Boglehead portfolio in a negative interest rate environment

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normaldude
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Boglehead portfolio in a negative interest rate environment

Post by normaldude »

Several countries already have negative interest rates (Switzerland, Sweden, Denmark). For example, Switzerland has negative yields on everything from short-term rates, all the way up to 9 yr government bonds.

http://www.investing.com/rates-bonds/wo ... ment-bonds

http://www.tradingeconomics.com/country ... erest-rate

Let's say a boglehead normally has 70% stocks / 30% bonds. And let's say that USA moves into negative interest rates (let's say negative yields on everything from savings accounts, all the way up to 10 yr US treasuries). But let's say you still can't borrow at negative interest rates.

What would be the ideal boglehead portfolio in this example negative interest rate environment?

a) 70% stocks / 30% bonds, stay the course, and swallow the negative yields on the bonds.

b) 70% stocks / 30% physical cash, stuffed in a fireproof safe, with lots of termite spray nearby.

c) 70% stocks / 30% physical gold, stuffed in a fireproof safe.

d) 70% stocks / 30% real estate.

e) Something else?
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galeno
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Re: Boglehead portfolio in a negative interest rate environment

Post by galeno »

I vote for a).

Loose cash can be dangerous. Gold is for speculation.

In a negative interest environment RE and REITS will be priced high as the yield-chasers will bid prices up.
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Phineas J. Whoopee
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Re: Boglehead portfolio in a negative interest rate environment

Post by Phineas J. Whoopee »

Do you mean nominal or real interest rates?
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normaldude
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Re: Boglehead portfolio in a negative interest rate environment

Post by normaldude »

Phineas J. Whoopee wrote:Do you mean nominal or real interest rates?
PJW
Nominal.

$100,000 in physical cash, in a fireproof safe, after one year, will still be $100,000.

$100,000 in a bank savings account or 1yr T-bill yielding -1.00%, after one year, will be $99,000.
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Phineas J. Whoopee
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Re: Boglehead portfolio in a negative interest rate environment

Post by Phineas J. Whoopee »

normaldude wrote:...
Nominal.
...
Thanks for the clarification.

So long as you can accurately predict future twelve month nominal interest rate changes, and so long as your physical arrangements cost less than the nominal loss, you're correct that an individual could in nominal terms come out ahead with stacks of $100s in a safe.

Most of us individual investors who have such luxuries can, in small ways, outrun institutions and very wealthy individuals. They may be best served by rolling T-bills, or even using the zero-percent certificate of indebtedness.

Imagine Apple trying to make payroll with physical cash stored in safes.

Those with bank accounts earning zero or small positive nominal rates, but for which they're charged fees, will find themselves behind as well, even if it the fees aren't calculated as interest. My local B&M banker, no fault to her because it's what her boss told her to do, attempted to convince me to sign up for a $5 / month optional plan so I could get free checks. I thought $60 / year was an awful lot to pay for free checks, and therefore declined.

During the recent financial crisis, secondary market short US T-bills did indeed, briefly, trade at negative nominal YTMs.

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Last edited by Phineas J. Whoopee on Thu Jul 23, 2015 8:44 pm, edited 2 times in total.
dad2000
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Re: Boglehead portfolio in a negative interest rate environment

Post by dad2000 »

I would be thankful that I have a significant amount of my fixed income ($160k) in I-bonds, and probably not change much.
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Re: Boglehead portfolio in a negative interest rate environment

Post by kolea »

Are you confusing interest rate and yield? Yield as in YTM is more important if you are an active investor. If you buy and hold, the coupon rate is more important. Personally, I stay the course so I don't pay a lot of attention to YTM or SEC 30 day yield. I bought long ago so what I have is what it is and all I care about are the distributions that come in.
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ctreada
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Re: Boglehead portfolio in a negative interest rate environment

Post by ctreada »

Replace bond allocation with high yield savings.

