Question for Melveyr

General Discussion on the Permanent Portfolio Strategy

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BearBones
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Question for Melveyr

Post by BearBones » Sun Feb 14, 2016 1:14 pm

melveyr wrote: I don't think the PP is a good strategy right now. The PP is only different from BH strategy because it advocates for a bond barbell and gold ownership; neither make sense to me now. Holding an intermediate term bond portfolio instead of the cash/ltt has a higher sharpe ratio and I am very confident it will continue to do so in the future. LTT treasuries act like a levered version of intermediate term bonds, so why would you want to delever that with cash that is earning 0%? The cost of implicit leverage in the LTT is higher 0%, so if you really wanted less leverage why not just use ITT? I posted about that in 2012 here

http://gyroscopicinvesting.com/forum/pe ... cal-logic/

and the intermediate term bond portfolio has continued to outperform since then (just go to ETF replay and test the sharpe ratio of 100% TLH vs the 50/50 blend of TLT and SHY).

A heavy gold weighting has really hurt the PP. I am always trying to learn more about how the monetary system works and I found that the main advocates for gold were using old models that have already been proven wrong. I am young and always trying to learn more (going for CFA level 3 this June), and it would be a shame to not incorporate new knowledge into how I make decisions. Gold ownership can still make sense, especially if you hold LTT, but the weighting in the PP is too high.
Always respected your thoughts, Ryan. Congrats on getting your CFA. Since you are no longer in favor of gold, I am curious what portfolio you would advise someone in the following 2 circumstances. Low tolerance for sustained drawdown in both scenarios.

1. Someone who is nearing retirement and has accumulated, say a million or two distributed evenly among taxable and tax deferred accounts. Age 60.
2. Someone without a lot of saving who recently entered the beginning of the most productive phase of career, say age 37.
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Re: Question for Melveyr

Post by Pointedstick » Sun Feb 14, 2016 1:18 pm

Let me add a third:

3. Someone with substantial savings preparing to retire very young following the MMM/ERE approach, with the requirement that the money sustain them another 50 years or more.
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melveyr
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Re: Question for Melveyr

Post by melveyr » Sun Feb 14, 2016 6:48 pm

My thoughts are quite mainstream and not terribly exciting! But I will try to explain it in a different way to hopefully make it interesting.

I do think that time horizon matters. I think that long term liabilities should be financed with longer term assets and shorter term liabilities should financed with shorter term assets.

I think that longer time horizons can warrant more equities for two reasons.
1) Stocks are a long duration asset because they are best thought of as a risky perpetuity. The united states doesn't offer perpetual bonds so we don't think about them often but the UK has issued them. They call them consols. With consols the bond never matures, it just pays you a fixed coupon forever. Imagine a LTT on steroids. A nice mathematical trick to calculate the duration of perpetuity is to simply invert the dividend yield. So a perpetual bond with a yield of 2% has a duration of 50. For a buy and hold investor equities are similar because the dividend payments persist indefinitely with no lump sum return of your principal. But with equities the payments are risky because they can be cut in times of stress or grow in times of prosperity.

2)Apart from the long duration element that makes it a natural pairing for a long term liability, most of us believe that capitalism produces booms that more than offset the busts given enough time. Longer term investors have the ability to ride out these storms.

Both of these put together means that all else equal, younger investors should have higher allocations to equities than older ones.

The next objective should be to gradually decrease your duration and exposure to the boom/bust cycle as you get older while still generating a decent return. Intermediate term bonds are an obvious choice because their duration of 5-7 years is much lower than equities (lowering your portfolios duration) and they are often the steepest part of the yield curve (generating a decent return). If you are DIYer I think that looking at CDs makes a lot of sense right now because you can get 100bps over treasuries without much more credit risk (and some direct CDs come with a put option which is a nice feature if rates rise).

