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SCHP: The Best TIPS Exposure Investors Can Get

Summary TIPS offer very weak yields, but SCHP is designed the right way for investors. The ETF offers a very low expense ratio, easily beating a much larger competitor. The difference in expense ratio alone should be enough to make SCHP an easy winner for an investor planning to keep part of their portfolio in TIPS. If I were retiring and really needed access to the inflation protection, I would be planning to convert part of my holdings to SCHO at the start of each year. Combining SCHP for inflation protection with SCHO to get some yield off a position that would otherwise be cash provides a nice interaction between the two bond ETFs. The Schwab U.S. TIPS ETF (NYSEARCA: SCHP ) has everything investors could hope for other than strong yields. The yield issue is not surprising; there are no good yields to be achieved on TIPS. When it comes to comparing SCHP to competitors, SCHP looks like the gold standard. As I’ve told investors, I’m avoiding TIPS because I want to see better yields. If I were a retiring investor and needed inflation protected bonds, SCHP would be the champion on the list of options. Portfolio Characteristics Investors should start with looking at things like the duration risk. Keep in mind that the since the portfolio is holding TIPS the risk of inflation over time is already built into the portfolio. Since there are many retirees that could use more stability in their portfolio, there should be very strong demand for TIPS. Honestly, I would love to have the inflation protection in my portfolio but I don’t want it bad enough to accept the yields on TIPS. Simply put, other investors want that inflation protection more than I do and they have demonstrated that desire by buying up the TIPS until the yields were incredibly low. The effective duration on the portfolio is 7.79 years which matches the average effective duration for the iShares TIPS Bond ETF (NYSEARCA: TIP ). Since the portfolio is 95.3% in TIPS with the rest in a mix of U.S. Treasury securities and a very small amount of cash, the question for each investor simply comes down: “Do you want inflation protection enough to accept the very weak yields after inflation?” There is not one correct answer. For some people it should be yes and for others it is no. This is not meant to be 100% of an investor’s portfolio but it would be a useful holding for stabilization of portfolio values. If you are buying an ETF filled with TIPS, you’re accepting having a yield that is just barely above inflation and even getting a positive yield after inflation requires taking some duration risk. The Next Question If an investor does not want to buy TIPS, there isn’t much reason to consider an ETF packed with them. For the investor that does want the TIPS in their portfolio, the next question is “Which ETF Should I Use?” In my opinion, the Schwab U.S. TIPS ETF is a clear winner in this category for many investors though some of them may not know it. The biggest competitor is the iShares TIPS Bond ETF. With the same effective duration, the actual allocation to individual security length is not identical. However, the holdings are similar enough that I am fairly confident that over the next 10 years the difference in returns between the two would come down to the expense ratio. For TIP the expense ratio is .20%. For SCHP it is only .07%. This is a case of a lower expense ratio outweighing virtually all other considerations because the portfolios being held are so similar. I don’t see any good argument for TIP to beat SCHP over the long haul when portfolios are similar and SCHP is willing to let investors keep an extra .13% of the portfolio value. Remember that these bond yields are not great; a difference of .13% on the expense ratio should make a meaningful difference over time. If SCHP is able to match TIP in gross returns, then SCHP is offering investors about another 1.3% to their portfolio value over a decade. The next factor is that investors holding Schwab portfolios are getting free trading on SCHP. If the investor wants to be able to frequently liquidate small positions and avoid holding a large amount in cash, then SCHP is offering another benefit by not charging a commission on the trade. For the retiree that wants to be able to withdraw one or two grand at a time to supplement their other income sources, saving a trading fee on the transaction will be an enormous