Updated Modification of Harry Browne Permanent Portfolio

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matt
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Post by matt »

MediumTex wrote:
In early 2008, people were just as certain as they are today that treasurys were not a good place to be, yet TLT provided the protection promised by the PP through the 2008 crisis, while VUSTX would not have carried its weight when it was needed the most.
A lot of chance would play into whether VUSTX or TLT was better to hold through 2008-9. It all depends on when you ended up rebalancing your portfolio. If you do it on 12/31 each year, then TLT was probably better. If you use rebalancing bands, then each investor will rebalance at a different time. It's possible that a PP investor in VUSTX was better off because he ended up rebalancing in February 2009 instead of November 2008.

Both funds have high duration, so I think it's excessive to claim that if use VUSTX instead of TLT, that somehow you've broken the PP. Here's the simple truth: the maximum duration you can achieve on your Treasury bonds is outside of your control. The best Treasury bonds for deflation protection are those with the highest duration. Thus, it is EDV, not TLT, that is the optimal choice for the PP. Most people are resisting it because HB made some dubious comments about zero coupon bonds, but you just have to follow the logical extension of his original PP arguments to see that maximum duration is the goal, not maximum coupon bond duration.

Consider the arbitrary nature of capturing maximum duration in the first place. If the U.S. Treasury stops issuing 30-year bonds again, EDV, TLT, and VUSTX will all be less effective than they used to be. But they will still be some of the best tools at hand.

It is the duration that makes Treasury bonds work for you in deflation, not the coupon payment.
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craigr
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Post by craigr »

matt wrote:A lot of chance would play into whether VUSTX or TLT was better to hold through 2008-9. It all depends on when you ended up rebalancing your portfolio. If you do it on 12/31 each year, then TLT was probably better. If you use rebalancing bands, then each investor will rebalance at a different time. It's possible that a PP investor in VUSTX was better off because he ended up rebalancing in February 2009 instead of November 2008.
The problem with a fund like VUSTX is that it can hold (last I checked) 80% Treasury bonds and 20% non-Treasury bonds. The 20% is at the discretion of the fund managers and can include things like mortgages.

I talked about some of these issues here:

http://crawlingroad.com/blog/2009/12/16 ... ond-funds/

For Vanguard's fund for instance, it states:
The fund invests at least 80% of its assets in U.S. Treasury securities, which include bills, bonds, and notes issued by the U.S. Treasury. The fund is expected to maintain a dollar-weighted average maturity of 15 to 30 years.

The fund reserves the right to invest in repurchase agreements, contracts in which a bank or securities dealer sells government securities and agrees to repurchase them on a specific date and at a specific price.

The fund may invest in futures and options contracts, which are traditional types of derivatives, when they allow a transaction to be completed at a better price than by purchasing actual bonds. However, the market value of futures contracts will not constitute more than 20% of the fund’s assets.

The fund reserves the right to invest, to a limited extent, in collateralized mortgage obligations, which are moderately vulnerable to mortgage prepayment risk.

The fund may lend its investment securities to qualified institutional investors for the purpose of realizing additional income.
After 2008 when many supposedly safe bond funds had surprises lurking underneath I feel that it's best to make sure the fund holds, as best as possible, close to 100% treasuries as their policy. You don't want to give the bond managers any leeway to do cute things to try to boost returns. I don't want to own mortgages, collateralized mortgage obligations, repurchase agreements, futures contracts or lend out securities to other banks which may not honor their contracts if they run into trouble.

Overall, it's still best to own the bonds directly if you can. They just sit in your account and pay you interest and you pay no expenses on them. You can ladder them if you feel like it and buy new ones every few years or so as others mature to less than 20 years.

Zero coupons bonds are a big problem for taxable investors because you have imputed income. I personally just stick to nominal bonds and don't sweat it.
IMPORTANT NOTE: My old website crawlingroad{dot}com is no longer available or run by me.
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MediumTex
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Post by MediumTex »

The Dan wrote:
MediumTex wrote:PRPFX opts for a lighter dose of long-dated treasurys, and that's why in 2008 it was down 8.35%, while the PP was up 1%.
As I understand it, PRPFX deviates in other significant ways than its Treasury bond holdings, so it may be unfair to solely attribute any performance differences to the bonds. But in any event, I'm willing to bet that an investor holding 100% PRPFX did much better than the average investor in 2008, just like I'm willing to bet that IF another crisis hits, even the VUSTX-containing PP would perform better than most.
Yes, I agree with you that a VUSTX-equipped PP is probably safer than many other traditional asset allocations.

As long as the VUSTX user in the PP context understands that he is reducing the overall safety of the PP by using VUSTX rather than longer dated t-bonds, then I say if it feels good do it.

There is, however, a zen-like repose in the structure of the PP that provides a calmness in the face of market uncertainty that I find very appealing. It is this asset equanimity that I enjoy sharing with people when discussing the PP. Introducing VUSTX as a surrogate in the PP for the prescribed LT treasurys is sort of like taking the zen master's shakuhachi (bamboo flute) and replacing it with a kazoo.
"Early in life I noticed that no event is ever correctly reported in a newspaper." | -George Orwell
matt
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Post by matt »

craigr wrote:
After 2008 when many supposedly safe bond funds had surprises lurking underneath I feel that it's best to make sure the fund holds, as best as possible, close to 100% treasuries as their policy.
I don't disagree that you need to know what the fund is invested in. VUSTX is quite transparent and has very low manager risk. If you can trade individual bonds in a cost effective manner by yourself, by all means do so.
Zero coupons bonds are a big problem for taxable investors because you have imputed income
The PP has 25% in cash, so I would think tax payments would come from the cash regardless of whether imputed or cash income is taxed. It really seems that people are just making up reasons to avoid zero coupon bonds. I don't understand the aversion.
Roy
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Post by Roy »

The Dan wrote:
MediumTex wrote:PRPFX opts for a lighter dose of long-dated treasurys, and that's why in 2008 it was down 8.35%, while the PP was up 1%.
As I understand it, PRPFX deviates in other significant ways than its Treasury bond holdings, so it may be unfair to solely attribute any performance differences to the bonds. But in any event, I'm willing to bet that an investor holding 100% PRPFX did much better than the average investor in 2008, just like I'm willing to bet that IF another crisis hits, even the VUSTX-containing PP would perform better than most.
I agree. But why have these when you can have the PP? PRPFX is a good enough facsimile that it has done well in downturns. But it represents, to me, the very essence of the tinkers discussed throughout this thread—just done by "experts". In fact, Cuggino tinkers so well that they invite him to speak on CNBC regularly. Else, he'd be a forgotten man. Think about that. If he actually held to the standard of "permanent portfolio" (which very poster they allow him to stand before as he speaks) he'd be about as popular a speculator as Bogle (who invariably disappoints when they are silly enough to bring him on).

PRPFX has more stocks and selected ones too; has shorter bond maturity; Gold not good enough, need Silver; domestic coin not good enough, need foreign. For this you pay quadruple the price for an item that is inferior to the HB PP when set against its prime directive. But you do get to hear him speak on the great game show that is CNBC.

And Tex is right about all these "valuations" issues too. Harry spoke of them years ago. By 1996 we had Irrational Exuberance in equities, yet had about 4 more years of stellar returns. LT Treasuries have been overvalued— forever. Gold? Yeah it's overvalued too. I think one of the resident experts here said it would hit 500 before it ever broke 1000. The PP is the greatest investment in "I don't know" you're likely to see. Certainly as good as another alternative.

Emotions, well, that's another thing...

VUSTX as a "kazoo". Tex, this has been a fun day!

And Craig's point about style drifting applies even to VFISX (ST Treasuries). While far more stable, and almost always holding pure Treasuries, they have held as much as 16% TIPS in the last few years. I worry less about VFISX but still. Another reason to consider the original design.

