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By Christine Benz | 09-27-2010 05:53 PM

How Many TIPS Do You Need?

Vanguard's John Ameriks offers a default allocation based on Vanguard's target-date lineup, plus outlines the individual factors investors should consider to personalize their inflation protection.

Christine Benz: Hi. I'm Christine Benz for Morningstar.com.

How to position an in-retirement portfolio's asset allocation is a hugely important question, but it's one that retirees often struggle with.

Here to discuss that question with us is John Ameriks. He is head of Investment Counseling and Research at Vanguard.

John, thanks for being here.

John Ameriks: Thanks for having me, Christine.

Benz: So, John, I'd like to discuss one question that we've debated with users on Morningstar.com. This question of how much to hold in TIPS within a fixed-income portfolio. What's the right level of allocation for that asset class.

Ameriks: Sure. Well, it's a tough question. I mean TIPS are a very unique asset class and that actually, I think, was reflected. I know the Barclays committee just got together and talked about the aggregate and whether it would include TIPS. And I know, at this point, have made the decision that it won't be included in that aggregate.

But for an individual investor, you've got to think about what type of inflation protection do you really need. I think the higher your need for a CPI-linked sort of disaster protection in terms of inflation, the more you're going to want to look at TIPS as a part of the portfolio.

So, in our target-date funds in the retirement income portfolio--and that portfolio is 70% fixed income, 30% equities--20% of that portfolio is in TIPS. The remainder in a broad-based domestic fixed income.

So, that's what we're doing in the target-date fund exposure for, I would say, a default situation for somebody who is looking at spending from their portfolio gradually over time in retirement, but looking at spending that down. Their objective is to make it last as long as they do basically. They are not really looking to grow that portfolio. That type of an allocation might be something to consider.

Benz: So, how would I know if my need for inflation protection is greater than my neighbor's need for inflation protection in retirement?

Ameriks: Well, a lot of it may come down to different aspects of your financial situation. There are some folks who, matter of fact more than, I think, people expect, that are getting into retirement now, they do have a pension income that may come from a state or local government or from the federal government, that has literal inflation protection embedded in it, and for those people maybe the need for something like TIPS could be a little less than for someone else.

A lot of folks are getting some of their income from property, other sources that may have some inflation component built into it, maybe their need for TIPS allocation is a little less. So it really does come down to personal circumstances and thinking about, well, how will the rest of my income deal with an inflation surprise, and to the extent that you see a risk there and exposure there, TIPS may make some sense.

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