When I announced my stripped-down model portfolios at the beginning of last year, one of the asset classes I dropped was real-return bonds (RRBs). Part of the reason was simplicity: it’s easier to manage a portfolio of three or four funds compared with five or six, and you’re not giving up much diversification. But there was a more important reason for booting real-return bonds from my recommended portfolios.
First, a quick refresher. RRBs are a type of government bond designed to protect investors from the effects of inflation. Both their face value and interest payments are pegged to the Consumer Price Index and adjusted twice a year, which means you’re guaranteed to maintain your purchasing power over the life of the bond. That feature overcomes one of the biggest shortcomings of traditional bonds.
There’s little question that RRBs are useful in theory. Consider a retiree who needs $50,000 annually to meet her expenses today. She could build a 10-year ladder of traditional bonds with a face value of $50,000 each, but by the time that last bond matures $50,000 won’t buy as much as it used to.