Roy
Last edited by Roy on Wed Apr 07, 2010 7:01 pm, edited 1 time in total.
Kevin K
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Post by Kevin K »

And Craig's point about style drifting applies even to VFISX (ST Treasuries). While far more stable, and almost always holding pure Treasuries, they have held as much as 16% TIPS in the last few years. I worry less about VFISX but still. Another reason to consider the original design.
Interesting, Roy, I wasn't aware of that. So what is the closest one can get to what HB specifies for the cash component, given that Treasury MM funds are closed (assuming that few of us want to deal with buying individual treasuries). Looks like SHV and BIL are the main choices, unless I've missed something. VFISX holds much longer maturities and based on that and recent performance seems quite vulnerable to spikes in short term bond interest rates.

Switching the cash to FDIC-insured six month CDs paying 1.25-1.30% at any number of online banks seems like the obvious choice, but after some digging I found out (and am probably the only one on this thread who didn't already know this :? ) that the FDIC is NOT backed by the full faith and credit of our government, so that choice, while tempting, is another "warranty violation." Then again, MT feels okay with a slice of the cash in the Vanguard Total Bond Market Index, which is intermediate in duration and not guaranteed by anyone.

Sorry if I am splitting hairs here, but I hope that's one valid use of this thread.
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MediumTex
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Post by MediumTex »

Kevin K wrote:Interesting, Roy, I wasn't aware of that. So what is the closest one can get to what HB specifies for the cash component, given that Treasury MM funds are closed (assuming that few of us want to deal with buying individual treasuries). Looks like SHV and BIL are the main choices, unless I've missed something. VFISX holds much longer maturities and based on that and recent performance seems quite vulnerable to spikes in short term bond interest rates.

Switching the cash to FDIC-insured six month CDs paying 1.25-1.30% at any number of online banks seems like the obvious choice, but after some digging I found out (and am probably the only one on this thread who didn't already know this :? ) that the FDIC is NOT backed by the full faith and credit of our government, so that choice, while tempting, is another "warranty violation." Then again, MT feels okay with a slice of the cash in the Vanguard Total Bond Market Index, which is intermediate in duration and not guaranteed by anyone.
Don't forget Series EE and I savings bonds. Those are full faith and credit instruments, no principal risk and complete deferral of gains until the bonds are redeemed. $5,000 per year for you and $5,000 for your spouse. IMHO, in the context of the PP, savings bonds are an easy decision--with series EE bonds you get the benefit of going a little farther out on the yield curve (returns are similar to that of a two year treasury) with none of the risk (i.e., rising rates).
"Early in life I noticed that no event is ever correctly reported in a newspaper." | -George Orwell
Kevin K
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Post by Kevin K »

Thanks for the reminder MT. I guess I dismissed savings bonds because it's yet another account to open (Treasury Direct) and the amounts you can buy are so small, but there's no arguing with their virtues as you've so clearly stated them. Clearly they're part of the solution; thanks.
weltschmerz
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Post by weltschmerz »

MediumTex wrote:Don't forget Series EE and I savings bonds. Those are full faith and credit instruments, no principal risk and complete deferral of gains until the bonds are redeemed. $5,000 per year for you and $5,000 for your spouse. IMHO, in the context of the PP, savings bonds are an easy decision--with series EE bonds you get the benefit of going a little farther out on the yield curve (returns are similar to that of a two year treasury) with none of the risk (i.e., rising rates).
I'm a big believer in using I-bonds for the cash portion of the PP. As far as EE-bonds, these are currently only earning 1.2% for the life of the bond, but the real value of these may be that they double every 20 years, resulting in an annual return of around 3.6%. This could be of value if rates stay low for a really long time, and otherwise you could just cash out the bonds and then re-invest the proceeds if rates do head upwards. I don't currently use the EE's myself, but maybe I should consider it. I've asked bank tellers about the EE's whenever I buy my I-bonds, and they tell me that the EE's are just as popular as the I-bonds.
Roy
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Post by Roy »

Kevin K wrote:
And Craig's point about style drifting applies even to VFISX (ST Treasuries). While far more stable, and almost always holding pure Treasuries, they have held as much as 16% TIPS in the last few years. I worry less about VFISX but still. Another reason to consider the original design.
Interesting, Roy, I wasn't aware of that. So what is the closest one can get to what HB specifies for the cash component, given that Treasury MM funds are closed (assuming that few of us want to deal with buying individual treasuries). Looks like SHV and BIL are the main choices, unless I've missed something. VFISX holds much longer maturities and based on that and recent performance seems quite vulnerable to spikes in short term bond interest rates.
I'd probably feel OK with VFISX as the TIPS it holds are also quite short and it does not hold enough Agency or Foreign to hurt, that I've seen in recent years anyway. But MM is safer than ST Treasury funds, and that's part of what makes the original PP what it is. Are all Vanguard MM funds closed? A basic one should be OK. SHV is fine; but hate the transaction costs around the cash portion.

And hey, if Hussman is right about stock valuations they'll be another flight to safety anyway. But as discussed, any valuations here are too tough to suss-out.

I would not sweat it too much providing you stay highest quality and pretty short.


Roy
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MediumTex
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Post by MediumTex »

Kevin K wrote:Thanks for the reminder MT. I guess I dismissed savings bonds because it's yet another account to open (Treasury Direct) and the amounts you can buy are so small, but there's no arguing with their virtues as you've so clearly stated them. Clearly they're part of the solution; thanks.
Don't go the Treasury Direct route--just buy the paper bonds at your local bank. It feels sort of retro in an electronic world to deal in bonds you can hold in your hand.

It's sort of fun to collect all of the denominations, and the faces on them make them kind of like trading cards. :)

(As a side note, if you have kids savings bonds are probably THE easiest way to introduce them to investing concepts. The rest of the investing world is often way too abstract for a kid to grasp.)
"Early in life I noticed that no event is ever correctly reported in a newspaper." | -George Orwell
Gumby
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Post by Gumby »

The Dan wrote:I also am fearful that long-term treasuries will be the laggard going forward. One strategy that is worth considering would be to use the Vanguard Long-term Treasury Fund (VUSTX) instead of TLT.
Keep in mind that by tweaking the PP, you are now speculating — which is a bit oxymoronic in that the PP is a neutral portfolio that is designed to eliminate speculation.

In many respects this entire discussion is oxymoronic because the PP doesn't need to be touched. However, I should point out that without the existence of this very healthy (and lengthy) discussion, I wouldn't have learned about the PP — and more importantly, I wouldn't have been able to question its philosophy and its strategy. So I'm extremely grateful for the learning process this thread has allowed me to take part in.

I can only speak for myself, but my speculation skills haven't been all that stellar these last few years. Very little has turned out the way I thought it would. And even though it's been stomach-churning for me to invest in LT Treasuries, I'd much rather keep my PP neutral and pure than to introduce my own emotional and "fearful" speculations into what is a highly proven and tested portfolio.

Think of it this way... You have a choice of two investment products for the money that you can't afford to lose:
  • The first product follows a simple set of rules that have been thoroughly tested in all conditions. The manager of that fund is contractually bound not change its winning formula.
  • The second product is a brand new, and untested, offering — from a competing institution — that allows its manager to tweak the original winning formula based upon his own speculations, fears and beliefs of what will happen in the short term and long term. The fine print on this investment product makes it clear that the manager's speculative formula is unproven and may incur more risk than the other investment product that was offered. In fact, the prospectus makes it clear that this particular investment product could lag behind the other investment product.
Personally, I would choose the first option because I prefer less risk. I'm just not sure I see the point in speculating with an investment that isn't supposed to involve any speculation.