[No way -- admin LadyGeek] am I keeping money in bonds with a negative nominal yield. Makes no sense to GIVE up money for the sake of "portfolio security"
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Phineas J. Whoopee
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Re: Boglehead portfolio in a negative interest rate environment

Post by Phineas J. Whoopee »

ctreada wrote:Replace bond allocation with high yield savings.
...
OP specified in the question, realistically or unrealistically, that even bank savings accounts charged, rather than paid, nominal interest.
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JonnyDVM
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Re: Boglehead portfolio in a negative interest rate environment

Post by JonnyDVM »

There's several countries with negative yields now. Depending on how negative it was I guess I'd just move some more to equities and load up on physical cash. Only issue with that is I only would want to keep so much cash under the mattress. Not sure what I'd do when the amount was getting uncomfortable. Let's cross that bridge when we get to it.
Last edited by JonnyDVM on Fri Jul 24, 2015 10:01 pm, edited 1 time in total.
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ogd
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Re: Boglehead portfolio in a negative interest rate environment

Post by ogd »

normaldude wrote:b) 70% stocks / 30% physical cash, stuffed in a fireproof safe, with lots of termite spray nearby.
This one. A bank deposit box is a good alternative, rates not tied to yields because they don't know how much is in there.

But I don't think it will ever come to that, for two reasons. One is that for small depositors (for which above is feasible), I don't think there will be negative rates in the US, ever. It might indeed be the case, as it is now, that savings accounts yield some 1% higher than market bonds, in that situation transforming negative into zero.

The other is that I don't think the US will do as terrible a job of managing the money supply as the Europeans have. But I can't go far into that subject because it's forbidden on this board.
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ogd
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Re: Boglehead portfolio in a negative interest rate environment

Post by ogd »

TwoByFour wrote:Are you confusing interest rate and yield? Yield as in YTM is more important if you are an active investor. If you buy and hold, the coupon rate is more important. Personally, I stay the course so I don't pay a lot of attention to YTM or SEC 30 day yield. I bought long ago so what I have is what it is and all I care about are the distributions that come in.
Actually, YtM is always the thing you should pay attention to, even if you're a buy and holder. It tells you a couple of things that you'd miss by looking just at coupons:

1) That you're paying too much for a bond. For example, you can buy right now a Treasury with 10% coupon and 0.2% yield. Your money is much better off in a good savings account, as in guaranteed more money in your pocket. Just a few months ago I explained to a fellow on this board who was thinking "so what if I have to pay a little premium, if I'm getting a bond that good" that the premium made his bond garbage.

2) That it's time to sell an old bond that you got in times of high yield. Pretty much the same thing -- if that 10% Treasury is in your portfolio, you should sell it and put the money in a 1% savings account, even if you bought it when it was born at auction. It's not speculative to say that if the market is willing to hand you almost all the remaining coupons immediately in the form of bond premium, you should take them. There is no possible way that holding a short Treasury to maturity can beat the savings account proposition, so you're not speculating.
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Re: Boglehead portfolio in a negative interest rate environment

Post by Call_Me_Op »

galeno wrote: Loose cash can be dangerous.
Please explain what you mean.
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longinvest
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Re: Boglehead portfolio in a negative interest rate environment

Post by longinvest »

ogd wrote:
TwoByFour wrote:Are you confusing interest rate and yield? Yield as in YTM is more important if you are an active investor. If you buy and hold, the coupon rate is more important. Personally, I stay the course so I don't pay a lot of attention to YTM or SEC 30 day yield. I bought long ago so what I have is what it is and all I care about are the distributions that come in.
Actually, YtM is always the thing you should pay attention to, even if you're a buy and holder. It tells you a couple of things that you'd miss by looking just at coupons:
True, but the average YTM assumes that a fund will distribute all the capital of maturing bonds, in addition to coupons, until the duration falls to zero (and the fund is closed).

Bond funds (other than target maturity ones), reinvest the principal of maturing bonds, most often at a higher yield than the average YTM of the fund (it's actually always the case when the yield curve is steep). So, one must really be careful not to confuse the average YTM of a relatively constant duration bond fund with the YTM of a single decreasing duration bond.

In other words, there is a non-negligible chance that a bond fund will have a higher total return than its average YTM over its duration. But, that's no promise. The return could be higher or lower. We just don't know. The average YTM can serve as a gross indicator of a very approximate destination (thanks to mathematics that limit the movement of bonds). I would say that the actual future annualized return has a good chance of being in the range of YTM +/- 2% over the duration.

