Modeling Cash in Monte Carlo

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gavinsiu
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Modeling Cash in Monte Carlo

Post by gavinsiu »

In another post, I asked if people can get index return return or if you have to factor in some cost. Empower for example automatically factor in a 1% drop in return due to expense. I believe the response was that many of the big name index fund actually track the index closely enough to be essentially the index. What about cash though? CashX return 5.13% last year, this is on a par with many of the money market, but If you keep money in a banking account or one of the settlement funds, it may end up being closer to 2% or worse like 0.01%. While Monte Carlo is just a model, you want to get the input as accurate as possible, so leave out any low interest bearing accounts in the model?
jebmke
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Re: Modeling Cash in Monte Carlo

Post by jebmke »

Mentally, I’ve always assumed that over the long term (50-75 years or so) that cash would have a real return in the vicinity of 0-50bp - plus or minus some constant of your choice. That’s why I tend to hold very little.
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gavinsiu
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Re: Modeling Cash in Monte Carlo

Post by gavinsiu »

jebmke wrote: Sun Feb 11, 2024 6:29 am Mentally, I’ve always assumed that over the long term (50-75 years or so) that cash would have a real return in the vicinity of 0-50bp - plus or minus some constant of your choice. That’s why I tend to hold very little.
Same here, but my mom holds a really large cash balance and I need to make sure ensure she's not somehow eroding her portfolio too much. To model the erosion, I just remove the accounts with low interest rate, reasoning that they return zero after taxes.
jebmke
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Re: Modeling Cash in Monte Carlo

Post by jebmke »

gavinsiu wrote: Sun Feb 11, 2024 6:58 am
jebmke wrote: Sun Feb 11, 2024 6:29 am Mentally, I’ve always assumed that over the long term (50-75 years or so) that cash would have a real return in the vicinity of 0-50bp - plus or minus some constant of your choice. That’s why I tend to hold very little.
Same here, but my mom holds a really large cash balance and I need to make sure ensure she's not somehow eroding her portfolio too much. To model the erosion, I just remove the accounts with low interest rate, reasoning that they return zero after taxes.
That means you are excluding accounts that may have negative real interest rates. I wouldn't exclude them.
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gavinsiu
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Re: Modeling Cash in Monte Carlo

Post by gavinsiu »

jebmke wrote: Sun Feb 11, 2024 7:11 am That means you are excluding accounts that may have negative real interest rates. I wouldn't exclude them.
Good point.

First, if the account is small enough, I could probably just ignore it and just assume it will be lost int he noise. For example, I do not include my emergency cash in my retirement portfolio calculations.

If the account is negative after inflation and taxes, I could probably replace it with an expense.

The sensible solution may be to get as much of the cash into some higher interest bearing account so that it would match the model asset's return.
chassis
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Re: Modeling Cash in Monte Carlo

Post by chassis »

Some overthinking in this thread.

Model one's estate in nominal dollars. Cash doesn't erode. If it earns 0% in a traditional bank account, which would be a misstep by the investor, it just sits there. It doesn't go anywhere.

Cash in a money market, HYSA or other low risk instruments does not erode, generally keeps up with inflation and, for some investors, grows faster than inflation.
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Re: Modeling Cash in Monte Carlo

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chassis wrote: Sun Feb 11, 2024 7:27 am Some overthinking in this thread.

Model one's estate in nominal dollars. Cash doesn't erode. If it earns 0% in a traditional bank account, which would be a misstep by the investor, it just sits there. It doesn't go anywhere.

Cash in a money market, HYSA or other low risk instruments does not erode, generally keeps up with inflation and, for some investors, grows faster than inflation.
The cash doesn't erode, but the buying power of it does.

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gavinsiu
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Re: Modeling Cash in Monte Carlo

Post by gavinsiu »

chassis wrote: Sun Feb 11, 2024 7:27 am Some overthinking in this thread.

Model one's estate in nominal dollars. Cash doesn't erode. If it earns 0% in a traditional bank account, which would be a misstep by the investor, it just sits there. It doesn't go anywhere.

Cash in a money market, HYSA or other low risk instruments does not erode, generally keeps up with inflation and, for some investors, grows faster than inflation.
I am not sure I am overthinking. She originally kept around 40% of her portfolio in a 0.01% paying account, so it is not keeping up with inflation, the return figure of portfolio Visualizer would be off since I am using cashx as the asset or cash, which is expected to return more than 0.01 (more like 5%). I have managed to get her to reduce the low yielding asset. But suppose cash was returning 0.01%, how do I model that in portfolio Visualizer? What asset would I pick?
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Re: Modeling Cash in Monte Carlo

Post by jebmke »

gavinsiu wrote: Sun Feb 11, 2024 10:31 am
chassis wrote: Sun Feb 11, 2024 7:27 am Some overthinking in this thread.

