, including stable value funds, are guaranteed to beat inflation.
"Most plans do not have an investment that allows them to make a long-run hedge against the inflation risk," he added. "Suppose the rate of inflation from now on is 3 percent per year. You want something to guarantee that the dollar would be worth a dollar in 30 years."
It was this fact that led him to idea to add TIPs to plans. With those instruments participants could lock in a real, and known, return for their retirement.
The concept faces at least to major hurdles, either of which could sink a product build around the concept. The first is that to lock in the return participants must buy TIPs in their raw form and not as a part of a mutual fund. For the industry that would likely add a recordkeeping headache that few providers would want to take on for so unsexy a product.
The second is that small market for TIPs. That market is estimated to be less than $150 billion in total assets currently. Meanwhile, nearly $2 trillion is now invested in 401(k) plans. Moving even a small proportion of those assets to TIPs would swamp the market.
Of course, it would also juice demand for the bonds and please the Treasury. Let's not give the Feds any ideas.
-Sean Hanna