real cash vs cash index. How it really works?

[Arturo]

Hi all,

since i started reading about PP, i have noticed that there are persons that selects different products for cash allocation, like an ETF that follows a specific index (short term bonds), or even maintain it in real cash in a bank.

if you invest on a ETF, i can understand that it try to replicate a short term bonds index, so year per year, it will give a quote and a return.

But i do not understand from where the people that invest their cash allocation in real cash (not a fund,  ETF, or second market bonds), obtain the return needed for PP.  I mean, how do they obtain the return needed for PP just having cash in a bank account. Does it have to be invested in short term deposits?

i hope somebody can give me a clue about this doubt,

thanks in advance!

[k9]

Real cash, as you call it, gives your the opportunity to buy falling assets on a bargain. With 25% cash in 2008-2009 you could buy the stock market at its lowest ; without cash, you couldn't do that and could only wait for the market to recover, thus actually achieving a lower overall return. In 1981 cash was the only winning asset, so you better had some to buy gold, LT bonds & stocks on a bargain.

Returns are, of course, probably a little higher with with ST treasuries or any low yielding but safe alternative, but a few more percents on the 25% cash portion will probably not have a big influence.

[whatchamacallit]

If I understand the question, you are asking how you receive dividends on cash deposited in a bank account?

I wonder if you might be in a country that doesn't have savings accounts that pay interest?

Here in the United States, you can still find some rewards checking accounts that pay over 2.00 % APY with different limitations and requirements to get the APY.

[Gosso]

Returns are, of course, probably a little higher with with ST treasuries or any low yielding but safe alternative, but a few more percents on the 25% cash portion will probably not have a big influence.

A small percent difference can have a significant impact:

10.5% ^ 30 years = 2,000%
10.0% ^ 30 years = 1,745%

That's a lot of pennies! 

Hi all,

since i started reading about PP, i have noticed that there are persons that selects different products for cash allocation, like an ETF that follows a specific index (short term bonds), or even maintain it in real cash in a bank.

if you invest on a ETF, i can understand that it try to replicate a short term bonds index, so year per year, it will give a quote and a return.

But i do not understand from where the people that invest their cash allocation in real cash (not a fund,  ETF, or second market bonds), obtain the return needed for PP.  I mean, how do they obtain the return needed for PP just having cash in a bank account. Does it have to be invested in short term deposits?

i hope somebody can give me a clue about this doubt,

thanks in advance!

There are several options:
- You can buy short-term government treasuries through your broker and create a two or three year ladder.
- Buy certificates of deposit from the bank in a two or three year ladder.
- Place money is a high interest savings account. (downside here is that your duration is zero, and so will likely have a lower yield than above options)

If you go with CD's or HISA make sure your bank is covered by FDIC (or equivalent), and that you live in a country that is not overly corrupt and values individual property rights.  It also helps if the country has its own printing press.

Here's a primer on bond/CD laddering: http://www.bogleheads.org/wiki/Ladderin ... ite_note-6

[Arturo]

There are several options:
- You can buy short-term government treasuries through your broker and create a two or three year ladder.
- Buy certificates of deposit from the bank in a two or three year ladder.
- Place money is a high interest savings account. (downside here is that your duration is zero, and so will likely have a lower yield than above options)

If you go with CD's or HISA make sure your bank is covered by FDIC (or equivalent), and that you live in a country that is not overly corrupt and values individual property rights.  It also helps if the country has its own printing press.

Here's a primer on bond/CD laddering: http://www.bogleheads.org/wiki/Ladderin ... ite_note-6

Hi Gosso,

i think i am misunderstanding something about cash allocation. i understand that

1. with cash, as k9 pointed out, you are the king in recesion, because it lets you buy when everything is cheap
2. you can also obtain a small return if you invest it on products like short term bonds (secondary market, etf or funds) or bank deposits.

the issue here is that i do not understand PP investors that leave their cash allocation in a bank account cash, so they have 'cash' also for the day by day purchases or short term needs. Because if you invest the cash in a deposit, and you need  to rescue money, you have to pay a cancellation penalty (deposits normally are for 6-12 or 15 months).