Model one's estate in nominal dollars. Cash doesn't erode. If it earns 0% in a traditional bank account, which would be a misstep by the investor, it just sits there. It doesn't go anywhere.

Cash in a money market, HYSA or other low risk instruments does not erode, generally keeps up with inflation and, for some investors, grows faster than inflation.
I am not sure I am overthinking. She originally kept around 40% of her portfolio in a 0.01% paying account, so it is not keeping up with inflation, the return figure of portfolio Visualizer would be off since I am using cashx as the asset or cash, which is expected to return more than 0.01 (more like 5%). I have managed to get her to reduce the low yielding asset. But suppose cash was returning 0.01%, how do I model that in portfolio Visualizer? What asset would I pick?
I guess the question is do you need Monte Carlo analysis to know that this is a bad situation and seek an alternative? I don't. I don't even need a spreadsheet to see that.
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gavinsiu
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Re: Modeling Cash in Monte Carlo

Post by gavinsiu »

jebmke wrote: Sun Feb 11, 2024 10:34 am I guess the question is do you need Monte Carlo analysis to know that this is a bad situation and seek an alternative? I don't. I don't even need a spreadsheet to see that.
Oh it is bad. However, fixing it is another issue. I was trying to figure out how bad it affects her future portfolio return in general. I have been periodically running Monte Carlo as a sanity check,

As for mitigation, it is a real pain.
  1. You can't tell her, she won't listen, and has to be shown. I convince her to move some of the cash to a HYSA. She then notices that she is making way more money now than before. She starts to lose confidence in her bank and get greedy about profit.
  2. Convince her that the profit is real and not because I invested the money in the black market, this is the first push back. Seriously, shouldn't crime pay better than a riskless Tbill?
  3. Move to a different HYSA because she can't figure out how to transfer funds between the two institution. Once that is accomplish, convince her to move more to the higher paying account.
chassis
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Re: Modeling Cash in Monte Carlo

Post by chassis »

gavinsiu wrote: Sun Feb 11, 2024 10:31 am
chassis wrote: Sun Feb 11, 2024 7:27 am Some overthinking in this thread.

Model one's estate in nominal dollars. Cash doesn't erode. If it earns 0% in a traditional bank account, which would be a misstep by the investor, it just sits there. It doesn't go anywhere.

Cash in a money market, HYSA or other low risk instruments does not erode, generally keeps up with inflation and, for some investors, grows faster than inflation.
I am not sure I am overthinking. She originally kept around 40% of her portfolio in a 0.01% paying account, so it is not keeping up with inflation, the return figure of portfolio Visualizer would be off since I am using cashx as the asset or cash, which is expected to return more than 0.01 (more like 5%). I have managed to get her to reduce the low yielding asset. But suppose cash was returning 0.01%, how do I model that in portfolio Visualizer? What asset would I pick?
Exclude cash from the simulation. Run the simulation excluding cash from the portfolio, then add cash manually after the fact to the value from the simulation. Cash does not erode, so this is a valid approach.

But most importantly move the cash out of a 0.01% account.

There are many good choices for cash now. I’m pretty sure you know this.
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gavinsiu
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Re: Modeling Cash in Monte Carlo

Post by gavinsiu »

chassis wrote: Mon Feb 12, 2024 6:11 am Exclude cash from the simulation. Run the simulation excluding cash from the portfolio, then add cash manually after the fact to the value from the simulation. Cash does not erode, so this is a valid approach.

But most importantly move the cash out of a 0.01% account.

There are many good choices for cash now. I’m pretty sure you know this.
Yes, I was thinking of excluding the cash asset from the simulation and then applying a inflation factor on the cash portion separately and then adding it back. At 0.01%, it's not keeping up with inflation.

In this case, I am trying. I don't know about other people's parent, but they seemed to get attached to their brick and mortar institution. I had made a few attempts in the past to move the money in the past, but with interest difference being so high, this is a good time to make the case for the switch. Current plan is to move the cash allocation at 0.01% from 40% to 2%. We still have 40% cash, but at least it earns closer to 5%.
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