Did Harry Browne consider this flaw in his strategy?

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gaston
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Did Harry Browne consider this flaw in his strategy?

Post by gaston » Sat Dec 12, 2015 4:48 am

Hi all,

I just read Harry Browne's 'why the best laid investment plans usually go wrong'. In chapter 18, he wrote:
Volatile stock-market investments, long-term Treasury bonds, gold,
and Treasury bills combine to provide balance and safety.
Apart from Treasury bills, each has the ability to rise by more than
100% over a period of time, while the decline of any investment is
limited to 100%. So a Permanent Portfolio comprised of these investments
has a natural tendency to gain in value. And this upward
bias is augmented by the interest earned by the Treasury bills and
bonds.
The problem I see here is that while stocks and gold indeed have the ability to rise by more than 100% from any level at any time, long terms bonds do not.

The yield on a canada 30 year is 2.162%. In his radio shows, Browne said that rates dropped to 1% during the great depression. Let us assume that rates go even lower to 0.01% on a 30 year and plug in the numbers in a calculator (http://www.free-online-calculator-use.c ... lator.html) and we find a gain of 64%. A rate drop to 1% would create a gain of 30%. In any case, bonds do not seem to have the ability to rise by more than 100% as he said. For a 30 year bond to have the potential to rise by 100% assuming rates drop to 0%, current rates would have to be >3.5%.

So first I'd like to know if my math is right or if I'm missing something.

And then, what should be done about this apparent flaw? In the absolute best case of rates going to 0%, bonds would gain 64%, which would 'pull' the portfolio upwards by 16%. In a more reasonable case of rates going to 1%, the positive effect on the overall portfolio would be +7.5%.

Shouldn't we simply not bother and go with 50% cash/ short term bonds in the portfolio until long term bonds recover their potential? What are the experts thinking?
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Re: Did Harry Browne consider this flaw in his strategy?

Post by dutchtraffic » Sat Dec 12, 2015 5:36 am

gaston wrote: In the absolute best case of rates going to 0%, bonds would gain 64%, which would 'pull' the portfolio upwards by 16%. In a more reasonable case of rates going to 1%, the positive effect on the overall portfolio would be +7.5%.
Rates can go negative.
In Europe most are already.
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Re: Did Harry Browne consider this flaw in his strategy?

Post by dualstow » Sat Dec 12, 2015 8:35 am

I'm no expert, but at the same time you're posing this question, U.S. treasuries are really doing their job. The market is 80% certain that rates will rise in December (source: Wall Street Journal). However, TLT and long-term bonds are going up, proving that there is no clear connection between Yellen's actions on short term rates and the behavior of the bond portion of the pp.

Executive summary: yesterday the S&P was down 1.94%, the DOW was down 1.76% and TLT was up 1.58%.
Of course, it doesn't work out like that in every 24-hr period, but it sure felt good that I'm holding more than just stocks and cash.
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Re: Did Harry Browne consider this flaw in his strategy?

Post by gaston » Sat Dec 12, 2015 9:52 am

Thanks for your replies. I am aware that rates are negative for short term bonds in some countries like germany and switzerland (not yet for 30 year bonds).

I have a hard time to fathom this negative rates thing. To me, at this time the long term bonds allocation conflicts with rules #9 and #16:
Rule #9: Don't ever do anything you don't understand.

Don't undertake any investment, speculation, or investment program that you don't understand. If you do, you may later discover risks you weren't aware of. Or your losses might turn out to be greater than the amount you invested.

It's better to leave your money in Treasury bills than to take chances with investments you don't fully comprehend. It doesn't matter that your brother-in-law, your best friend, or your favorite investment advisor understands some money-making scheme. It isn't his money at risk. If you don't understand it, don't do it.
Rule #16: Whenever you're in doubt about a course of action, it is always better to err on the side of safety.

