Matching 3% TIPS

If you can find the equivalent of TIPS at a 3% real interest rate over a decade, you can lift your withdrawal rate to 6% of your original balance (plus inflation) indefinitely. This shows what it involved.

The Requirements

Back of the Envelope 6% shows what you need to do to withdraw 6% (plus inflation) indefinitely. The key ingredient is finding corporate bonds and/or preferred stock that produce the equivalent of 3% TIPS.

Back of the Envelope 6%

The Right Investment

What you need to find is a bond or preferred stock that redeems its principal after 10 years. Otherwise, you are at the mercy of the secondary market when you need to buy stocks.

At a 6% (plus inflation) withdrawal rate, TIPS at 3% still have 66% of their buying power after 10 years.

At 3% inflation, the inflation adjusted principal of a bond or preferred stock falls to 74% of its original value after 10 years. At 4% inflation, inflation adjusted principal is reduced to 68% of its original value after 10 years.

Historically, inflation has ranged between 3% and 4%. The inflation adjusted principal of a 10-Year bond or preferred stock matches the buying power of a 3% TIPS ladder. All that you need is adequate income from the interest to meet the withdrawal requirement.

At a 6% interest rate, a bond would provide an inflation adjusted income ranging from 6% initially to 4.0% to 4.4%.

At a 7% interest rate, a bond would provide an inflation adjusted income ranging from 7% initially to 4.8% to 5.2%.

A bond or preferred stock with 6% interest produces too little income. But 7% interest along with some cash management is enough. You would transfer some of the income from the early years into the later time period.

Availability

I went to QuantumOnline.com. I specified a maturity date no later than 1/1/2020. I specified investment quality (Baa3 or BBB or better). I specified United States securities. I found 21 such investments. They did not look satisfactory to me. They might to an experienced income investor.

I removed the maturity date requirement, accepting the possibility of unfavorable prices 10 years from now. I found many issues that would satisfy a stock investor.

QuantumOnline.com

Conclusion

Finding a satisfactory substitute for a 3% TIPS ladder is difficult, but doable.

Have fun.

John Walter Russell
May 25, 2008