Now, most PPers are aware that the achilles heel of a stock/bond portfolio is unexpected inflation, especially if it comes from a supply shock (like the oil crisis in the 70s). These supply shocks are usually temporary, and I think it is reasonable for younger investors to accept it and ride them out. The equities will likely do okay given enough time. As you get older and your portfolio shifts more towards bonds the risk becomes more serious, but I don't like the idea of relying solely on gold to handle this. I think the combination of a paid off home, exposure to foreign equities (protects if the inflation is only local in nature), more of your bonds in TIPS (these get a lot of flak here because they don't protect you from extreme tail risk, but I like them as PART of the solution), and if you are still nervous, yes a little bit of gold. But I wouldn't go above 10% of the portfolio and I wouldn't criticize a portfolio that totally skipped out on it.

Recommending specific portfolios for specific people makes me uncomfortable, but if someone who was 60 said they had a paid off home, and sixty percent of their liquid assets in 5 year CDs (now yielding more than a 20 year treasury!) and 40% in global equities I would say they have a great plan. If some of those bonds/CDs were in TIPS and they had a 10% allocation to gold I would also see that as a great plan.

I hope that helps, but I really think it depends so much on the person and their psychology. Different people worry about different things and I think the sleep factor is huge! I hope that answered your questions.
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Re: Question for Melveyr

Post by Desert » Sun Feb 14, 2016 7:40 pm

Melveyr,

That's a great summary, and I couldn't agree more.  When I'm asked (typically by family and friends), I recommend about 60% in CD's or intermediate treasuries, about 30 percent equities, and a 10% slice of gold.  As you've pointed out, the gold is optional.  Many don't want to mess with it, and that's fine, historically.  It mostly serves as a bit of catastrophe insurance (if held in physical form), and a random, uncorrelated slice that may help calm nerves in some situations. 

CD's represent a (small) free lunch for individual investors, relative to treasuries, so I prefer CD's in most cases. 
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Re: Question for Melveyr

Post by melveyr » Sun Feb 14, 2016 8:03 pm

Oh and regarding tax efficiency because you mentioned split between taxable/tax advantaged... Try to view your entire pool of assets as one portfolio but understand that some accounts are more suited to specific assets.

Roth: Stocks
401k: Bond funds
Traditional IRA: CDs (because 401ks don't offer them)
Taxable: Stocks / Gold

Don't let these tax strategies dictate the overall asset allocation, but once you have your allocation try to follow this as best as you can. Make withdrawals from your taxable account and adjust the others as you do it to keep your total AA in check because tax advantaged space is precious.

Desert, glad that you agree! I remember you were moving towards intermediates at well. CDs are an especially great opportunity right now because the rates haven't come down as quickly as treasury yields in the last month.
Last edited by melveyr on Sun Feb 14, 2016 8:08 pm, edited 1 time in total.
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Re: Question for Melveyr

Post by Austen Heller » Sun Feb 14, 2016 8:42 pm

Desert wrote: I recommend about 60% in CD's or intermediate treasuries, about 30 percent equities, and a 10% slice of gold. 
I have heard this 30:60:10 suggestion from you before, and I have filed it in my brain as 'the Desert portfolio'.  But do you offer your suggestion regardless of age?  In other words, should the non-gold 90% should be allocated among stocks:bonds according to age, such as:

age - stocks:bonds:gold
20  - 70:20:10
30  - 60:30:10
40  - 50:40:10
50  - 40:50:10
60  - 30:60:10
70  - 20:70:10

This would then be in essence an 'age-in-bonds' portfolio.
melveyr wrote: CDs are an especially great opportunity right now because the rates haven't come down as quickly as treasury yields in the last month.
I know we have gone over this a few times, but I still find that CDs are no bueno compared to treasuries, up until a difference in yields of about 1%.  The CDs carry FDIC risk, state taxation, and the hassle-factor of dealing with different banks to get the best rate.  If the difference in yield is greater than 1%, then I might re-evaluate, but for now, I still favor treasuries.
Last edited by Austen Heller on Sun Feb 14, 2016 8:46 pm, edited 1 time in total.
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Re: Question for Melveyr