Or maybe i am wrong and people don't do this :-)

[Gosso]

Hi Gosso,

i think i am misunderstanding something about cash allocation. i understand that

1. with cash, as k9 pointed out, you are the king in recesion, because it lets you buy when everything is cheap
2. you can also obtain a small return if you invest it on products like short term bonds (secondary market, etf or funds) or bank deposits.

the issue here is that i do not understand PP investors that leave their cash allocation in a bank account cash, so they have 'cash' also for the day by day purchases or short term needs. Because if you invest the cash in a deposit, and you need  to rescue money, you have to pay a cancellation penalty (deposits normally are for 6-12 or 15 months).

Or maybe i am wrong and people don't do this :-)

Oh, I see.  Well here's what I do.  For daily purchases I place everything on my credit card, and then pay it off in full every month (it acts as a nice buffer until I get my pay check).  I keep at least $1000 in my checking account (normally around $1200), since by maintaining $1000 all banking fees are waived (that works out to a 4% return on the $1000).  I then keep a few months of living expenses in a High Interest Savings Account, which is highly liquid and can transfer into my checking account immediately.  Then for "cash" beyond that I place into CDs and/or short term government bond, since I don't need these funds to be liquid.  However, for rebalancing there are a few options.  The first is to rebalance once a year when the CD matures (so we forget about rebalancing bands (this might suit some peoples personality better)).  The second is to buy cashable CDs that can be redeemed without penalties (government bonds can be sold on the secondary market whenever you like).  Personally I'm still in accumulation mode so once my savings build up I place them into the underperforming asset.

You could buy an ETF for the cash, but I personally cannot justify paying the 0.20% MER, $10 trade, and spread, when I can do it myself essentially for free and get a better yield, plus I enjoy it.  If you want a hands off approach then maybe go with the ETF.

Keep in mind that I'm in Canada so a lot of this may not translate to whichever country you're in.

[Arturo]

Oh, I see.  Well here's what I do.  For daily purchases I place everything on my credit card, and then pay it off in full every month (it acts as a nice buffer until I get my pay check).  I keep at least $1000 in my checking account (normally around $1200), since by maintaining $1000 all banking fees are waived (that works out to a 4% return on the $1000).  I then keep a few months of living expenses in a High Interest Savings Account, which is highly liquid and can transfer into my checking account immediately.  Then for "cash" beyond that I place into CDs and/or short term government bond, since I don't need these funds to be liquid.  However, for rebalancing there are a few options.  The first is to rebalance once a year when the CD matures (so we forget about rebalancing bands (this might suit some peoples personality better)).  The second is to buy cashable CDs that can be redeemed without penalties (government bonds can be sold on the secondary market whenever you like).  Personally I'm still in accumulation mode so once my savings build up I place them into the underperforming asset.

You could buy an ETF for the cash, but I personally cannot justify paying the 0.20% MER, $10 trade, and spread, when I can do it myself essentially for free and get a better yield, plus I enjoy it.  If you want a hands off approach then maybe go with the ETF.

Keep in mind that I'm in Canada so a lot of this may not translate to whichever country you're in.

Hi Gosso,

some facts i don't understand:

1. You could buy an ETF for the cash, but I personally cannot justify paying the 0.20% MER, $10 trade, and spread, when I can do it myself essentially for free and get a better yield, plus I enjoy it.

do you mean that you can buy&sell short term bonds at the secondary with better MER/TER than with an ETF? if i understood right, as far as i know, brokers normally don't charge deposit and 'dividends' comissions, so maybe you are right and i didn't realized it until you said it :-). With short and long term bonds, you dont have to pay TER, so is something you can save (2 x 0.20%).


2. Personally I'm still in accumulation mode so once my savings build up I place them into the underperforming asset.

a. how many times per year do you use to do that? or with how much percentage?

3. Can you explain how is the procedure of rebalancing bands?

thanks in advance!

