Shorter Term Instead of LT Bonds?

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EdwardjK
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Shorter Term Instead of LT Bonds?

Post by EdwardjK » Wed Mar 11, 2015 6:39 pm

Interest rates have been declining over the past 30-years.  The LT Treasury component of the PP has performed very well in a declining interest rate environment.  But with the Fed edging toward increasing rates in the not-too-distant future, should we consider alternatives to LT Treasuries?

If you buy individual LT Treasuries and hold them until maturity, you will get your money back with some degree of interest.  But if your LT Treasury component is a fund, such as TLT, then you face significant risk if and when the Fed does increase interest rates.  With a duration around 18, a 1% increase in interest rates will cause TLT to significantly decline in value.  I do not believe the Fed will increase interest rates to 1% right away, but increasing rates to 0.50% in a years time is not unrealistic.

All that said, should PP investors begin to move out of LT Treasury funds and into shorter duration funds to minimize the impact? 

I welcome all THOUGHTFUL comments.
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Re: Shorter Term Instead of LT Bonds?

Post by Alanw » Wed Mar 11, 2015 6:55 pm

EdwardjK wrote: Interest rates have been declining over the past 30-years.  The LT Treasury component of the PP has performed very well in a declining interest rate environment.  But with the Fed edging toward increasing rates in the not-too-distant future, should we consider alternatives to LT Treasuries?

If you buy individual LT Treasuries and hold them until maturity, you will get your money back with some degree of interest.  But if your LT Treasury component is a fund, such as TLT, then you face significant risk if and when the Fed does increase interest rates.  With a duration around 18, a 1% increase in interest rates will cause TLT to significantly decline in value.  I do not believe the Fed will increase interest rates to 1% right away, but increasing rates to 0.50% in a years time is not unrealistic.

All that said, should PP investors begin to move out of LT Treasury funds and into shorter duration funds to minimize the impact? 

I welcome all THOUGHTFUL comments.
That's why we hold cash along with long term treasuries. With most of the industrialized worlds bonds yielding less than US bonds, I'm not convinced that LTT's yields cannot go lower. Perhaps substantially lower.
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Re: Shorter Term Instead of LT Bonds?

Post by ozzy » Wed Mar 11, 2015 7:23 pm

The PP goes back further than 30 years.  Look at how the PP performed during rising interest rates (late 70’s and early 80’s).  It did just fine.  That's because while LT Treasures may decline, the other assets (stock, gold) will rise more than sufficiently to compensate.

I say "Rising interest rates? No problem, bring it on!"
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Re: Shorter Term Instead of LT Bonds?

Post by madbean » Wed Mar 11, 2015 7:30 pm

EdwardjK wrote: Interest rates have been declining over the past 30-years.  The LT Treasury component of the PP has performed very well in a declining interest rate environment.  But with the Fed edging toward increasing rates in the not-too-distant future, should we consider alternatives to LT Treasuries?

If you buy individual LT Treasuries and hold them until maturity, you will get your money back with some degree of interest.  But if your LT Treasury component is a fund, such as TLT, then you face significant risk if and when the Fed does increase interest rates.  With a duration around 18, a 1% increase in interest rates will cause TLT to significantly decline in value.  I do not believe the Fed will increase interest rates to 1% right away, but increasing rates to 0.50% in a years time is not unrealistic.

All that said, should PP investors begin to move out of LT Treasury funds and into shorter duration funds to minimize the impact? 

I welcome all THOUGHTFUL comments.
I think the standard PP answer would be no, you don't want to move out of LT Treasury funds into shorter duration funds. You hold 25% LT's at all times as protection against deflation. End of story, if you buy into the philosophy.

Your angst is understandable however. As far as I can see, and I'm not someone who studies these things closely, so somebody correct me if I'm wrong, there is no historical U.S. precedent for the long term trend we have been seeing in interest rates.
Last edited by madbean on Wed Mar 11, 2015 7:32 pm, edited 1 time in total.
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Re: Shorter Term Instead of LT Bonds?

Post by Alanw » Wed Mar 11, 2015 7:37 pm

We hear all the talk about the 30+ year bull market in bonds. How do we know that won't turn into a 40 or even a 50 year bull market? One of the main premises of the PP is being agnostic about the future.  I prefer keeping the PP pure and using a VP to tilt your total portfolio.
'
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Re: Shorter Term Instead of LT Bonds?