factor. Investors paying trading fees would be saving around .45% to .9% of the value of the distribution. When we are talking about securities with a very small real yield, saving the trading costs can become material. Return Comparison SCHP has a fairly limited history, but it is playing out as I would expect so far. The distribution yields for TIP and SCHP have been almost identical (.85% for tip, .83% for SCHP). When we look at the NAV return over the last year SCHP was down 1.81% while TIP was down about 1.9% (rounded). The difference may be significantly tied to SCHP having a benefit from the lower expense ratio. The difference in price return over the period also favors SCHP by a small amount. These results are precisely what I would expect when the two ETFs hold extremely similar assets. If I Was Using SCHP If I was retiring, I would probably be holding part of my portfolio in SCHP. While the TIPS provide a return that automatically adjusts for inflation, there is still some volatility due to the duration risk on the portfolio. Therefore, I would consider pulling out money from SCHP at the start of the year. I would take the amount that I was pulling out of SCHP and reinvest it in the Schwab Short-Term U.S. Treasury ETF (NYSEARCA: SCHO ) to hold that cash until I needed to pull it out. I find SCHO to be a fairly acceptable substitute for cash in a portfolio. It does not provide inflation protection, but the very low duration works nicely. Keep in mind that this strategy would only work with free trading. Without free trading it would be better to just hold the cash rather than parking it in SCHO. My View I assume investors looking heavily at the Schwab funds probably opened a Schwab account to take advantage of those funds the same way I did. Schwab doesn’t give me anything for covering their ETFs, but I frequently choose Schwab ETFs to research because I want to know more about the ones I can trade without paying commissions. I’m adding to my portfolio several times per year and my investment mentality absolutely despises paying any unnecessary costs. Best Contender In my opinion, the best contender for the title of “Best TIPS ETF” would be the Vanguard Short-Term Inflation-Protected Securities ETF (NASDAQ: VTIP ). For investors seeking shorter duration, VTIP is a solid alternative. For investors willing to take on longer term TIPS as part of their retirement strategy, I think the SCHP portfolio’s longer duration is acceptable to seek stronger yields. If the investor had free trading on VTIP but not on SCHP, they would probably be better off with VTIP. If there were no free trades on either, I would favor SCHP for longer term allocations. Conclusion If investors want to put TIPS in their portfolio, SCHP looks like the way to do it. As long as investors are willing to accept the yield on TIPS, there is no weakness for SCHP. It easily beats other major ETFs on expense ratio while offering investors (through Schwab) the opportunity to avoid commissions on the trades. I’m not willing to accept the yield on TIPS since I expect to be working for a long time and can absorb any hits from inflation over my career. When I get to that point, hopefully yields will be stronger. Even if yields are weak, SCHP embodies all the other things I would be looking for. As for TIP, I don’t see any value in higher expense ratios. When it comes to SCHO, I’m planning to start using SCHO in my portfolio as a way to park cash while still generating a positive yield with very little risk. Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. (More…) I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article. Additional disclosure: Information in this article represents the opinion of the analyst. All statements are represented as opinions, rather than facts, and should not be construed as advice to buy or sell a security. Ratings of “outperform” and “underperform” reflect the analyst’s estimation of a divergence between the market value for a security and the price that would be appropriate given the potential for risks and returns relative to other securities. The analyst does not know your particular objectives for returns or constraints upon investing. All investors are encouraged to do their own research before making any investment decision. Information is regularly obtained from Yahoo Finance, Google Finance, and SEC Database. If Yahoo, Google, or the SEC database contained faulty or old information it could be incorporated into my analysis.