In the long term (many durations), it would be true that the return is mostly made of the coupons if the fund was a CD ladder (each CD bought at issue and held to maturity). A better approximation would be to say that it will be mostly made of the YTM of bonds at the time they are acquired by the fund. (Yet, this does not include the impact of the general practice of selling bonds one year prior to maturity).
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Hunky-dory
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Re: Boglehead portfolio in a negative interest rate environment

Post by Hunky-dory »

Obviously if you are not a new investor, in your hypothetical only future bond purchases would be receiving negative yields. It is an interesting question. I would pay off all outstanding debt (including mortgage debt) prior to purchasing more bonds and after all debt is paid off would consider holding cash or exploring other low-volitality investments that serve a similar purpose as bonds in my portfolio (e.g., money-market funds or stable value funds). I don't think options c or d are consistent with boglehead philosophy, as both involve drastic changes to a portfolio in response to current market conditions.
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Re: Boglehead portfolio in a negative interest rate environment

Post by magneto »

normaldude wrote:
Phineas J. Whoopee wrote:Do you mean nominal or real interest rates?
PJW
Nominal.

$100,000 in physical cash, in a fireproof safe, after one year, will still be $100,000.
But less inflation in purchasing power, if we determine real yield as the critical measure for investors.
So we have been there, done that.

Leaning towards d) the 30% real estate or some other real asset producing income. That rules out the Porsche. :)
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Re: Boglehead portfolio in a negative interest rate environment

Post by Johno »

normaldude wrote:Several countries already have negative interest rates (Switzerland, Sweden, Denmark). For example, Switzerland has negative yields on everything from short-term rates, all the way up to 9 yr government bonds.
a) 70% stocks / 30% bonds, stay the course, and swallow the negative yields on the bonds.
b) 70% stocks / 30% physical cash, stuffed in a fireproof safe, with lots of termite spray nearby.
c) 70% stocks / 30% physical gold, stuffed in a fireproof safe.
d) 70% stocks / 30% real estate.
e) Something else?
You mean negative nominal bond yield as is true in those countries. And I suppose you implicitly assume highest bank deposit rates are also negative, but for example you can see on link there are banks offering positive rates to domestic retail investors in Switzerland, though the best ones have limited withdrawals that make them more like short term CD's.
http://www.moneyland.ch/en/savingsAccount/index

Anyway assuming safe bank accounts pay a negative, b) makes sense, though I'd say safe deposit box rather than safe in one's home*, assuming it's really practical. That's going to be a function of size. Also an investor might put a value on not attracting the kind of attention, including from the govt, that you would attract trying to arrange say a $300k paper money withdrawal from a bank. :D

a) seems to be the choice of many CHF's, SKR's, DKR's etc invested in those countries, even if some banks do have non-negative deposit rates.

on e) that's I-bonds up to the purchase limit assuming that's significant and assuming they don't change the policy of issuing them at a minimum rate of inflation plus zero, and/or series E bonds, especially if they keep the feature of their value at least doubling in 20 yrs regardless of stated rate.

I wouldn't make blanket statements against gold or real estate, but by same token they are not direct substitutes for cash/bond in a positive rate environment, and don't automatically become direct substitutes just because rates are negative. And their own values tend to be increased and their expected returns decreased by low rates.

*based on what I pay for an SDB, not especially for paper money, and how much paper money I think would fit with nothing else, I guess the implied nominal 'interest' rate would be on order of negative a few .01's%
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Re: Boglehead portfolio in a negative interest rate environment

Post by itstoomuch »

I kinda wish that I stayed in cash in 01Jan2015, rather than buying investment grade utilities with dividends. :oops:

Money is always kinda relative. :mrgreen:
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Re: Boglehead portfolio in a negative interest rate environment

Post by rca1824 »

:idea: I have high risk tolerance so I would move to 100% equity (actually am already 100% equity). If I was retired and wanted bonds, I would have to make a trade-off between paying the negative interest rate versus purchasing a home safe and insuring it. I think the home safe and insurance would cost more than a -0.25% interest rate. I could also investigate a bank safe but they will also charge a fee no doubt. Then there's the effort of depositing the cash into my checking account so I can spend it. I think I would just pay that -0.25% interest. Plus it would be a tax deductible capital loss I believe whereas the deposit and insurance fees are not tax deductible.

Somethings it's just not worth chasing such small savings you pay more in effort and other fees by doing so.
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