If you pass up an opportunity to increase your fortune, another one will be along soon enough. But if you lose your life savings just once, you might never get a chance to replace it.
I do not understand how rates can go negative to the point of justifying the long bond allocation. At the very least I am in doubt about this course of action. According to Browne himself (#9), the 25% long bond allocation should therefore sit in treasuries until I 'comprehend'...
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Re: Did Harry Browne consider this flaw in his strategy?

Post by ochotona » Sat Dec 12, 2015 10:18 am

Also see "Stay on the short end of the yield curve" which I posted in Bonds.

A number of us have US Treasuries in the 7 - 10 year range, not 20 - 30.

To which some would ask, "Well, what if interest rates stay low, go lower, go negative?" To which I would reply, that gets into the mode of speculation. Because if you are buying long bonds in a NIRP ZIRP QE1, QE2, QE3, QE4? world, you really are buying at or near the top, if you stand back a few paces from the charts.

The word "what if" is the tip-off. The 5-7-10 year range is more neutral, less committed position you can take while the world goes bat-scheiss crazy.

Remember 2008... return OF your capital was more important than return ON your capital, and yes, you can lose big money on long bonds.
Last edited by ochotona on Sat Dec 12, 2015 10:25 am, edited 1 time in total.
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Re: Did Harry Browne consider this flaw in his strategy?

Post by gaston » Sat Dec 12, 2015 10:51 am

Thank you for the helpful replies. I agree with you ochotona and your combination of 7 year bonds and cash looks good to me. Desert, I like having 25% real cash separate from the bond allocation.
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Re: Did Harry Browne consider this flaw in his strategy?

Post by dualstow » Sat Dec 12, 2015 10:59 am

Are you just starting out, gaston? I can certainly see one's hesitation in plunging into long bonds from scratch this year, compared with merely holding what I already have. I can't help it but it colors my whole view on treasuries (just as holding 100% in equities colored my view on equities.  ;) )

ADDED: still, I don't know if replacing long bonds is erring on the side of safety, or just erring. The whole pp is about safety. It's not like anyone's going into *all* long bonds.
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Re: Did Harry Browne consider this flaw in his strategy?

Post by ochotona » Sat Dec 12, 2015 11:24 am

If you make a US Treasury bill / bond ladder, with 2, 3, 4, 5, 6, 7, 8, 9, 10, 11, 12, 13, and 14 year maturities, then as your bonds mature every year, buy new 30 year bonds with the proceeds. Eventually, you'll be in long bonds. Something will change over the next 14 years on the long end of the yield curve... that's guaranteed!

The MachineGhost and I both don't like how the orthodox philosophy encourages people to leap into a new allocation. You should generally move deliberately when making any investment moves. I tried to jump in early this year, and got shocked out :'( by the dual plunge in Long Treasuries and gold. I am making my way back in slowly. I am slowly bolting directly-held Treasuries and physical gold onto stocks I already own. I have the cash already.

Likewise, I would also strongly encourage you, if you don't own stocks already, set up a buying program stretching out over the next 24 - 36 months. Just so you don't buy a big chuck and get shocked out.
Last edited by ochotona on Sat Dec 12, 2015 12:18 pm, edited 1 time in total.
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Re: Did Harry Browne consider this flaw in his strategy?

Post by barrett » Sat Dec 12, 2015 12:40 pm

It's good to see balanced discussions like this again on the forum.

Long bonds are a complicated beast and it's therefore ironic that they are included in Harry Browne's creation.

I think one idea that doesn't get enough attention is that people only rarely have a pure 4X25 PP. By the time most folks start to investigate this way of investing, they are already entangled in some other investments that take time to unwind. Some of those assets, like cash and savings bonds, may tilt an investor toward deflation protection. Others, like having more residential real estate (either in number or in scale) than one needs in the long term, offer some inflation protection and/or allow one to take advantage of an economy that is growing.

With other deflation buffers in place, you can either go to a lower percentage of long bonds or shorten up bond duration as Desert and ochotona advocate. One of the things that I like about the shorter duration approach is that, unless you are old and unhealthy, you can most likely ride out interest-rate spikes and get the full value of the bonds at maturity. That is in theory possible for a 30-year bond as well, but you could have a lot of money locked up in something that is only going to return a nominal 2% or 3%.