5 Reasons To Lower Your Allocation To Riskier Assets

Fewer and fewer components are holding up the Dow, the S&P 500 and the NASDAQ. If foreign stocks are faltering at a time as when half of U.S. stocks are in their own downtrends, it may reasonable to assume that the major U.S. benchmarks could buckle. There are a number of headwinds that are likely to bring about a substantive correction to the Dow, S&P 500 and NASDAQ in the near-term. For months, I have been discussing the likely implications of deteriorating market breadth. For instance, fewer and fewer components are holding up the Dow, the S&P 500 and the NASDAQ. Only a small number of industry sectors are keeping the popular benchmarks in the plus column. Similarly, half of the stocks in the S&P 500 currently demonstrate bearish downtrends. And declining stock issues are significantly pressuring advancing stock issues for the first time since July of 2011. Historically, when a handful of stocks like Amazon (NASDAQ: AMZN ), Apple (NASDAQ: AAPL ), Facebook (NASDAQ: FB ), Gilead (NASDAQ: GILD ), Google (NASDAQ: GOOG ) and Walt Disney Co (NYSE: DIS ) account for all of the gains for a major index like the S&P 500 – when 250 of the index constituents show bearish patterns – the narrow breadth tends to drag the benchmark’s price downward. To be fair to the bull case, the major indices have held up so far. Nevertheless, U.S. equities in the Dow and the S&P 500 have been churning sideways for the better part of seven months. What about the prospect for underperforming sectors of the economy contributing to widespread market gains? I wouldn’t hold my breath on the possibility of wider breadth in the near term. Materials and resources-related companies continue to be plagued by slumping oil and weak commodity demand around the globe. Most economists believe that while the rout in commodities may conceivably abate, a significant increase in global demand or a sharp decline in global supply is unlikely. In the same manner, the manufacturing segment’s pullback may be structural, not cyclical. Miners, industrial conglomerates and utilities probably won’t be getting wind at their back anytime soon. For better or worse, the primary hope for continued appreciation in the U.S. indices rests atop the shoulders of the healthcare juggernaut, dot.com usage and the iPhone-oriented consumer. Indeed, investors have been remarkably willing to pay almost any price for the growth of the “Facebooks” and “Gileads” of the world. On the flip side, can the market-cap behemoths do any wrong? Of course they can. It wasn’t so long ago that Facebook shares face-planted for a 50% loss out of the IPO gate? Similarly, Apple tumbled 45% at the tail-end of 2013. Even at this moment, questions about the viability of the iWatch and the corporation’s ability to grow at a rapid pace in future quarters is keeping the shares of the largest company on the planet from breaking through resistance. For the time being, however, let’s assume that the “Big Six” identified earlier maintain their proverbial cool. And let’s assume that the narrow breadth in the U.S. benchmarks (as well as sky-high stock valuations) are not enough to dent the positive impact provided by health care and retail/consumer stocks. Is it possible that waning enthusiasm for foreign equities might couple with the weakness in U.S. market internals and sky-high valuations to eventually topple the major U.S. benchmarks? Looking back to the last stock market smack-down might provide some clues. Specifically, in 2009 and 2010, stocks throughout the world staged a revival. What’s more, in the same manner as they had in the previous decade, foreign stocks significantly outpaced U.S. stocks in 2009 and 2010. In fact, the global growth theme that dominated the initial decade of the 21st century remained in the driver’s seat. The dominance ended in October of 2010, however. Not only were the “emergers’ emerging at a slower pace, particularly China, but central bank stimulus supplanted the global growth story altogether. Consider the Vanguard FTSE All-World ex-US ETF (NYSEARCA: VEU ): SPDR S&P 500 Trust ETF (NYSEARCA: SPY ) price ratio below. VEU:SPY began descending in the 4th quarter of 2010. The fading relative strength for VEU:SPY cemented itself early in 2011, when 200-day trendline support shifted to resistance. Not only did the weakness in U.S. market internals matter in July 2011 via the NYSE Advance Decline (A/D) Line, but relative weakness in foreign stocks also mattered. Fewer and fewer U.S. stocks were participating in the rally by July of 2011 and fewer and fewer international stocks were participating in the worldwide equity rally. It is worth noting that the deterioration of the VEU:SPY price ratio over the last three months of 2015 may be another headwind to U.S. benchmark gains. Historically, all stock