Speculating, when you get right down to it, is best left to your Variable Portfolio where you aim for the fences with the money that you can afford to lose.

Rule# 12 of HB's Fail-Safe Investing is: "Speculate Only With Money You Can Afford to Lose." It may very well be the most important Rule in the entire book.
Jim Lyon
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Post by Jim Lyon »

The Dan wrote:I also am fearful that long-term treasuries will be the laggard going forward. One strategy that is worth considering would be to use the Vanguard Long-term Treasury Fund (VUSTX) instead of TLT.
I am going to sit on both sides of this debate.

As far as using VUSTX or other tinkering with the traditional PP, it will not cause the PP to disintegrate. The HB PP is very robust under almost all market conditions. If you change to shorter maturities you can probably expect about the same returns as the traditional PP. You might even get higher returns if you are lucky. Or not. While I don't fiddle with the components based on projections of the market, many of us are forced into less-than-optimal vehicles for the individual components of the PP, and it will still work.

The one catch is that this does void the PP "warranty" to some extent. What is the warranty? That under the one economic condition that LT bonds are needed to carry the entire portfolio, they won't be there to the full extent desired. So under periods of protracted deflation, as in Japan, a PP with lower duration bonds will not behave as well. But it will still do better than most traditional investments, and as a PP investor you will be able to evaluate whether it makes sense to move to longer maturities if it is available to you. Of course, you will pay a tidy price to do so, since the full LT bonds will now command a much higher price.

One of the things I find so amazing about the PP is that it is actually very hard to break. I am currently using a LT bond fund with a maturity of less than 20 years, and while I plan to transition to longer term bonds over time, I know that I'm not running too much risk in the meantime. It's not ideal, but sometimes you have to make do with what you have.

HB was very pragmatic about this in his radio broadcasts and books. Real world portfolios have to deal with all kinds of messy constraints. You just do the best you can and then stop worrying about it. HB didn't consider money worth worrying about. I think that point gets lost sometimes in this thread.

Jim
Wonk
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Post by Wonk »

Ok, new info on Japan meets U.S. PP...

In an effort to compare the PP vs. traditional portfolios using Japanese-centric data, I've created a "worst case" date range: 1989-2008. The idea would be to see how a portfolio would survive under the worst conditions and date range. Here are the results using Clive's spreadsheet:

Permanent Portfolio

CPI: 0.65
AAR: 3.32
RR: 2.67

50-50 TSM/10Y JGB

CPI: 0.65
AAR: 2.23
RR: 1.58

75-25 TSM/10Y JGB

CPI: 0.65
AAR: 0.54
RR: -0.11

This leads me to the following conclusions:

1. Compared to a 1930's deflationary crash and a 1970's stagflation, the Japanese-type prolonged deflation is without question the most damaging economic malaise an investor can encounter.

2. Measured against traditional asset allocations, the PP performs well on a relative basis yet again.

3. If the U.S. follows this path (nothing is guaranteed but we're following quite nicely so far), accumulating investors who like to exclaim "can't wait to buy stocks on sale!" should watch what they wish for as they may have a 20 year sale in progress.

4. I'm now officially a Ben Bernanke supporter and hope he gets a fleet of shiny helicopters from which to drop newly minted cash. Where can I apply for a Federal Reserve Mastercard?
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MediumTex
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Post by MediumTex »

Jim Lyon, to extend upon your point a bit, I think that it is some basic part of human nature, especially male human nature, to express appreciation for something we are very fond of by tinkering with it.

Think about a campfire. It is hard to simply sit by a campfire without wanting to poke it, move the logs around, maybe add some wood to it, because as good as it is, we want to make it even better.

Think about hot rods. Think about custom car stereo systems. Think about any number of projects around the home--we express our interest and curiosity for a deeper understanding in the form of tinkering.

Sometimes tinkering can lead to great improvements. OTOH, sometimes it can take an elegant system that is already optimized and turn it into an idiosyncratic mess. The key is to understand what type of system you are dealing with.

In my view, there are really two main steps to gaining a strong understanding of the PP concept. The first step is to accept that it works. This first step is a hard hurdle for some people to clear, primarily because the PP just looks so counterintuitive and appears to throw out basically all market projections and analysis (is it really possible that the entire investment chatterbox community is nothing but a finance-themed soap opera?). The second step in realizing the promise of the PP is to fully internalize the concept that the PP is not a system that can be improved upon by tinkering. Basically, HB tinkered with it in his mind and in practice for about 30 years before coming up with his last fully optimized iteration of the PP. To me, the 25%x4 approach is about as close to a permanent portfolio as you are likely to find.

I get my tinkering fix by talking shop here, which helps me resist the temptation to take apart the PP and reassemble it based upon my own perception of the market and the future, which is sometimes right on the money and is sometimes WAY off the mark.

I don't mean to say that anyone who does choose to tinker with the PP is wrong; rather, I just want to provide a little commentary on why the impulse to tinker in general may be misplaced when applied to the PP.
"Early in life I noticed that no event is ever correctly reported in a newspaper." | -George Orwell
wannabe_CPA
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Post by wannabe_CPA »

Well I've been away doing some reading and planning. I am going to try the PP concept in a limited way for my own amusement if nothing else.

For various and sundry reasons I won't bother explaining here, many of which have to do with simple convenience, I have decided to ignore Mr. Browne's basic perogatives of splitting the PP across instituitions and hording it away in a foreign bank. For now I have decided to be completely "lazy" with the concept.

I plan to hold it in my Sharebuilder account, probably not until the middle of next year again for various and sundry reasons, in ETF form. One could presumably find suitable mutual funds but for me in this situation I chose ETFs.

So here's my "Lazy" PP.

25% VTI for the stocks - I thought about VT instead since apparently international exposure is okay but upon pondering it decided on VTI instead.

25% TLT for the bonds - I could buy these directly from Treasury Direct, transfer and sell them every 10 years, but that just seems like so much hassle.

25% GLD - Again, buying actual gold and storing it somewhere just seems like work, plus as far as I'm concerned it's a lot harder to steal an ETF from me and the fees and hassle for buying physical gold seem annoying.

25% Cash - Truthfully I think I'm just going to leave this in an ING savings account so that the Sharebuilder and ING accounts can be linked together for easy transfers. Or maybe I bonds.

Close enough?
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macclary
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Post by macclary »

I would buy SGOL, GTU, or CEF before I would buy GLD. GTU and CEF do trade at a premium right now, but think about it this way: there are hundreds of millions of dollars holding that premium open for either tax or safety reasons.

Keep in mind that loaning your money to ING is not as safe as loaning it to the government. SHV or SHY are reasonable choices if you want a counterparty with a higher credit rating for all or part of your cash holding.
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Post by weltschmerz »

Kevin K wrote:Switching the cash to FDIC-insured six month CDs paying 1.25-1.30% at any number of online banks seems like the obvious choice, but after some digging I found out (and am probably the only one on this thread who didn't already know this :? ) that the FDIC is NOT backed by the full faith and credit of our government, so that choice, while tempting, is another "warranty violation."
Is it realistic to assume that the US govt will always print money to backstop treasuries, but they would NOT print money to backstop FDIC-backed deposit accounts? Allowing banks to fail and not guaranteeing the deposits seems like a sure way to have panic in the streets, and I bet this will be avoided at all costs.