Post by Reub » Wed Mar 11, 2015 8:05 pm

The most important aspect of the HBPP is to stop thinking (aka timing, aka worrying).
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Re: Shorter Term Instead of LT Bonds?

Post by buddtholomew » Wed Mar 11, 2015 9:04 pm

As Alan mentioned, combining LTT's and Cash reduces the FI duration to a manageable 8-9 years. I personally hold more than 25% in cash to further reduce duration to 5.6 years (considered intermediate term). Yields can certainly fall further and if they rise, the short end of the curve could be impacted the most.

I'll come out and say it. I expect the FED to raise the inter-bank lending rate and for long-term treasuries to rally on the decision. The FED may believe the economy has strengthened, but the bond market could disagree. I'm more concerned with gold as inflation is a distant thought and the strong dollar puts downward pressure on the metal even more. I am already mentally prepared to buy more when AU comprises less than 15% of the portfolio.
Last edited by buddtholomew on Wed Mar 11, 2015 9:08 pm, edited 1 time in total.
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Re: Shorter Term Instead of LT Bonds?

Post by Alanw » Wed Mar 11, 2015 11:12 pm

Very well put, Budd. Holding more cash is a great way to shorten your bond duration. And if the Fed does start raising short term rates, our cash will start yielding more. Right now I would be more afraid of not holding LTT's the way the world's financial system looks. As usual, gold is the real wild card.
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Re: Shorter Term Instead of LT Bonds?

Post by murphy_p_t » Wed Mar 11, 2015 11:26 pm

buddtholomew wrote:
I'll come out and say it. I expect the FED to raise the inter-bank lending rate and for long-term treasuries to rally on the decision.
Kinda like the *counter-intuitive* rally bonds did during the talk of US govt default in 2011...
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Re: Shorter Term Instead of LT Bonds?

Post by craigr » Thu Mar 12, 2015 3:22 pm

buddtholomew wrote: As Alan mentioned, combining LTT's and Cash reduces the FI duration to a manageable 8-9 years. I personally hold more than 25% in cash to further reduce duration to 5.6 years (considered intermediate term). Yields can certainly fall further and if they rise, the short end of the curve could be impacted the most.
I think this is a part a lot of people miss when looking at the assets in isolation. Bogleheads for instance like Intermediate term bonds for the most part. They will criticize the Permanent Portfolio for holding long-bonds. But if you look at the blended duration, they are nearly the same as intermediate term bond funds!

The barbell of the bonds adds a ton of flexibility to ride out market panics, and have dry powder around for rebalancing. If the long bonds are worrying, then there is no issue just holding more cash. I mean a portfolio that was 70% cash and 30% other PP components is fine if that's what someone needs to sleep at night.
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Re: Shorter Term Instead of LT Bonds?

Post by Alanw » Thu Mar 12, 2015 3:49 pm

If you are overly concerned about one component of the PP, just reduce the size of that component as well as all the other components. That way you retain the integrity of the PP for rebalancing and the remainder can be used to establish a VP to tilt your total portfolio in whichever direction you wish.
Personally I like to underweight gold but do so by only having 70% of my total portfolio in PP with my VP in VWINX. That way I am slightly overweight stocks and bonds. A very simple portfolio and still easy to rebalance.
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Re: Shorter Term Instead of LT Bonds?

Post by ochotona » Thu Mar 12, 2015 7:31 pm

Alanw wrote: If you are overly concerned about one component of the PP, just reduce the size of that component as well as all the other components. That way you retain the integrity of the PP for rebalancing and the remainder can be used to establish a VP to tilt your total portfolio in whichever direction you wish.
Personally I like to underweight gold but do so by only having 70% of my total portfolio in PP with my VP in VWINX. That way I am slightly overweight stocks and bonds. A very simple portfolio and still easy to rebalance.
Alanw, very soon people are going to jump upon you for violating the Holy and Cardinal Rules. Thou shall turn off thy Mind and just follow the Rules.
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Re: Shorter Term Instead of LT Bonds?

Post by Sam Brazil » Thu Mar 12, 2015 7:39 pm

Why try to time when the fed will start to raise rates? Any kind of negative economic news could yet again push off raised rates farther into the future. Who knows what will happen. Besides, if it's so obvious that the fed is going to raise rates soon, in theory, then shouldn't that already be priced into bonds? That sounds counter-intuitive because they seem so expensive, which seems incompatible with the view that rates are inevitably going to go up...but maybe LT prices would be even higher now if not for risk of rates going up?
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Re: Shorter Term Instead of LT Bonds?