As discussed elsewhere at various times, Harry Browne lived long enough to see Japan's experience  from 1990 to 2006. Really low long bond yields were certainly on his radar but I never heard him talk about Japan in particular. Has anyone else?

Yes, rates can always go lower but the excellent point that gaston is essentially bringing up is "so what?" If bond yields going lower from here doesn't really have a strong positive impact on the whole portfolio, then a tweak seems in order.

Oh, and I am not one of the "experts."
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Re: Did Harry Browne consider this flaw in his strategy?

Post by Pet Hog » Sat Dec 12, 2015 2:50 pm

I'm no expert either, but a couple of things.

HB published that book in 1989, I believe, when yields on 30-year treasuries were >8%, so there was definitely room to double if rates decreased.  Today, it's a different story, as you have stated.

Your calculated maximum bond price increases of 64% (yield reaching 0.01%) and 30% (yield reaching 1%) are interesting because they correspond to 35 and 30% rebalancing bands, respectively.  (If bonds were initially $100 of a $400 portfolio and they went up by 64% then they would now be $164 of a $464 portfolio -- i.e., 35%; similarly, $130 of a $430 portfolio is 30%.)  So in an era where bonds can't double in value, it seems appropriate to use narrower rebalancing bands.
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Re: Did Harry Browne consider this flaw in his strategy?

Post by barrett » Sat Dec 12, 2015 3:22 pm

Pet Hog wrote: Your calculated maximum bond price increases of 64% (yield reaching 0.01%) and 30% (yield reaching 1%) are interesting because they correspond to 35 and 30% rebalancing bands, respectively.  (If bonds were initially $100 of a $400 portfolio and they went up by 64% then they would now be $164 of a $464 portfolio -- i.e., 35%; similarly, $130 of a $430 portfolio is 30%.)  So in an era where bonds can't double in value, it seems appropriate to use narrower rebalancing bands.
Agreed that narrower bands are a good idea in a low-yield environment. 2014 was a good example as bonds had a great year but not nearly strong enough to break through to 35%. Incidentally, I would extend this thinking to stocks as well... that with dividend yields so low, it's unlikely that stocks would soar to 35%. Of course in both scenarios I am assuming that another asset is not falling at the same time.
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Re: Did Harry Browne consider this flaw in his strategy?

Post by Reub » Sat Dec 12, 2015 4:27 pm

gaston wrote: Thank you for the helpful replies. I agree with you ochotona and your combination of 7 year bonds and cash looks good to me. Desert, I like having 25% real cash separate from the bond allocation.
gaston ignore that advice. invest in the PP properly or dont invest in it. you need all of the asset classes to reach the proper balance.
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Re: Did Harry Browne consider this flaw in his strategy?

Post by ochotona » Sat Dec 12, 2015 4:49 pm

Reub wrote:
gaston wrote: Thank you for the helpful replies. I agree with you ochotona and your combination of 7 year bonds and cash looks good to me. Desert, I like having 25% real cash separate from the bond allocation.
gaston ignore that advice. invest in the PP properly or dont invest in it. you need all of the asset classes to reach the proper balance.
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Re: Did Harry Browne consider this flaw in his strategy?

Post by gaston » Sat Dec 12, 2015 5:47 pm

Your insights are all helpful.

There seems to be 2 camps on this forum, those who think it's best to apply the portfolio to the letter and those who try to apply some critical thinking.

HB's investment principles are genius and his writings are far above the rest, however I think believing that the asset allocation he left us with should not change one iota until the end of time is being unrealistic. Circumstances change. Since he is not here to tell us what to do, we have to think for ourselves and incorporate those principles according to one's context.

Anyway in the end everyone has to decide for him/herself (rule #8, 'make your own decisions'  ;D)
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Re: Did Harry Browne consider this flaw in his strategy?

