Real estate returns, measured unleveraged, have been between those of stocks and bonds over 1960-1982. Due to appraisal smoothing and imperfect marketability, one must be careful about directly comparing measured real estate returns with those on other assets. It is likely, however, that low correlations with stocks and bonds make real estate a diversification opportunity for traditional portfolio managers. In addition, the issue of how various assets are priced is addressed. While stocks are priced primarily on market or beta risk, and bonds are priced primarily on interest rate and default risk, the real estate pricing mechanism includes residual risk and non-risk factors such as taxes, marketability costs and information costs. Copyright American Real Estate and Urban Economics Association.

After examining an array of approaches to determining a spending rule for retirees, the authors propose the annually recalculated virtual annuity. Each year, one should spend (at most) the amount that a freshly purchased annuity-with a purchase price equal to the then-current portfolio value and priced at current interest rates and number of years of required cash flows remaining-would pay out in that year. Investors who behave in this way will experience consumption that fluctuates with asset values, but they can never run out of money.

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ot long ago, when the real yield (that is, the yield before adding the inflation adjustment) on Treasury InflationIndexed Securities (formerly called Treasury Inflation-Protected Securities, TIPS) exceeded 4 percent, investors could be forgiven for thinking that TIPS were the magical asset. At that time, it was not clear whether equities (much less nominal bonds) offered prospective real returns higher than 4 percent. So, TIPS offered not only inflation protection and the repayment of nominal principal (if one bought TIPS that were selling close to par) but a rich absolute return.Investors did not figure out the special attractiveness of TIPS for a while after the initial issuance of these securities, but apparently they did so in droves beginning in early 2000: The real yields on these instruments fell from a high of 4.36 percent in January 2000 to a low of 1.03 percent in March 2004.1 At today's more modest real yields, the case for TIPS is not one of timing or undervaluation but of structural advantage. One should ask: What are the characteristics of this instrument that make it fundamentally different from other securities? Who is the natural clientele for these characteristics; that is, for what kinds of investors are TIPS so attractive that it is rational for them to outbid others to acquire TIPS? Conversely, what kinds of investors should avoid TIPS?To answer these questions, we focus on the fact that, as Leibowitz, Sorensen, Arnott, and Hanson (1989) pointed out, an asset or stream of cash flows (in their case, equities) can be regarded as having two durations-(1) an inflation duration, D i , or sensitivity of the asset's return to a change in the inflation rate, and (2) a real-interest-rate duration, D r , or sensitivity of the asset's return to a change in the real interest rate. Although this distinction can, in principle, be drawn with nominal bonds, for such a bond, D i and D r are essentially equal to one another and also equal to the regular, or nominal, duration. The distinction between D i and D r becomes interesting when applied to TIPS, for which D i is emphatically not equal to D r , and to other assets, to liabilities, and to portfolios with the same characteristic.After exploring this "dual duration" characteristic of TIPS, we draw on Goodman and Marshall's (1988) observation that pension liabilities also have such a dual duration. We develop this parallel to show how TIPS can be used, together with nominal bonds, to hedge the inflation and real-interest-rate risks of pension liabilities. Finally, noting that equities also have an inflation duration that is different from their real-interestrate duration, we address the question of how to manage the asset class exposures in pension plan, foundation, and endowment fund portfolios and in the investment programs of individuals. 2 Because TIPS play into investors' natural desire to hedge against inflation and because of economists' special fondness for a security that provides a direct market measure of the real rate of interest, TIPS have re...

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