My point is that the safety of FDIC-backed accounts could be, realistically, considered equivalent to the safety of treasuries. Have I got this wrong? Are most people following the PP actually using treasury MM accounts for the cash portion (yielding near 0%) instead of using bank MM accounts (yielding 1%-1.5%) to avoid the FDIC risk?
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MediumTex
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Post by MediumTex »

The Dan wrote:
Kevin K wrote:Switching the cash to FDIC-insured six month CDs paying 1.25-1.30% at any number of online banks seems like the obvious choice, but after some digging I found out (and am probably the only one on this thread who didn't already know this :? ) that the FDIC is NOT backed by the full faith and credit of our government, so that choice, while tempting, is another "warranty violation."
Is it realistic to assume that the US govt will always print money to backstop treasuries, but they would NOT print money to backstop FDIC-backed deposit accounts? Allowing banks to fail and not guaranteeing the deposits seems like a sure way to have panic in the streets, and I bet this will be avoided at all costs.

My point is that the safety of FDIC-backed accounts could be, realistically, considered equivalent to the safety of treasuries. Have I got this wrong? Are most people following the PP actually using treasury MM accounts for the cash portion (yielding near 0%) instead of using bank MM accounts (yielding 1%-1.5%) to avoid the FDIC risk?
HB discussed this topic in detail in "Why the Best Laid Investment Plans..."

The short answer is that there is a big difference between treasurys and virtually every other form of government guarantee. The most prominent difference is in liquidity. In a mass bank failure scenario, it is possible that everyone would get paid...eventually, but with treasurys you can get paid any time.

There are a lot of what-ifs involved in this topic, but the easiest example is what actually happened in 2008, where some GSE bondholders were within about 15 minutes of getting wiped out. Under a slightly different set of political conditions, these bonds could have defaulted.

Deposit insurance is probably on a higher rung of safety than GSE debt, but FDIC-related claims will always be paid behind the claims of treasury holders and depositors of failed banks have no control over WHEN they will get paid.

With all that said, it's probably not unreasonable to have CDs if you are under the deposit insurance limits and are not overly troubled by fractional reserve lending or the current reserve requirement regime and are comfortable with the different risk profile of FDIC-insured deposits as opposed to treasurys. The important thing is to understand that an FDIC insured account is a fundamentally different animal than a treasury bill.

Some of this may sound a bit far-fetched, but as I have said before, events have a way of going from inconceivable to inevitable without even stopping at improbable. Imagine a person back in early 2008 talking about money market funds being risky--such a person would have sounded like Chicken Little.
"Early in life I noticed that no event is ever correctly reported in a newspaper." | -George Orwell
Kevin K
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Post by Kevin K »

Since I brought this up Dan I've had very helpful feedback from a bunch of people here. I fell into the trap of looking at the low yields on T-bills (and MM accounts composed of them) in isolation and as has been repeatedly stated by many here that just isn't how one looks at the integrated system that is the PP.

I haven't heard from anyone who thinks FDIC-insured MM accounts or CDs are likely to default, but if there were a run on the banks or other such catastrophe you might very well get back your guaranteed principal, sans interest. You're certainly not going to benefit from any flight to safety that might occur, because at most there's an implied ("sense of Congress") intention to guarantee such deposits, not full faith and credit.

The leading lights of this board (there are many, but I'm thinking in particular of Craig Rowland and Medium Tex) point out that the role of the cash is as an anchor when the seas get choppy with the other three volatile assets. You want zero counterparty risk and zero temptation to abandon the strategy, and having several years worth of expenses (or more) in short Treasuries is the only way to do this.

The way I'm currently looking at it is with Treasury MM funds closed one could buy SHV as the ETF equivalent if one wants to keep to the Treasury MM/T bill ultra-short duration.

Plan B, which I personally feel comfortable with, is to have a year's worth of living expenses in an FDIC insured MM account earning decent interest, and the rest of the cash allocation in savings bonds, SHY or VFISX, with a willingness to ride out the volatility (including, potentially, a year of slightly negative total returns) in these funds. The point is to not get fixated on the 25% cash part of your PP earning zero or less, but rather to look ONLY at the total return of the PP.

Jim Lyon's great quote applies here:
HB didn't consider money worth worrying about. I think that point gets lost sometimes in this thread.
If I go chasing ~1% higher yield on my cash and it makes me worry due to counterparty risk why take that on, having already made so many other changes to put the PP into place for the sake of sleeping well at night?
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Post by Roy »

Kevin K wrote:The point is to not get fixated on the 25% cash part of your PP earning zero or less, but rather to look ONLY at the total return of the PP.
Yes. And yet the same applies to any asset class within the PP, assuming one has allocated to those in any reasonable manner already discussed: portfolio as whole only. Easy to understand, yet devilishly hard to shake the tinker's gene.

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Post by Clive »

Wonk wrote:In an effort to compare the PP vs. traditional portfolios using Japanese-centric data, I've created a "worst case" date range: 1989-2008....
Adding a small amount of bonds to an all stock portfolio can improve the risk/reward ratio

Adding a small amount of stocks to an all bond portfolio can improve the risk/reward.

Have a look at 80% bonds (i.e. 40% MM, 40% LT barbell) combined with 10% stocks and 10% gold thrown in for good measure over a range of dates/markets Wonk.

Gilts in the UK are quite tax efficient as they're free of capital gains tax and the income - whilst taxable - is paid gross. With good tax planning the difference between 80% bonds, 10% stocks, 10% gold can be quite narrow compared to PP. e.g. For US 1972 to 2008 the US PP returned 9.77% compound compared to 9.05% compound for the 80B/10S/10G. For Japan 1989 to 2008 the PP turned out a 2.09% compound average with -12.93% worse year compared to 3.09% compound average and -5.7% worse year for the 80/10/10

There's a neat little math trick you can do in Excel to calculate the implied compound average gain given the yearly simple average and the standard deviation. Assuming the average yearly gain is in Cell G41 and the Standard Deviation is in Cell G42 then

=(((((1+(G41/100))^2)-((G42/100)^2))^0.5)-1)*100

will approximate the compound average growth rate.

e,g, 6.92% yearly average and 11.92% standard deviation will indicate a 6.25% compound average gain. And at the end of the day it is the compound average that is the actual $$$ gain that we get to spend (the simple average is just a figure).
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Post by macclary »

FDIC insurance is probably going to be a necessary casualty of the financial meltdown at some point. Allowing banks to just compete on APY instead of safety, what could go wrong ;->

http://www.econtalk.org/archives/2009/1 ... on_th.html
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Post by b007er86 »

In response to the poster(s) who keep saying the Treasury Money Market Funds are all closed, the American Century Treasury MMF, CPFXX, looks like it's still open. I believe HB mentioned this one in Fail Safe Investing. I've not looked at the prospectus lately, though.

Jeff
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Post by Quasimodo »

American Century Capital Preservation MMF is open - we recently exchanged some funds into it.

https://www.americancentury.com/funds/f ... p?fund=901

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Post by macclary »

I think keeping a MM fund open is a great way to attract assets. They must be losing money on administrative overhead, but you could just view this as marketing costs - or philanthropy...

In other news you can earn ~21% on Greek 3mo, but this won't last for long ;->
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Post by Lbill »

As this graph shows, gold and treasuries have been going up together for the last decade.

Image
Can you imagine a scenario under which precious metal and Treasury bond prices would fall together? Most people would think such an event would be impossible. After all, as we showed in our study of March 2008, bonds do well during deflationary recessions, and gold goes up during inflationary booms. Shouldnt they be contra-cyclical? If gold and T-bonds can go up together for ten years, they certainly can go down together as well.
http://safehaven.com/article-16354.htm

The unexpected scenario of falling gold prices and falling treasury prices would be negative for the PP. It is certain that it would be accompanied by falling stock markets as well. I've been speculating that this could take place if treasury rates spike, which would suddenly dry up all the liquidity from the dollar "carry trade" and bring down long bonds, stocks, commodities, and gold together. Another possibility, outlined in the article, is bonds would suck value out of all other investments as they are sold so that investors can lend (buy bonds) at attractive higher rates. Yikes!
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Post by Quasimodo »

I often read articles on the SafeHaven website, but I sort of consider it a vice. I usually wind up feeling really depressed, just like with most of the other vices I've had through the years.