[Gosso]

1. You could buy an ETF for the cash, but I personally cannot justify paying the 0.20% MER, $10 trade, and spread, when I can do it myself essentially for free and get a better yield, plus I enjoy it.

do you mean that you can buy&sell short term bonds at the secondary with better MER/TER than with an ETF? if i understood right, as far as i know, brokers normally don't charge deposit and 'dividends' comissions, so maybe you are right and i didn't realized it until you said it :-). With short and long term bonds, you dont have to pay TER, so is something you can save (2 x 0.20%).

Here's a 1-5 year government bond ladder ETF in Canada: http://www.etfs.bmo.com/bmo-etfs/glance ... 4663.  It pays 1.05% annual interest, while I can open an account at ING Canada and build a 1-5 year CD ladder and get ~2.0% annual return: http://www.ingdirect.ca/en/save-invest/gic/index.html

Since I consider CDIC (Canadian FDIC) equivalent and possibly better than Canadian bonds (most PPer's would disagree with me, I think?), I have a hard time not going for CDs.

2. Personally I'm still in accumulation mode so once my savings build up I place them into the underperforming asset.

a. how many times per year do you use to do that? or with how much percentage?

Whenever cash gets above 30% or so.  I then drop the weighting of cash down to around 20%.  Not an exact science.

3. Can you explain how is the procedure of rebalancing bands?

If the weighting of either gold/stocks/bonds/cash reaches 35% or falls to 15% of your total PP, you then rebalance everything back to 25% weighting.  This will likely never happen if you are in accumulation mode and the portfolio is still smallish.

[Arturo]

2. Personally I'm still in accumulation mode so once my savings build up I place them into the underperforming asset.

Whenever cash gets above 30% or so.  I then drop the weighting of cash down to around 20%.  Not an exact science.

Hi Gosso,

are there studies that measured the impact in the annual total return with both versions? i mean, which one gives better returns, inyecting savings on the underperforming asset, or band rebalancing (I assume that the first approach canbe made only when the portfolio is small).

[Gosso]

2. Personally I'm still in accumulation mode so once my savings build up I place them into the underperforming asset.

Whenever cash gets above 30% or so.  I then drop the weighting of cash down to around 20%.  Not an exact science.

Hi Gosso,

are there studies that measured the impact in the annual total return with both versions? i mean, which one gives better returns, inyecting savings on the underperforming asset, or band rebalancing (I assume that the first approach canbe made only when the portfolio is small).

Some people like to add new contributions evenly to all four assets, and then rebalance only when a band is hit.  This does produce a slightly higher return over the past 40 years (I believe Sophie looked into it).  Although, if in a taxable account then the cap gains will likely erase the small advantage.

The most important thing about rebalancing is that you actually do it.  The method used doesn't matter too much.  Just remember to keep costs low.

[Arturo]

2. Personally I'm still in accumulation mode so once my savings build up I place them into the underperforming asset.

Whenever cash gets above 30% or so.  I then drop the weighting of cash down to around 20%.  Not an exact science.

Hi Gosso,

are there studies that measured the impact in the annual total return with both versions? i mean, which one gives better returns, inyecting savings on the underperforming asset, or band rebalancing (I assume that the first approach canbe made only when the portfolio is small).

Some people like to add new contributions evenly to all four assets, and then rebalance only when a band is hit.  This does produce a slightly higher return over the past 40 years (I believe Sophie looked into it).  Although, if in a taxable account then the cap gains will likely erase the small advantage.

The most important thing about rebalancing is that you actually do it.  The method used doesn't matter too much.  Just remember to keep costs low.

thanks for your advises Gosso.

[Arturo]

I have one doubt about a particular issue here in Europe.

As everybody knows, we don't have a central bank issuing european bonds like FED. So the best option for periods of deflation, the best solution is buying bonds from the country with less probability of default. On this case, Germany.

On the other hand, in periods of recession, governments have the lack of cash flow, so short term bonds increases its value.

So my question is the next: in our particular european position, would't be better to buy short term bonds from countries feeling more in depth the recession like Italiy or Spain, in stead of Germany, that does't have cash flow issues, so we obtain better CAGR?

regards