Post by Reub » Thu Mar 12, 2015 7:41 pm

Do you believe that you know what the markers are going to do and when?  Do you believe that you can beat the markets? If so,  then the PP is not for you.
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I Shrugged
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Re: Shorter Term Instead of LT Bonds?

Post by I Shrugged » Thu Mar 12, 2015 7:57 pm

Harry Browne said it was always a tough sell getting PP investors to commit to the LT bonds.  They were once mocked as "certificates of guaranteed confiscation".  We could easily go Japanese, in which case the LT bonds will keep going up.
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Re: Shorter Term Instead of LT Bonds?

Post by MachineGhost » Thu Mar 12, 2015 8:52 pm

Fed raising the FFR/DR won't effect long term rates.  So long as they stay behind the curve of economic growth and capacity constraints, then it won't be "tight money".  You can get an idea of what the Fed will do in the future by just following T-Bill rates since there is a high correlation between the two.

HOWEVER, investor perceptions matter a great deal.  It's hard to know how they will react given all the complete fairy tale B.S. they believe in.

That being said, from a yield/valuation perspective, I have already reduced my duration risk in T-Bonds and I also have a lot more cash than 25%, but that is because I consider public equities overvalued in that they won't produce suitable long-term returns at this point.  I can also do that because I have absolute return prosperity investments that don't need hedging protection in the way public equities do.  Ideally you should match the durations between public equities and T-Bonds, but I don't think anyone could stomach a 50-year duration risk in their T-Bonds.  Portfolio duration is sort of a marker for economic confidence...  if you were forced to have more cash because there's less attractive investment opportunities available, then your portfolio duration would decline accordingly.  The duration of the standard PP at current valuation levels of the assets is around 7 years I think.

We don't know what another 40-year bear market in T-Bonds will do to the PP since it has no track record other than 12 years of one.  That's not a risk I'm willing to take at this time.
Last edited by MachineGhost on Thu Mar 12, 2015 9:10 pm, edited 1 time in total.
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Re: Shorter Term Instead of LT Bonds?

Post by MachineGhost » Fri Mar 13, 2015 8:01 am

MangoMan wrote: Didn't you try that once before recently, with disastrous unhappy results?
No, that was a bad data point causing a premature trend following buy signal on T-Bonds, about 6 months too early.  That had nothing to do with duration, unless you want to view it as a binary choice, i.e. T-Bills duration vs T-Bills+T-Bonds duration.  After that, I decided the duration risk of 30-yr T-Bonds was too much for my blood given my portfolio composition (and that was with only half of the 25% too!).  30-yr T-Bonds are deathly risky in isolation and are only good for protecting equity.  Keep in mind that the duration of 30-yr T-Bonds with current yields is higher than at anytime as far back as 1968 that the PP can be backtested.  And the duration will continue to increase as yields decrease to 0% (or negative)...

[align=center][img width=800]http://www.gpb.org/files/nuts.jpg[/img][/align]
Last edited by MachineGhost on Fri Mar 13, 2015 8:15 am, edited 1 time in total.
"All generous minds have a horror of what are commonly called 'Facts'. They are the brute beasts of the intellectual domain." -- Thomas Hobbes

Disclaimer: I am not a broker, dealer, investment advisor, physician, theologian or prophet.  I should not be considered as legally permitted to render such advice!
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Re: Shorter Term Instead of LT Bonds?

Post by hoost » Fri Mar 13, 2015 8:47 am

Alanw wrote: If you are overly concerned about one component of the PP, just reduce the size of that component as well as all the other components. That way you retain the integrity of the PP for rebalancing and the remainder can be used to establish a VP to tilt your total portfolio in whichever direction you wish.
Personally I like to underweight gold but do so by only having 70% of my total portfolio in PP with my VP in VWINX. That way I am slightly overweight stocks and bonds. A very simple portfolio and still easy to rebalance.
I think if you read the early rationale behind the permanent portfolio, the idea was to have A permanent portfolio...not necessarily THE permanent portfolio.  As long as you have the four basic asset classes included in your portfolio, choose percentages that you are comfortable with, establish rebalancing bands, and stop looking at it.

I found for me that being 4x25 caused me to want to tinker, and that I couldn't handle trailing the market as much.  So, I adjusted my target allocation to percentages I'm more comfortable with, and haven't thought twice about it since.  I think this is the important lesson...set up a portfolio for the money you can't afford to lose, and leave it alone instead of trying to time the market, etc.