OK, so what's a positive spin to keep me from getting too depressed? If everything is going to plunge, maybe our rent is going down as well? And I do have some money in T bills and short treasury bonds, so all is not lost.

John
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Post by Paul Douglas Boyer »

Lbill wrote:As this graph shows, gold and treasuries have been going up together for the last decade.
I checked Simba's speadsheet and noticed that the correlation between GOLD/GLD and VUSTX (Long Bonds) was -0.23, not especially great. In fact, it shows that they moved somewhat oppositely. Perhaps just looking at the graphic of prices is misleading.

I'd also note that the author's interest would be in having people trade and thus be reliant upon his frequent advice.

And furthermore, adding stocks and cash into the whole portfolio means we don't worry about the individual components, even two at a time.
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Post by macclary »

I think this "theory" of a bond and physical gold crash sounds like gibberish. Consider:

1) Bond/Note/Bill rates don't just spike for no reason. It takes inflation or default fears to cause a real spike. Both of these scenarios are bullish for gold - there will be eager buyers.

2) Higher bond rates do not make bonds more attractive to investors, it makes them more scary.

3) There is no possible way in the world that the Treasury is going to let long bond yields rise dramatically. The Fed would rather buy up the whole long bond market before that happens.

4) The dollar carry trade is not executed at the long end of the curve, but at the short end.

5) Bonds and gold have gone up together because they were both seen as safe havens (and because gold was undervalued after a long period of prosperity). If one of bonds or gold is not seen as a safe haven anymore, then they will stop moving together to say the least.
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Post by MediumTex »

One thing to remember is that the amount of capital in the world at any point in time is fixed.

This fixed amount of capital migrates from one asset class to another, but at any given point in time the capital has to be sitting somewhere. For the last couple of years much of it has been sitting in t-bills.

The thesis that gold, stocks, and LT treasurys could fall at the same time is hard to square with the idea that capital that is fleeing one asset is always going into another asset. Thus, some asset must always be appreciating in value if another asset is declining in value.

Part of the genius of the PP is that it has identified excellent assets or proxies for asset classes, at least one of which will always be the asset investors are running to in the process of running away from another asset. That's part of the reason that the "cash" portion is held in the world's reserve currency, since a reserve currency will normally be the asset or the proxy for asset classes into which investors favoring maximum liquidity will move when frightened.

***

Everyone talks their book. The stock market/CNBC crowd talks their book. The inflation crowd (e.g., goldbugs and coin dealers) talk their book. The deflationists (Prechter/Mish/Rosenberg) talk their book. They all tell a good story.

The thing that is different about the PP-er is that his "book" is simply complete indifference to which of the crowds above are right and which are wrong. The PP-er's book is simply that the future is unpredictable and thus no one can predict it reliably. Once the future becomes predictable, the PP will probably stop working. Until then, I am confident that the PP will be my best strategy for minimizing future regret.
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Post by Paul Douglas Boyer »

MediumTex wrote:One thing to remember is that the amount of capital in the world at any point in time is fixed.
I fully accept your point here, but I might suggest some modification to indicate that it is actually increasing. Otherwise the PP might have a CAGR of 0%.

But I like getting across to folks the concept that all of capital is in a large pool. Just own the whole pool and as they add water, we'll be nice and wet.
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Post by Quasimodo »

I'm sure this has been discussed somewhere before in this thread, but I can't find it. What would be a reasonable PP approximation with mutual funds but no option to buy bullion? We don't have access to PRPFX in our 403b plan.

We have American Century and Vanguard in our 403b and we could buy American Century's Global Gold fund, but the Vanguard Precious Metals and Mining fund is not available in our plan. I realize the Global Gold fund behaved quite differently from gold bullion during the stock market action of late 2008, but if and when inflation comes back strongly Global Gold could do well.

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Post by MediumTex »

Quasimodo wrote:I'm sure this has been discussed somewhere before in this thread, but I can't find it. What would be a reasonable PP approximation with mutual funds but no option to buy bullion? We don't have access to PRPFX in our 403b plan.

We have American Century and Vanguard in our 403b and we could buy American Century's Global Gold fund, but the Vanguard Precious Metals and Mining fund is not available in our plan. I realize the Global Gold fund behaved quite differently from gold bullion during the stock market action of late 2008, but if and when inflation comes back strongly Global Gold could do well.

John
IMHO, gold mining stocks should not be considered in any was as a substitute for the gold portion of the PM.

Compare the chart for GDX and GLD for the last few years to see what I mean.

If you can't buy physical gold or one of the PM ETFs, then I would study ways of changing your portfolio so that you can make some room for real or paper gold.

Mining stocks are a different animal from gold. Since you mentioned VGPMX, before you buy any of that take a look at what it holds and take a look at how it has performed relative to GDX. I sometimes wonder if VGPMX isn't being run by a bunch of monkeys throwing darts.
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Post by macclary »

Hi Quasimodo, as MT said the best thing to do is to find a way to buy some physical gold.

If you want to try to build the best portfolio you can with limited offerings in your retirement account then my online optimizer might be helpful.

Here are some ideas from that tool that offer PP like returns:

Portfolio Allocation: 66.1% MKT-TSM , 0.0% ST Trsry , 0.0% TBILL , 33.9% LTGB
Compound return = 9.75%
Worst year: 2008 -17.04%

If you can add REITs:

Portfolio Allocation: 26.9% ST Trsry , 34.0% LTGB , 0.0% MKT-TSM, 39.1% REIT
Compound return = 9.75%
Worst year: 1973 -5.28%

If you can also add a commodities fund:

Portfolio Allocation: 51.6% LTGB , 0.0% MKT-TSM , 12.8% ST Trsry , 14.9% REIT , 20.7% COMM
Compound return = 9.75%
Worst year: 1994 -2.23%

http://www.riskcog.com/portfolio-theme2 ... aeoc0003ne
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Post by 6 Iron »

macclary wrote:I think this "theory" of a bond and physical gold crash sounds like gibberish. Consider:

1) Bond/Note/Bill rates don't just spike for no reason. It takes inflation or default fears to cause a real spike. Both of these scenarios are bullish for gold - there will be eager buyers....
Macclary, perhaps I have spent too much time reading Nassim Taleb. Based on our recent economic history, I completely agree. But considering an unknowable future, A hypothetical combination of gold price depression from a global recession, with a drop in our credit rating for treasuries would potentially create just such a scenario (with equities taking a hit as well).

Faced with a black swan scenario such as this, should PP'ers have a mental stop loss for their portfolio? Or, using a baseball metaphor, do you consider the PP the Mariano Rivera equivalent of "closers"?
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Post by craigr »

6 Iron wrote:Faced with a black swan scenario such as this, should PP'ers have a mental stop loss for their portfolio? Or, using a baseball metaphor, do you consider the PP the Mariano Rivera equivalent of "closers"?
Unknown scenarios are just that, unknown. So planning for an unknown with specific "what ifs" just isnt't that effective. Extremes are not predictable in type nor in outcome.

Secondly, a point I've mentioned before, is that if this particular allocation is going to be hurt then what allocation isn't? And, if there is some allocation that you know will be better, then what happens to it if you place all your money there and the particular situation predicted doesn't happen? Or suppose the markets just kind of shrug off the situation as irrelevant (as has happened many times in the past)? Will you lose more money by shifting your strategy and being wrong there?
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Post by Roy »

6 Iron wrote: Faced with a black swan scenario such as this, should PP'ers have a mental stop loss for their portfolio? Or, using a baseball metaphor, do you consider the PP the Mariano Rivera equivalent of "closers"?
Large and rapid movements happen for the PP—an interesting quality for a strategy that is smooth-riding over the longer term. 2008 was an example of how one might have assumed a doomsday-stop-loss scenario for the PP which, was down considerably (for it, I think maybe as much as -10%) until late in the year when LT Treasuries (of the TLT or longer type) made a hard charge and pulled it into positive territory. Had you bailed sooner, you'd have missed the run, and where would the money be sitting?

