Short answer: TIPS bond mutual funds performed better than ordinary bond mutual funds of similar duration through the recent inflationary period provided that the TIPS funds were purchased well before inflation started. TIPS performed worse than ordinary bond funds when purchased during high inflation, and significantly worse when purchased before a period of low inflation and sold while inflation remained low.
As happens so often, it depends on the clarity of your crystal ball that makes you decide when to get in and when to get out of TIPS vs ordinary bond funds. I'll give you some examples using Vanguard mutual funds. We'll assume that taxes don't play any role because the funds are in an IRA.
For non-TIPS, I'm using VBILX, an intermediate term bond fund that invests in U.S. Treasuries, U.S. agency bonds and some U.S. investment grade corporate bonds. Its average duration is currently 6.2 years. I'll abbreviate it "IB" for intermediate bond.
For TIPS I'm using VIPSX, a TIPS mutual fund that invests almost exclusively in TIPS. Its average duration is currently 6.7 years, a reasonably close match.
In the early days of the COVID pandemic, there was a so-called "flight to safety" with people buying up Treasury bonds up until about March 5, 2020. If you had bought IB and TIPS just then, you would have been kicking yourself because the next few weeks comprised the March 2020 "dash for cash" when people started realizing that the pandemic would be prolonged and they'd better sell some bonds for cash to ride out the economic storm. The intermediate bond market lost about 7% in a matter of days. If you held fast, and held your two investments until today (October 2024) always reinvesting dividends, the IB would today be worth -3% and the TIPS would be +6%. Good deal, TIPS came through inflation better than IB.
Looking at inflation year-to-year, 2020 was a mere 1.4% and 2021 was 7%. Suppose your long-term strategy had been to include TIPS and intermediate bond in your portfolio all along, and you bought both well before inflation hit. From January 1, 2019 to today, TIPS gained +19% and IB gained 13.5%. Again a good deal through massive inflation.
Suppose the 7% inflation made you panicky in 2021, so on January 1, 2022, amid rampant inflation, you bought both TIPS and IB? Oops, bad deal. From then through today, TIPS lost -5.7% but IB lost only -4.7%.
So these numbers suggest that if you buy TIPS rather than intermediate bond before high inflation and hold them through inflation, it's a good deal. If you buy during high inflation, not so good.
But what happens when there's no significant inflation for a long time? Looking at 2014 through 2019, those five years racked up inflation rates of 0.8%, 0.7%, 2.1%, 2.1% and 1.9%. If you had bought both of these two funds on 1/1/14, reinvested dividends and held them until 1/1/19, the TIPS would have gained +7.5% and the IB would have gained +15.5% during that time. Bad deal!
So what's the answer? Don't buy TIPS unless everything is normal and calm and you're the only one who knows that we're going to have sustained high inflation for the next few years. Why should you be the only one who knows about coming inflation? Because if everybody else knows, TIPS are already overpriced. It's the old Efficient Market Theory spoiling things for you.