I ended up targeting 50% stock, 40% treasury bonds (20/20 split LT/ST or 40% IT depending on available investments), and 10% gold.  This winds up being almost like a boglehead allocation, but has the benefit of using the assets as laid out by H.B.  Drawdowns will be a bit higher, as will expected return, and it tracks the market a bit better, so you don't lag as much and get tempted to tinker.

Some people may want to go the opposite direction and hold less stock or reduce the duration of the treasury holding.  That's fine, too.  But come up with an allocation and stick to it.  The temptation to tinker is what kills us at the end of the day.
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Re: Shorter Term Instead of LT Bonds?

Post by Hal » Fri Mar 13, 2015 4:29 pm

Perhaps this series of articles will help with your decision?

http://idiosyncraticwhisk.blogspot.com. ... .html#more

Just increase your VP holding with other assets so you can sleep at night…

Hal

PS: Open question: What process did HB use to elimate components from the PP as he developed it? Eg. Silver is out. It would be interesting to measure LT's against his criteria
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Re: Shorter Term Instead of LT Bonds?

Post by ozzy » Mon Mar 16, 2015 5:09 pm

One more thought.  Forgive me for sounding too cocky here, but I don’t think rising interests are going to hurt to PP much at all.  It may hurt overall performance for a year or two, but then the PP is likely to over-perform.  Here’s why I believe this.  Take a look at this historical chart of Interest rates:

http://www.accuval.net/insights/newslet ... s/hffr.jpg

Notice that rates never rise or fall in a straight line.  They oscillate.  For example, they rose in 1994/1995, and here’s how VUSTX performed:

1994 = -7.04
1995 = +30.09 (WOW!)

So yes, TLT may take a dump for a year or two, then come back with a vengeance the next year.  If you’re rebalancing yearly, you should be able to profit from those movements.

FYI - You can customize the time periods you’d like to view historical interest rates at this website: http://research.stlouisfed.org/fred2/series/FEDFUNDS/
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Re: Shorter Term Instead of LT Bonds?

Post by D1984 » Mon Mar 16, 2015 7:05 pm

ozzy wrote: One more thought.  Forgive me for sounding too cocky here, but I don’t think rising interests are going to hurt to PP much at all.  It may hurt overall performance for a year or two, but then the PP is likely to over-perform.  Here’s why I believe this.  Take a look at this historical chart of Interest rates:

http://www.accuval.net/insights/newslet ... s/hffr.jpg

Notice that rates never rise or fall in a straight line.  They oscillate.  For example, they rose in 1994/1995, and here’s how VUSTX performed:

1994 = -7.04
1995 = +30.09 (WOW!)

So yes, TLT may take a dump for a year or two, then come back with a vengeance the next year.  If you’re rebalancing yearly, you should be able to profit from those movements.

FYI - You can customize the time periods you’d like to view historical interest rates at this website: http://research.stlouisfed.org/fred2/series/FEDFUNDS/
Ozzy,

What happens if we get rising rates several years in a row, though? Look at 1963 through 1969 or 1977 through 1981 (for the period in the 1960s, use the 20-year bond data from the Federal Reserve website you mentioned since they don't have 30 year bond yield data going back that far....then when calculating annual total return, extrapolate the bond maturity to 24 or 25 years since that would give you approximately the maturity Harry Browne recommended in his "buy at 30 years, sell at 20 years left" for the LTT portion of the Permanent Portfolio...it's a good bet yields on 25 year bonds would be very little different from 20-year bond yields so this calculation will give you a pretty decent idea of total return on holding a constant maturity 25 year LTT during this period).

The results won't be pretty; IIRC, during the years I mentioned long-term yields rose EVERY SINGLE YEAR.
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Re: Shorter Term Instead of LT Bonds?

Post by ozzy » Mon Mar 16, 2015 8:12 pm

Hi D1984,

The PP did just fine during 1977-1981.

Also, let’s not forget the perceived flight to safety that LT US bonds represent.  For example, right you need to pay the German govt to hold their bonds (negative interest rates).  And you know what, people are paying it!  People will pay to keep their money “safe”?.  As long as they perceive US bonds as a safe haven they won’t be down for long.

Even if interest rates rise for several years in a row, there could be any crisis that would drive bonds up.  Interest rates are not the only factor.
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