Roy
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Post by Lbill »

Part of the genius of the PP is that it has identified excellent assets or proxies for asset classes, at least one of which will always be the asset investors are running to in the process of running away from another asset. That's part of the reason that the "cash" portion is held in the world's reserve currency, since a reserve currency will normally be the asset or the proxy for asset classes into which investors favoring maximum liquidity will move when frightened
MT - I'm trying to understand this. Let's suppose, for purposes of argument, that we have strongly rising treasury interest rates. First, the Prechter paper speculates that rising rates would cause investors to flee most other investments in order to buy bonds that are paying high interest rates. That would cause stocks, commodities, and gold to lose value because they are being sold. I recall that it is often said that stocks and bonds compete for investor dollars: when rates are low, investors are forced into equities because they are getting low returns on bonds and vice versa. So, I can imagine that rising bond rates would attract money out of stocks, commodities, and gold into bonds. In fact, there's a lot of "hot money" going into these investments because interest rates have been zero, and money can be borrowed for next to nothing and leveraged into the stock market, commodities, and gold. That money will come out like a scalded rat when rates start increasing.

The reason bonds become attractive to investors when rates are going up is because rising rates have cut the price of existing bonds. So, if you were sitting there when rates ramped up it seems like you'll lose on stocks, commodities, gold, and your existing long term treasuries. Assuming that T-bill rates go up commensurately with long bonds, then the interest paid goes up as you (or your fund) rolls T-bills, so that portion of the PP would gain value as interest rates increase. Small comfort though, since the other 75% of your PP is in the tank. Of course, everyone else in non-PP land is taking gas too. In a relative sense the PP rock may not be dropping as fast as the other investment rocks because of the 25% in T-Bills.

I always like to play out possible unexpected scenarios with any asset allocation plan to imagine "what can go wrong." I don't recall that this scenario has been played out anywhere relative to Harry Browne's PP was it? It certainly isn't an impossible scenario - rare though it might be. All it requires is that interest rates ramp up without inflation, or with actual deflation. I don't think this has occurred historically in the U.S. In the last period of strongly rising interest rates, we had high inflation (1970s). Rising rates killed stocks and treasury bonds, but gold and commodities did great because of inflation. In the last deflationary period, we had falling interest rates (1930s). Stocks and commodities got killed, but long bonds did great because of falling rates. I don't think we've had a period where rising rates were accompanied by zero inflation or by deflation - that is uncharted territory.

There's been some speculation lately that this could happen if bond investors, particularly foreign investors, become less willing to purchase treasury debt in the massive quantities required to fund unprecedented deficit spending in the U.S. The result would be rising interest rates, but not driven by inflation (as in the 1970s). There could even be outright deflation in the U.S. due to a weak or failing economy, at the same time interest rates are being forced up. I for one certainly don't discount this scenario - in fact, it seems at least moderately likely to me in this Alice-in-Wonderland screwed up world economy we are living in these days.
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Post by craigr »

Lbill wrote:MT - I'm trying to understand this. Let's suppose, for purposes of argument, that we have strongly rising treasury interest rates. First, the Prechter paper speculates that rising rates would cause investors to flee most other investments in order to buy bonds that are paying high interest rates.
I don't think so. That's an indicator that bond risk has gone way up. Most investors do not go running towards the burning building. Most take their money and get out of there. Not saying someone following the PP would, just that most investors are not looking to do this.

This is a separate issue as to whether the bonds would be a good deal or not though. In the mid-1970s LT bonds spiked at around 8%. Investors then probably felt they were getting a good deal. But inflation didn't subside until the early 1980s. Twenty year bonds between 1980-1985 were in the 10-14% range (http://www.federalreserve.gov/releases/ ... OM_Y20.txt).

So this idea that the bond market is going to attract new money with high interest is not necessarily true. It could be a great time to buy (like 1985) or a really bad time to buy (like 1975).

Greek bond yields are high right now. Anyone interested in jumping in? :)
The reason bonds become attractive to investors when rates are going up is because rising rates have cut the price of existing bonds. So, if you were sitting there when rates ramped up it seems like you'll lose on stocks, commodities, gold, and your existing long term treasuries.
Again, is it 1975 or 1985? Stocks, BTW, were a great place to be in the early 1980s when LT bonds rates were at their peak.
There's been some speculation lately that this could happen if bond investors, particularly foreign investors, become less willing to purchase treasury debt in the massive quantities required to fund unprecedented deficit spending in the U.S.
This affects US Govt. operations and borrowing. This does not mean the stock market is going to crash.
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Post by Quasimodo »

LBill, I recall investing during the inflationary 1970s with gold and silver coins, swiss francs and South African gold miner stock, and those did pretty well for most of the decade. There was a sinking spell for the PP-style investments during 1975 and 76 when the regular stock market came roaring back from a bad slump in 74, but overall they held up well in an inflationary, rising interest rate scenario that decade.

Thank you Tex and MacClary for your responses to my earlier question.

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Post by MediumTex »

I will take a crack at a few of these. These are just my opinions, of course.
Lbill wrote:MT - I'm trying to understand this. Let's suppose, for purposes of argument, that we have strongly rising treasury interest rates.
Why would interest rates be rising? Only two reasons I can think of--(1) the stock market is doing well, which means the bond market has to pay more to lure money away from equities, or (2) inflation and inflationary expectations have taken hold and the market is asking for higher rates to compensate for perceived loss of future purchasing power.

Since stocks are, IMHO, in a secular bear market, I think that the current rally will stall at some point and I don't see sustained pressure for higher rates due to equities providing even higher returns.

With respect to inflation and inflationary expectations, I don't see that either. With a secular deleveraging trend taking shape, I think we will see moderate deflationary forces for quite some time being driven by overcapacity, structural unemployment, and continued credit contraction. Remember, too, that globalization is a deeply deflationary force on developed economies since anything that CAN be offshored WILL be offshored.
First, the Prechter paper speculates that rising rates would cause investors to flee most other investments in order to buy bonds that are paying high interest rates.
I'm not sure that's how it would go down. I don't recall that investors were flocking into treasurys in the early 1980s, even though they could have locked in 12%-14% for 30 years if they had chosen to do so. Higher rates suggest that investors DON'T want to buy bonds. For example, I don't see people selling their stocks right now to buy Greek bonds.
That would cause stocks, commodities, and gold to lose value because they are being sold.
Only if the initial premise is true. I don't think it is.
I recall that it is often said that stocks and bonds compete for investor dollars: when rates are low, investors are forced into equities because they are getting low returns on bonds and vice versa. So, I can imagine that rising bond rates would attract money out of stocks, commodities, and gold into bonds. In fact, there's a lot of "hot money" going into these investments because interest rates have been zero, and money can be borrowed for next to nothing and leveraged into the stock market, commodities, and gold. That money will come out like a scalded rat when rates start increasing.
I think that depends. In the late 1980s and all of the 1990s rates were relatively high compared to where they are today and world equity markets did very well.