Post by Desert » Sun Feb 14, 2016 8:52 pm

Austen Heller wrote:
Desert wrote: I recommend about 60% in CD's or intermediate treasuries, about 30 percent equities, and a 10% slice of gold. 
I have heard this 30:60:10 suggestion from you before, and I have filed it in my brain as 'the Desert portfolio'.  But do you offer your suggestion regardless of age?  In other words, should the non-gold 90% should be allocated among stocks:bonds according to age, such as:

age - stocks:bonds:gold
20  - 70:20:10
30  - 60:30:10
40  - 50:40:10
50  - 40:50:10
60  - 30:60:10
70  - 20:70:10

This would then be in essence an 'age-in-bonds' portfolio.
Yeah, the 30/60/10 advice is general.  I'm not a big proponent of age-dependent guidelines though, because a lot of younger folks panic and sell at market bottoms even though their theoretical investing timeline is long.  But yes, I think the equity allocation could be higher than 30 percent for folks who know they can handle the risk.  I wouldn't go much over 50 percent though.  Not just because of volatility and drawdowns, but because of the possibility that equity returns will be smaller than fixed income returns over the critical timeline of that investor.  It sounds absurd, but that's what risk really is.  It isn't only draw-downs and volatility, it's watching wealth be destroyed, with no recovery (Japan-style, for example). 

But for an aggressive investor with a longer timeline, I like a 45/45/10 with some tilting to riskier equities.  I'm middle age/old, so I'll be sticking with my 30/60/10. 
Our greatest fear should not be of failure, but of succeeding at something that doesn't really matter. 
- D.L. Moody

Diversification means always having to say you're sorry.
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Re: Question for Melveyr

Post by Desert » Sun Feb 14, 2016 9:02 pm

Austen Heller wrote: I know we have gone over this a few times, but I still find that CDs are no bueno compared to treasuries, up until a difference in yields of about 1%.  The CDs carry FDIC risk, state taxation, and the hassle-factor of dealing with different banks to get the best rate.  If the difference in yield is greater than 1%, then I might re-evaluate, but for now, I still favor treasuries.
I'm not melveyr, and he'll likely reply with a better explanation. 

But for what it's worth:  5YT yield is currently 1.38%.  It's pretty easy to find a 5Y CD yielding 2.25%.  Perhaps the FDIC represents some additional risk, but my view is that it's insignificant.  Also, direct-purchased CD's offer the ability to cash out and buy a higher yielding instrument in the event of a rapid rise in interest rates.  That option isn't guaranteed, but is typically honored.  You're right about the inconvenience, but I find the effort worthwhile.  I have half my fixed income in 3% Penfed CD's now.  I'll be purchasing some 2.25 percent CD's in the near future.  If the difference was less than 50 basis points, relative to Treasuries, I might not find it worthwhile.  But with today's spread, I find the small investor free lunch (snack?) worth harvesting. 
Our greatest fear should not be of failure, but of succeeding at something that doesn't really matter. 
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Re: Question for Melveyr

Post by melveyr » Sun Feb 14, 2016 9:05 pm

The only other point I would add to that is that the state taxation of CDs is mitigated by placing them in a traditional IRA. Your taxable account should really be equity focused as long as you are managing all of your assets as one portfolio.
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Re: Question for Melveyr

Post by Desert » Sun Feb 14, 2016 9:09 pm

True.  And some states don't tax CD income, including TN. 
Our greatest fear should not be of failure, but of succeeding at something that doesn't really matter. 
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Re: Question for Melveyr

Post by Austen Heller » Sun Feb 14, 2016 9:23 pm

Thanks for the fast responses guys.  I will say that the situation has changed rather quickly.  In December, the 5-year was auctioned at 1.785%, making the decision to buy the treasury a no-brainer.  But losing about 0.5% in just over a month has altered the equation.

Ah yes, the 3% 5-yr penfed CDs, a high triumph for any investor that saddled up to ride that unicorn.  I remember those times, the 10-yr was at 3%, the 30-yr was at 4%.  I snacked lightly upon the offering, but I wish I had gorged.
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Re: Question for Melveyr

Post by ochotona » Sun Feb 14, 2016 9:44 pm

I remember getting a CD for 13%
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