Hello, YieldAlley readers! In this issue:

🔑 The Key Drivers of Corporate Bond Returns (Larry Swedroe)

📈 How to Beat the Market (Humble Dollar)

🤯 The Surprising Truth About Dividend Growth Stocks (Morningstar)

🚚 Trump tariffs that are voided by — and ones that are safe from — Friday’s appeals court ruling (CNBC)

🏈 Sports fans to spend a record $30 billion betting on this year’s NFL football season (Sherwood)

When constructing a fixed income portfolio, one of the most critical decisions investors face is determining the optimal split between inflation-protected and traditional bonds. This allocation can significantly impact long-term returns, particularly during periods of unexpected inflation or deflation. Rather than relying on crystal ball predictions about future inflation, smart investors can use a systematic framework to guide these decisions.

The late David Swensen, Yale University's legendary Chief Investment Officer, provided a elegant solution for investors uncertain about future inflation trajectories. His approach was refreshingly simple: if you don't know which direction inflation will move, split your bond allocation evenly between inflation-protected and traditional bonds.

This 50/50 rule serves as an effective hedge against uncertainty. By diversifying across both inflation scenarios, you're positioned to be "right" roughly half the time while avoiding the concentration risk of betting everything on a single inflation outcome. For many investors, this balanced approach provides both reasonable returns and peace of mind.

While Swensen's 50/50 framework provides an excellent baseline, individual circumstances often warrant modifications to this approach. Investors generally fall into three distinct categories:

Group 1: The Balanced Approach

These investors stick closely to Swensen's original 50/50 allocation. They typically lack strong convictions about future inflation direction and don't have significant inflation hedges elsewhere in their portfolios. This group values simplicity and broad diversification over tactical positioning.

Group 2: Lower Inflation Protection

These investors may hold less than 50% in inflation-protected bonds for several compelling reasons. First, they might already own other inflation-hedging assets like real estate, commodities, or equity stakes in businesses with pricing power. Additionally, they may believe current market expectations for future inflation are too high, creating opportunities in traditional bonds.

The real estate factor deserves particular attention. Investment properties often provide excellent inflation protection through both rental income adjustments and property value appreciation. For investors with meaningful real estate exposure, reducing inflation-protected bond allocations below 50% can help avoid redundant hedging while potentially capturing higher yields from traditional bonds.

Group 3: Higher Inflation Protection

These investors warrant more than 50% allocation to inflation-protected securities due to specific circumstances. They might lack other inflation hedges in their portfolios, hold pessimistic views about future inflation relative to market consensus, or be approaching or already in retirement when inflation protection becomes more critical.

The retirement consideration is particularly important. Retirees face unique inflation risks since they typically can't easily adjust their "human capital" earnings to keep pace with rising prices. For investors within ten years of retirement, tilting toward higher inflation protection can provide valuable insurance against purchasing power erosion.

For most retail investors, Treasury Inflation-Protected Securities (TIPS) and Series I Savings Bonds represent the primary vehicles for inflation protection. TIPS offer the liquidity and diversification benefits of marketable securities, while I Bonds provide attractive tax advantages and guaranteed principal protection, albeit with purchase limits and liquidity constraints.

The choice between these vehicles often depends on investment timeline and tax considerations. I Bonds work well for shorter-term inflation hedging needs, while TIPS integrate more seamlessly into diversified bond portfolios for longer-term investors.

Applying this framework requires honest self-assessment across several dimensions:

Assess Your Inflation Hedges: Catalog existing inflation protection in your portfolio. Real estate, commodities, and stocks of companies with strong pricing power all provide varying degrees of inflation sensitivity.

Evaluate Your Inflation Views: While nobody can predict inflation perfectly, consider whether your expectations differ meaningfully from market consensus. If current TIPS pricing appears to incorporate inflation assumptions that seem too high or too low, this may inform your allocation decision.

Consider Your Timeline: Proximity to retirement or other significant spending needs may warrant a more conservative, inflation-protected approach.

Review and Rebalance: Like any portfolio allocation, this split should be reviewed periodically as circumstances change. A real estate investor who sells properties might need to increase inflation-protected bond allocations, while someone building substantial equity positions might justify reducing them.

The inflation vs. non-inflation protected bond allocation represents just one piece of a comprehensive fixed income strategy. However, getting this decision right can meaningfully impact long-term portfolio outcomes, particularly during periods when inflation surprises to either the upside or downside.

You can start with Swensen's balanced framework and then adjust based on individual circumstances. Investors can build bond allocations that align with their specific situations while maintaining reasonable diversification across inflation scenarios. In a world of genuine uncertainty about future inflation paths, this systematic approach offers a more robust foundation than attempting to time inflation cycles or making concentrated bets on specific outcomes.

Government Money Market Funds (7-Day Yields)

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ETFs (30-Day Yields)

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