assets typically exhibit positive correlations. It follows that, if foreign stocks are faltering at a time as when half of U.S. stocks are in their own downtrends, it may reasonable to assume that the major U.S. benchmarks could buckle. By way of review, there are a number of headwinds that are likely to bring about a substantive correction to the Dow, S&P 500 and NASDAQ in the near-term: Federal Reserve and the Rate Hike Quagmire . By itself, a bump up in overnight lending rates may not be a big deal. Conversely, participants may perceive inaction (an unwillingness to do anything) or too much activity (back-to-back rate hikes on wishy-washy data) as a major policy mistake. Extremely High Valuations and Eroding Domestic Internals . High valuations alone can always move higher; excitement can turn to euphoria. Yet history has rarely been kind to the combination of stock overvaluation and narrowing leadership (i.e., bad breadth). Fading Effects Of Quantitative Easing/Other Stimulative Measures In Foreign Stocks . Both Europe and Japan had seen their prices surge shortly after confirmation of asset purchases. Over the last three months, those fortunes have cooled relative to the U.S. In some instances, as has been the case in China, stimulative measures that didn’t work eventually turned to direct (as opposed to indirect) market manipulation. Is the world losing faith in its central banks? The Return of Credit Risk Aversion In Bonds . Seven months into 2015 and the widely anticipated jump in 10-year yields is nowhere to be seen. In fact, the 10-year at 2.25% is roughly in the exact same place as it was when the year started. It has been lower (much lower); it has been higher, not far from 2.5%. Yet the bottom line is that treasuries via the iShares 7-10 Year Treasury Bond ETF (NYSEARCA: IEF ) is rising in relative strength when compared with a high yield bond proxy like the iShares iBoxx $ High Yield Corporate Bond ETF (NYSEARCA: HYG ). Economic Weakness in the U.S. and Across the Globe. Latin America, Asia, Europe . Name the region and the economic deterioration is palpable. In contrast, many portray the U.S. economy in a positive light. Headline unemployment is low, home prices are high and Q2 GDP at 2.3% is faster than what we witnessed in Q1. Yet labor force participation (employment) is at 1977 levels, home ownership is at the lowest levels since 1967 and GDP has grown at an anemic 2% over the last six years. That’s not what a recovery typically looks like. It is no wonder that revenue (sales) at U.S. corporations will be negative for the second consecutive quarter. And when both the quality of job growth as well as the weakness in revenues are tallied, nobody should be surprised at the snail’s pace of wage growth either (2%). In spite of parallels that one can draw between the previous correction and/or prior bear markets (e.g., eroding domestic market internals, extremely high domestic stock valuations, near-term foreign stock weakness, etc.), the observations are not synonymous with prediction of disaster; rather, the observations lead me to conclude that a reduction of risk asset ownership is warranted for tactical asset allocation strategists. Practically, then, if you typically have 65% in equity (split between foreign and domestic, large and small) and 35% in income (investment grade and high yield), you might want to reduce the overall exposure to riskier assets until a significant correction transpires. How might I do it? I might have 55% in equity (mostly large-cap domestic), 25% allocated to income (mostly investment grade) and 20% cash/cash equivalents. Not only will you have reduced the amount of equity, you will have reduced the type of equity. Not only will you have reduced the income, but you will reduced the type of income. The efforts should assist in weathering the probable storm, as well as allow one to raise risk exposure at more attractive pricing. Is it possible that a tactical asset allocation shift might move further away from riskier assets? Like 35% equity, 25% income and 40% cash/cash equivalents? Yes. However, one would need to see a further breakdown of technicals and fundamentals beforehand. Disclosure: Gary Gordon, MS, CFP is the president of Pacific Park Financial, Inc., a Registered Investment Adviser with the SEC. Gary Gordon, Pacific Park Financial, Inc, and/or its clients may hold positions in the ETFs, mutual funds, and/or any investment asset mentioned above. The commentary does not constitute individualized investment advice. The opinions offered herein are not personalized recommendations to buy, sell or hold securities. At times, issuers of exchange-traded products compensate Pacific Park Financial, Inc. or its subsidiaries for advertising at the ETF Expert web site. ETF Expert content is created independently of any advertising relationships.