Post by ochotona » Sat Dec 12, 2015 5:59 pm

gaston wrote: Anyway in the end everyone has to decide for him/herself (rule #8, 'make your own decisions'  ;D)
:)
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Re: Did Harry Browne consider this flaw in his strategy?

Post by dualstow » Sat Dec 12, 2015 7:20 pm

Fair enough, gaston, but it's not like those who adhere to the pp don't also apply critical thinking to reach that conclusion (adhere) in the first place. There's always the variable portfolio. We're not like that M-O-O-N guy in 'The Stand', refusing to smash a store window to get a bicycle even after the world has gone to pot.

I have a vp, but if I ever needed to tinker with the pp, I'd probably scrap it altogether.
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Re: Did Harry Browne consider this flaw in his strategy?

Post by Alanw » Sat Dec 12, 2015 7:31 pm

After reading "Fail Safe Investing" as well as many other financial books, I came to the conclusion that the HBPP is an excellent investment portfolio to use especially for someone in or near retirement such as myself. I also believe that you should keep the portfolio at 4 X 25. However, I do not believe that you need or should have 100% of your investments in one investment philosophy. Using a pure HBPP as one portfolio and a boggleheadish portfolio as a VP can change your bond duration as well as the percentage of stocks and gold you hold in your total portfolio. Your cash allocation can also be increased to change these percentages and risk tolerance. I have mentioned on this forum several times in the past that I use a pure HBPP in combination with VWINX and cash. This gives me a fairly conservative portfolio that is very easy to manage. And don't forget that HB and Jack Bogle both agree on simplicity and staying the course. Even with the sub par performance of the HBPP the past several years, I find the total value of my portfolio unchanged even after taking several withdrawals. With low inflation, this suites me just fine. By the way, I use 30/20 rebalancing bands with the HBPP.
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Re: Did Harry Browne consider this flaw in his strategy?

Post by buddtholomew » Sat Dec 12, 2015 7:54 pm

Alanw wrote: After reading "Fail Safe Investing" as well as many other financial books, I came to the conclusion that the HBPP is an excellent investment portfolio to use especially for someone in or near retirement such as myself. I also believe that you should keep the portfolio at 4 X 25. However, I do not believe that you need or should have 100% of your investments in one investment philosophy. Using a pure HBPP as one portfolio and a boggleheadish portfolio as a VP can change your bond duration as well as the percentage of stocks and gold you hold in your total portfolio. Your cash allocation can also be increased to change these percentages and risk tolerance. I have mentioned on this forum several times in the past that I use a pure HBPP in combination with VWINX and cash. This gives me a fairly conservative portfolio that is very easy to manage. And don't forget that HB and Jack Bogle both agree on simplicity and staying the course. Even with the sub par performance of the HBPP the past several years, I find the total value of my portfolio unchanged even after taking several withdrawals. With low inflation, this suites me just fine. By the way, I use 30/20 rebalancing bands with the HBPP.
+1. OP, what portfolio allocation would you feel comfortable holding 10 minutes before the Wednesday FED announcement? The HBPP 4x25 allocation feels like a good place to start. Also, when looking at bond duration always consider the cash allocation of the portfolio in your calculations. I manage to 5.6 years and hold as much Cash as I have invested in LTT's and Gold combined.
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Re: Did Harry Browne consider this flaw in his strategy?

Post by ochotona » Sat Dec 12, 2015 8:32 pm

Alanw wrote: I have mentioned on this forum several times in the past that I use a pure HBPP in combination with VWINX and cash. This gives me a fairly conservative portfolio that is very easy to manage. And don't forget that HB and Jack Bogle both agree on simplicity and staying the course. Even with the sub par performance of the HBPP the past several years, I find the total value of my portfolio unchanged even after taking several withdrawals. With low inflation, this suites me just fine. By the way, I use 30/20 rebalancing bands with the HBPP.
+1
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Re: Did Harry Browne consider this flaw in his strategy?