The mechanics and psychology of the bond market are more complex than I think people realize. I think a lot of conventional bond market wisdom is based upon narratives that were anything but obvious at the time--e.g., who was screaming that treasurys were starting a 30 year secular bull market in 1982? Nobody.
The reason bonds become attractive to investors when rates are going up is because rising rates have cut the price of existing bonds.
I think this may sometimes be the case, but other times it is just the opposite--when rates go up, investors sell their existing bonds, which makes rates go up even more; see Greece.
So, if you were sitting there when rates ramped up it seems like you'll lose on stocks, commodities, gold, and your existing long term treasuries.
See my suggestion above regarding the two potential causes for interest rates to rise--inflationary expectations, a surging stock market, or both. In the current environment I see neither. Thus, I don't think rates will rise dramatically in the first place. See the Japanese, German and UK yield curves. Are they so much better off than the U.S.? Their yield curves suggest that they are, but common sense suggests otherwise (especially with respect to Japan and the U.K.).
Assuming that T-bill rates go up commensurately with long bonds, then the interest paid goes up as you (or your fund) rolls T-bills, so that portion of the PP would gain value as interest rates increase.
That is true.
Small comfort though, since the other 75% of your PP is in the tank.
I don't think such a scenario is possible for any length of time. We saw a temporary set of such conditions in the fall of 2008, but the level of fear during that period isn't sustainable--at some point people get "disaster fatigue" and stop freaking out, no matter how bad things get. That's what we saw after the market bottomed last spring. Things weren't necessarily any better, but people were starting to adjust to it (and put narratives around what had just occurred).
Of course, everyone else in non-PP land is taking gas too. In a relative sense the PP rock may not be dropping as fast as the other investment rocks because of the 25% in T-Bills.
Or it might be floating on the surface like a happy little cork while everything else sinks around it.
I always like to play out possible unexpected scenarios with any asset allocation plan to imagine "what can go wrong." I don't recall that this scenario has been played out anywhere relative to Harry Browne's PP was it? It certainly isn't an impossible scenario - rare though it might be.
I lean a bit toward the doomer side of things, which makes me great fun at parties. The truth is, though, life has a way of reverting to the mean. No matter how bad things may seem on a given day, over time they tend to improve. Similarly, just when you think you are on the verge of Utopia, the market crashes, or someone flies a plane into a building. The story of human civilization is like a great soap opera playing out against a series of artificial social and cultural backdrops which are consistently mistaken for permanent institutions.
All it requires is that interest rates ramp up without inflation, or with actual deflation. I don't think this has occurred historically in the U.S.
When have there been rising interest rates with deflation? How could businesses survive in an environment where borrowing costs were increasing when prices were falling? I don't see how that could happen for more than a short period.
In the last period of strongly rising interest rates, we had high inflation (1970s). Rising rates killed stocks and treasury bonds, but gold and commodities did great because of inflation. In the last deflationary period, we had falling interest rates (1930s). Stocks and commodities got killed, but long bonds did great because of falling rates. I don't think we've had a period where rising rates were accompanied by zero inflation or by deflation - that is uncharted territory.
I don't think that territory will be charted, other than on a very temporary basis. No market economy could survive such conditions for very long.
There's been some speculation lately that this could happen if bond investors, particularly foreign investors, become less willing to purchase treasury debt in the massive quantities required to fund unprecedented deficit spending in the U.S.
As long as the U.S. runs a trade deficit and Uncle Ben is in charge there will buyers of treasurys.
The result would be rising interest rates, but not driven by inflation (as in the 1970s). There could even be outright deflation in the U.S. due to a weak or failing economy, at the same time interest rates are being forced up. I for one certainly don't discount this scenario - in fact, it seems at least moderately likely to me in this Alice-in-Wonderland screwed up world economy we are living in these days.
One reasonable assumption to make is that however bad a shape the U.S. is in, Japan and the U.K. are in worse shape, no matter what economic or other metric you want to use. As long as those countries are selling long term debt at lower rates than the U.S., I'm not too concerned about treasury rates increasing dramatically.

All major economies are praying for inflation right now. Germany has figured out a backdoor way of devaluing its currency by playing this Greece mess for all it is worth (which is a gift to German manufacturers in the form of a lower euro). Short of gimmicks and gadget plays like Germany's Greek tragedy, I think finding inflation is going to be much harder than anyone imagines, and that's part of the reason that Uncle Ben has been willing to print so much money--he knows that in a secular deflationary trend inflation is the last thing to be worried about.
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Post by Lbill »

Craigr - I thought of your point that buying bonds when rates have increased might turn out badly if rates just keep rising. Thing is though, nobody knows at the time, only in the rearview mirror. You can expand the concept of "bonds" to encompass all forms of debt, such as CDs, etc. When interest rates are high, debt is going to attract a lot more money. Why invest in risky stocks, bonds, or gold when I can nail down juicy interest rates putting money into "safe" CDs, treasury bonds, etc.? That might turn out to be shortsighted, but it would take a lot for me to believe that investors would be willing to keep their money in stocks and commodities in the face of rising interest rates. They weren't willing in the 1970s, except for those who got "gold fever" and jumped on that bandwagon because the cost of everything was shooting to the sky. That money is going to come out of other investments, and they're going to fall in value as they are liquidated. As I said, I think they'll drop like a rock as soon as interest rates start to increase because the "carry trade" will have to be unwound as the hot money all tries to find the exit at the same time.

Over time, if things get progressively so bad that investors start worrying about how high rates might go, then I can see investors holding back on their willingness to lend money and incur "opportunity costs". Or they might fear the onset of inflation. But that would occur later on in the interest rate ramp-up, and wouldn't help stem losses in stocks, commodities, and long bonds because they would have already fallen. I recall being there in the 1970s and acting just that way myself as a "typical" naive investor. I wanted out of stocks and into CDs, bonds, and the like to latch onto those juicy interest rates. But then, as rates went to 10% and above, I finally got scared they were heading to the moon so I passed up the opportunity to lock in those double digit rates - just before they started down. Had I done that, I never would have had to think about stocks or anything else to invest in. I would have made a fortune holding my ultrasafe treasury bonds. In short, I don't underestimate the odds that stocks and commodites including gold could be killed if rates ramp up and there is no inflation. Of course, my bond holdings will be decimated as well by rising rates and I'm likely to lose money on new bond purchases as well if rates just keep going up. The only safe haven I can think of in this scenario is short-term treasury debt (T-bills).

I'm not trying to discredit the PP, but rather than clinging to the groupthink that the PP is a sort of "failsafe" asset allocation scheme that will do OK no matter what, I think at least for me it's worth playing devil's advocate to carefully think through the implications of the "rising rates + no inflation/deflation" scenario. There was a time I would have discounted this scenario as either impossible or so unlikely it wasn't worth worrying about. But I don't feel that way now. It has been discussed and I can see how it could happen. We are in uncharted territory these days with massive unsustainable national debt and deficit spending, zero interest rates, massive global debt, high unemployment, weak economies. If there was a recipe for economic depression plus strongly rising rates on sovereign debt, this is it.
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Post by MediumTex »

Lbill wrote:I'm not trying to discredit the PP, but rather than clinging to the groupthink that the PP is a sort of "failsafe" asset allocation scheme that will do OK no matter what, I think at least for me it's worth playing devil's advocate to carefully think through the implications of the "rising rates + no inflation/deflation" scenario. There was a time I would have discounted this scenario as either impossible or so unlikely it wasn't worth worrying about. But I don't feel that way now. It has been discussed and I can see how it could happen. We are in uncharted territory these days with massive unsustainable national debt and deficit spending, zero interest rates, massive global debt, high unemployment, weak economies. If there was a recipe for economic depression plus strongly rising rates on sovereign debt, this is it.
It seems like the only alternative in the scenario you are sketching is to have all of your money in t-bills. As I recall, though, you are also concerned about dollar devaluation, in which case the last place you would want to have all of your money would be t-bills.

When it comes to investing, nothing will ever be perfect, and the risk inherent in an imperfect world is what you are being compensated for when you invest in the first place. I think, however, that the PP is about as safe as it gets, all things considered.

