PP facelift

[Lonestar]

I was really interested in a recent thread that showed increasing the equity portion and decreasing the gold portion of the PP made little if no difference in long term returns.  Since I am currently at that ratio (35/50/15) I'm considering adopting that as a permanent allocation.

My question is in regards to the bond portion.  I'm also thinking about combining the cash/bond portion into one intermediate bond ETF.  The 2 choices would be IEF at an average maturity of 8.5 year and duration of 7.6 years.  The other choice is TLH at an average maturity of 10.1 years and duration of 13.4yr.

Any suggestions on which to use?

[craigr]

Average returns hide a lot of big drops and volatility. So if you are OK with perhaps a big drop in stocks hitting a portfolio then owning more stocks is fine. But just be aware of course that what looks fine on a spreadsheet may be a very stressful time when real dollars are at stake.

As for the Intermediate bond fund. The reason I prefer the barbell of LT bonds and cash is that the cash is very stable and able to be quickly accessed even in the worst markets with a good chance it will not have moved a lot in value. If you use an IT bond fund then the value will rise and fall with the interest rates. In certain markets if you need access to the cash you may find you are selling the asset when it is at a loss if you keep it all in one fund and can't wait things out.

Generally for Boglehead type portfolios though if someone were to say they were going to be X% Total World Index, X% Treasury Intermediate Term Bonds and X% gold there isn't much to argue with if they are OK with the volatility they get in exchange.

[MachineGhost]

As for the Intermediate bond fund. The reason I prefer the barbell of LT bonds and cash is that the cash is very stable and able to be quickly accessed even in the worst markets with a good chance it will not have moved a lot in value. If you use an IT bond fund then the value will rise and fall with the interest rates. In certain markets if you need access to the cash you may find you are selling the asset when it is at a loss if you keep it all in one fund and can't wait things out.

And historically, the maximum drawdown on T-Bills was only about -3.50% in 1980.  It took about 8.5 months to recover the loss.

[sophie]

But just be aware of course that what looks fine on a spreadsheet may be a very stressful time when real dollars are at stake.

This is an extremely important point!!!!

Investment schemes may look easy on backtesting, but where they fail is usually when people panic and sell during drawdowns.  Or, they see that performance is lagging some other investment scheme or fund, and then they sell in order to jump on that bandwagon just as it's about to revert to the mean.  So the question is primarily, how much of a drawdown or tracking error can you tolerate before selling?  CAGR, to me, is a distant second consideration.

The PP's drawdowns are quite tolerable for most, but it does suffer from tracking error.  I've found that I can cope with the tracking error, with the help of knowing how this works for the PP based on backtesting, but drawdowns would be a serious challenge for me.  For your proposed portfolio, I would guess that tracking error would be less but still present, and drawdowns would be larger.  If tracking error bothers you more than drawdowns, then by all means plan accordingly.

[Kbg]

I was really interested in a recent thread that showed increasing the equity portion and decreasing the gold portion of the PP made little if no difference in long term returns.  Since I am currently at that ratio (35/50/15) I'm considering adopting that as a permanent allocation.

I basically agree with the points on bonds. I think the barbell is better in terms of smoothing the ride. I also think it's pretty clear it doesn't do much over the long haul for performance though vice the alternative of a shorter maturity. Gold is also a portfolio smoother with just a dab helping quite a bit, but it also goes on some epic runs. Cherry picked dates, but seriously compare gold vs. stocks from Jan 2001 to Jan 2011. 10 years of basically nothing from stocks meanwhile gold is up 4x.

[Lonestar]

I understand and agree with everything that has been said above.  However, my PP only accounts for about one quarter of my total portfolio.  It may be more some day.

Being retired, an extremely large part is in fixed income, consisting of short to intermediate term instruments.  I also hold a fair amount in cash equivalents.  So with this in mind I have no intention or need to sell any part of my PP in a down market.  I don't particularly like volatility but I'm in my PP for long term and feel I can weather just about any storm.

Now back to my original question.  Anyone care to comment on maturity length of intermediate fixed income for PP??

[Cyclesguy]

I agree with the previous posters that past returns and backtesting has no bearing or guarantee in the future. To echo the last post as well, if you have periods like the 2000's where gold shoots up like a rocket and stocks are flat, you'd be able to rebalance a few times into stocks and eventually have many more stock shares to ride the bull market there when it starts. Having a lower allocation to gold would not benefit you in such a circumstance.

In observing my own portfolio (which is 25%x4 to a tee), I notice that long bonds and gold offset the equity quite well during volatile days on the market, almost by the exact same amount the stocks gained/lost. There can be huge swings in stock market and I end up even steven for the day. Harry argued that you need the volatility of the long bonds. As evidenced by this year, everyone keeps saying interest rates are going up soon yet the long bonds have done very well and pay a juicy interest rate given the current times (at least here in Canada, 4% dividend on the 30 year ETF), I understand the US went up > 20%, how many decades would it have taken the intermediate bonds to earn that?

I do not believe intermediate bonds have the same long term benefit if interest rates dive toward zero as they have in some parts Europe, with the money printing environment you want both long bonds and gold, but that's just my $.02. Maybe I'm too much a Harry Browne devotee?

[buddtholomew]

The investor has 25% allocated to LTT's and another 25% allocated to STT's for the fixed income portion of the portfolio. The combined duration of these investments is similar to holding an Intermediate Term treasury (e.g. IEF with 7-10 years duration).

50%*~16 years (TLT) + 50*~2 years (SHY) = ~9 years duration
100%*~9 years (IEF) = ~ 9 years duration

I prefer to hold LTT's and Cash over IEF for 1. tax purposes and 2. combining an EF in my portfolio allocation. The TLT/STT combination is expected to perform the same as IEF with a parallel shift upward/downward in the yield curve.

The HBPP is a 25/25/50 portfolio with 25% allocated to equities, 25% to gold and 50% to 7-10 year duration treasuries. Nothing more, nothing less.

[Reub]

Isn't it true that someone starting a new PP who was purchasing actual 30 year treasuries would have a much longer bond duration if they also owned, say, SHY? Probably closer to a 16 year average duration?

[MachineGhost]

Isn't it true that someone starting a new PP who was purchasing actual 30 year treasuries would have a much longer bond duration if they also owned, say, SHY? Probably closer to a 16 year average duration?

Yep, which is an argument for duration hedging the portfolio.  But, I don't think anyone was convinced by my solution.  Gold is pretty risky, but is it really THAT risky?

Perhaps the proper solution -- as I mentioned few years ago -- is to use FORWARD looking volatility for volatility hedging the portfolio.  I've yet to examine that in detail since it is not easy to backtest.

[buddtholomew]

Isn't it true that someone starting a new PP who was purchasing actual 30 year treasuries would have a much longer bond duration if they also owned, say, SHY? Probably closer to a 16 year average duration?

That is a correct statement, but the concept of managing fixed income duration remains the same.