Post by Cortopassi » Sun Dec 13, 2015 10:19 am

buddtholomew wrote: what portfolio allocation would you feel comfortable holding 10 minutes before the Wednesday FED announcement? The HBPP 4x25 allocation feels like a good place to start.
I think this comment deserves a thread all its own from now until Wed.  It is a very interesting question since the world revolves around the Fed for the past many years.
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Re: Did Harry Browne consider this flaw in his strategy?

Post by KevinW » Sun Dec 13, 2015 1:54 pm

My $.02, keep it simple, use a plain-vanilla 4x25 PP, and direct your energies toward things other than optimizing your investments.

For typical working- and middle-class households with portfolios below the multi-million mark, spending time and energy improving investment returns is less effective than is coming up with more capital to invest. Find ways to advance your career, start a side business, or cut expenses.

And, keep in mind that it's not at all clear that improving an all-weather passive portfolio is even possible. So far all the proposed changes I've seen are effectively re-allocations that tilt the portfolio toward one economic condition or another. For example PRPFX is notoriously tilted toward inflation. Unsurprisingly, it outperformed 4x25 during inflation and underperformed in other conditions. As I write this, there is a feeling that rising rates are coming soon, so there are calls to tilt the portfolio toward rising rates. That's fine, but keep in mind that a rising-rate-tilted portfolio will inevitably underperform in non-rising-rate environments. That's a fair tradeoff so there's nothing wrong with making it. But again, IMO, these tactical analyses are not the best use of time.
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Re: Did Harry Browne consider this flaw in his strategy?

Post by Reub » Sun Dec 13, 2015 2:11 pm

Great ideas, KevinW! As a matter of thought I wouldn't be surprised if long term rates went down in response to the Fed raising short term rates. It sure seems that we are reaching a crossroads with a possible shift in Fed policy and the new year beginning shortly with a bull stock market that is 7 years old. But what's next? Nobody knows.
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Re: Did Harry Browne consider this flaw in his strategy?

Post by sophie » Sun Dec 13, 2015 2:39 pm

Great comments, Kevin and Reub.

For most people, endlessly trying to optimize investment strategies based on predictions of the future of market will only get them in trouble.  The constant tinkering with portfolios that will most likely result, and the attendant losses thereof, is one reason.  The other is that predictions are notorious for being wrong.  It's perfectly possible that the Fed decision on Wednesday will have almost no immediate effect on long term bonds.

That's the biggest trouble with the forum:  there's just not a lot about the Permanent Portfolio that needs to be said, after all the discussions of the past several years.  It's mainly about the political and "other" discussions, which frankly are one of the best faux news & commentary channels you could possibly find.
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Re: Did Harry Browne consider this flaw in his strategy?

Post by lordmetroid » Sun Dec 13, 2015 2:39 pm

The chinese seems to be buying a lot of bitcoins. Have Bitcoins surpassed Gold as a safe haven now and Gold should be replaced by Bitcoin? Perhaps it would be smart to have both Bitcoin and Gold.
However, I kind of like the butterfly concept but find 40% of obligations to be quite a lot excessive. Perhaps Cash is superfluous and one can use a butterfly with Bitcoin instead:
  • 1/5 Index fund
  • 1/5 Best recently performing sector fund
  • 1/5 Gold
  • 1/5 Bitcoin
  • 1/5 Bonds
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Re: Did Harry Browne consider this flaw in his strategy?

Post by buddtholomew » Sun Dec 13, 2015 7:07 pm

lordmetroid wrote: The chinese seems to be buying a lot of bitcoins. Have Bitcoins surpassed Gold as a safe haven now and Gold should be replaced by Bitcoin? Perhaps it would be smart to have both Bitcoin and Gold.
However, I kind of like the butterfly concept but find 40% of obligations to be quite a lot excessive. Perhaps Cash is superfluous and one can use a butterfly with Bitcoin instead:
  • 1/5 Index fund
  • 1/5 Best recently performing sector fund
  • 1/5 Gold
  • 1/5 Bitcoin
  • 1/5 Bonds
This is a lot overboard wouldn't you say? 2/5 or 40 percent of the assets should be in a VP.
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