Could we have a hyperinflationary deflationary collapse? I don't know, I guess anything is possible, but it seems like the PP has weathered a lot of storms when other strategies have not. It seems like any perceived flaws in the PP are only troubling until you begin looking at the flaws in potential alternatives to the PP.
Last edited by MediumTex on Fri Apr 09, 2010 10:29 pm, edited 1 time in total.
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Post by Lbill »

Here's one example of recent commentary from an article at Marketwatch on the RR+D scenario I described:
One outside possibility: We could have price disinflation or deflation combined with rising long-term interest rates as wary investors demand a higher return on Treasury securities because of the U.S.'s precarious financial position.

While unlikely, that scenario would not be unprecedented, and it would be bad news for investors who've loaded up on gold and commodities, anticipating inflation's return.
Deflation may be the real enemy
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Post by Lbill »

Even one of the respected investing "gurus" on Bogleheads has discussed the scenario I described, even though he did so in the context of talking about TIPS:
In his article about TIPS, Ferri notes that interest rates could rise even with little or no inflation. This may seem odd at first, as inflation and interest rates tend to be highly correlated. But as Ferri points out, interest rates could go up if our trading partners lose confidence in the dollar. To attract investors to U.S. bonds, we’d have to raise interest rates. At the same time, however, inflation could remain low due to actions by the Fed and an aging population that consumes less
http://www.doughroller.net/investing/fe ... est-rates/
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Post by craigr »

Lbill wrote:Craigr - I thought of your point that buying bonds when rates have increased might turn out badly if rates just keep rising. Thing is though, nobody knows at the time, only in the rearview mirror. You can expand the concept of "bonds" to encompass all forms of debt, such as CDs, etc. When interest rates are high, debt is going to attract a lot more money. Why invest in risky stocks, bonds, or gold when I can nail down juicy interest rates putting money into "safe" CDs, treasury bonds, etc.?
If your bonds are yielding 10% but inflation is 12% then you still lose. The markets are not a monolith and different people are going to respond differently to each situation. Some are going to buy bonds, some stocks, some will want hard assets. We just don't know. If enough people want bonds then the yields fall and then we get back to this situation where the money may stop going to bonds. The entire thing self-adjusts based on perceived risks.

I'm not trying to discredit the PP, but rather than clinging to the groupthink that the PP is a sort of "failsafe" asset allocation scheme that will do OK no matter what, I think at least for me it's worth playing devil's advocate to carefully think through the implications of the "rising rates + no inflation/deflation" scenario. There was a time I would have discounted this scenario as either impossible or so unlikely it wasn't worth worrying about. But I don't feel that way now. It has been discussed and I can see how it could happen. We are in uncharted territory these days with massive unsustainable national debt and deficit spending, zero interest rates, massive global debt, high unemployment, weak economies. If there was a recipe for economic depression plus strongly rising rates on sovereign debt, this is it.
Nobody can guarantee anything. There could be some economic malady that comes along that really yanks the rug out from under the PP. The problem is I just don't know what will do better. What people are suggesting is that some portfolio be designed that addresses one particular (and probably remote) scenario. Yet, we really don't know the likelihood of such a thing or how the markets will react.

I see these articles and I guess my question I always ask myself when people generalize what the markets will or won't do is: "How do they know that?"

The markets are made up of millions of people making millions of decisions in their own best interest. It simply is impossible to know how it as an entity will react to any particular scenario ahead of time. There are two sides to each trade and each side of it made up their own mind on why it was a good idea to them.

Perhaps you point out that outsiders want to buy less US Treasury bonds. Ok. So rates go up. It becomes expensive for the US Govt. to borrow. But does that mean the market will crash? Just because it's riskier to loan money to Uncle Sam does not mean it's riskier to loan it to Coca Cola or Microsoft or that their profits will necessarily fall. Or perhaps the message is reached in DC and they raise taxes or have some budget cuts to satisfy the bond markets. Nobody knows how these things will play out.
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Post by 6 Iron »

craigr wrote:
Unknown scenarios are just that, unknown. So planning for an unknown with specific "what ifs" just isnt't that effective. Extremes are not predictable in type nor in outcome.

Secondly, a point I've mentioned before, is that if this particular allocation is going to be hurt then what allocation isn't? And, if there is some allocation that you know will be better, then what happens to it if you place all your money there and the particular situation predicted doesn't happen? Or suppose the markets just kind of shrug off the situation as irrelevant (as has happened many times in the past)? Will you lose more money by shifting your strategy and being wrong there?
The permanent portfolio has an excellent, but relatively brief history in a variety of economic climates. I have found nothing better for me. Still, it seems reasonable to me that there is a non-zero potential for a prolonged period of simultaneous devaluation of all of the volatile assets, no matter how unlikely. Continuing to rebalance down to a 50% or more loss in portfolio value would be challenging.

Perhaps this is on the order of worrying about meteorite damage if you park your car outside.
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Post by Lbill »

As Richard Nixon said, "let me make one thing perfectly clear:" I don't have any answers, just questions. But you can't answer unasked questions, and they may turn out to be the important ones. I guess a lot of people have been finding that out recently in regard to the financial meltdown that nobody saw coming (but they claim they did see it now). :roll:
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Post by craigr »

6 Iron wrote:
craigr wrote:
Unknown scenarios are just that, unknown. So planning for an unknown with specific "what ifs" just isnt't that effective. Extremes are not predictable in type nor in outcome.

Secondly, a point I've mentioned before, is that if this particular allocation is going to be hurt then what allocation isn't? And, if there is some allocation that you know will be better, then what happens to it if you place all your money there and the particular situation predicted doesn't happen? Or suppose the markets just kind of shrug off the situation as irrelevant (as has happened many times in the past)? Will you lose more money by shifting your strategy and being wrong there?
The permanent portfolio has an excellent, but relatively brief history in a variety of economic climates. I have found nothing better for me. Still, it seems reasonable to me that there is a non-zero potential for a prolonged period of simultaneous devaluation of all of the volatile assets, no matter how unlikely. Continuing to rebalance down to a 50% or more loss in portfolio value would be challenging.

Perhaps this is on the order of worrying about meteorite damage if you park your car outside.
I just don't want to worry about things I have no control over before they even happened. During 2008 on the board there were people taking tremendous losses and there was talk of a "Plan B" where, I presume, you bail out of your asset allocation to protect the rest of your principal. For some people that may be the best choice for them as each situation is different. However for me, I want a portfolio that is so widely diversified I have less chance ending up in that situation. I don't know if the PP is that portfolio for all occasions and all possibilities, but I looked at a bunch of different strategies and it's the best one I found. So while I think the strategy is great for diversifying against a wide number of risks, we just don't know if there is some remote bugaboo that could kill it in the future.

I just try to do the best I can and if I make a mistake I'll correct it when it happens. But I wouldn't go out and try to pre-emptively prevent a problem that we don't even know exists or how it will really pan out. Always remember, you may jump from the proverbial frying pan into the fire. There is no guarantee that a particular fix won't come back later to bite an investor. Think of the people before 2008 that were preparing for a real estate crash by buying non-dollar assets. They then found out that they took a worse drubbing than if they just held the S&P 500 index and Treasury Bonds through the thing. So you just never know.

EDIT: BTW. There is an economic condition that could cause stocks, bonds, and gold all to go down at once: A Fed-induced recession. Browne talked about this as well. This is caused by an artificial contraction in the money supply. This situation happened in 1981 to reign in inflation and resulted in a loss of about -4-6% for the portfolio. The good news is that this type of recession does not last long as the markets get used to the new level of the money supply and make adjustments. So just holding on and allowing the assets to adjust is the right course of action in this case.
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