Question for Melveyr

[barrett]

Hey melveyr,

You have written so eloquently (and concisely) in support of the PP on your site and I am curious what has caused you to change your mind about Harry Browne's ideas. Has something fundamentally shifted in the world, or were those just the writings of a younger version of your current self?

I think it's important to bring into this conversation that most of us on here (everyone, please correct me if I am wrong) are interested in a portfolio that is easy to maintain over a long period of time, doesn't get clobbered at any point, and can really perform when one of the big three assets is doing great.

Also, to me at least, the notion that boom cycles in the economy are longer than bust cycles strikes me as maybe not true. Historically, of course, that has been true here in the US. But we have the advantage of being able to look at Japan as an example of what can happen to a major economy as it matures. There were a lot of factors that went into 1982-1999 being great for stocks but some of them (for example, the great leap forward that computers helped bring about) may not be repeatable.

I guess I see that an economic boom, deflation or high inflation could all happen at some point in the next few years. Maybe I am just suffering from confirmation bias.

And FWIW, I fall into moda's category #1... basically gearing up for retirement with most of my earnings potential in the past. I am paraphrasing what he wrote but I think that puts me in with many on here who are either retired or at least closer to the end of their working lives than they are to the beginning.

Lastly, it's good to have you back even if you are not planning to stick around for long. Your input is greatly appreciated!

[melveyr]

Hey melveyr,

You have written so eloquently (and concisely) in support of the PP on your site and I am curious what has caused you to change your mind about Harry Browne's ideas. Has something fundamentally shifted in the world, or were those just the writings of a younger version of your current self?

I think it's important to bring into this conversation that most of us on here (everyone, please correct me if I am wrong) are interested in a portfolio that is easy to maintain over a long period of time, doesn't get clobbered at any point, and can really perform when one of the big three assets is doing great.

Also, to me at least, the notion that boom cycles in the economy are longer than bust cycles strikes me as maybe not true. Historically, of course, that has been true here in the US. But we have the advantage of being able to look at Japan as an example of what can happen to a major economy as it matures. There were a lot of factors that went into 1982-1999 being great for stocks but some of them (for example, the great leap forward that computers helped bring about) may not be repeatable.

I guess I see that an economic boom, deflation or high inflation could all happen at some point in the next few years. Maybe I am just suffering from confirmation bias.

And FWIW, I fall into moda's category #1... basically gearing up for retirement with most of my earnings potential in the past. I am paraphrasing what he wrote but I think that puts me in with many on here who are either retired or at least closer to the end of their working lives than they are to the beginning.

Lastly, it's good to have you back even if you are not planning to stick around for long. Your input is greatly appreciated!

Nothing hugely fundamental has changed. I think that Harry Browne's framework of real growth/real contraction and inflation/deflation is still relevant. Any economic event can be plotted on these two axes and changes in expectations about these factors drive the majority of asset class returns. Harry Browne was the first writer I know of to lay this out so clearly and I will always be grateful for that way of looking at things.

My only real departures are preferring bullet over barbell bond portfolios, and de-emphasizing gold's role in portfolios. I also want to make it clear that my new portfolio is more susceptible to inflation risk. The PP will outperform my portfolio if we have a big inflation, but I am accepting that as a risk that I am willing to take. Every portfolio has a weakness and you have to align that with what risks you are willing to take. The risk of the PP is that lately it has actually gone down when things look very rosy and had it's largest spikes when things get bad. It also is more correlated with gold than the other assets (true historically as well) so the 3 way split is not exactly balanced. I think that gold has the lowest theoretical underpinnings for long term returns, so I don't like that the PP is most correlated with that asset.

Most of my learnings are related to my own psychology as an investor. I am not trying to ring alarm bells about the PP. If you have been happy with it, then by all means keep going with it. I just have different risks that I am more comfortable taking than the risks that are within the PP.

[Pointedstick]

Most of my learnings are related to my own psychology as an investor. I am not trying to ring alarm bells about the PP. If you have been happy with it, then by all means keep going with it. I just have different risks that I am more comfortable taking than the risks that are within the PP.

That's really the important part, I think. Certain assets give some people fits and starts. It makes sense to tweak the asset allocations according to whatever is most compatible with your world view and the mindset with which you approach things so you don't feel vindicated and panic-sell when your least favorite asset starts to fall.

I too have started to implement a slight prosperity till to my PP, taking advantage of the recent stock decline. I'm now for 40% stocks, 20% everything else, with. I still like having a big slug of gold and in fact feel more confident about it when I'm more stock-heavy, and I like the barbell better than the bullet because the large cash reserve likewise makes me feel comfortable.

[melveyr]

Might as well ask here. Elsewhere you said, "I found that the main advocates for gold were using old models that have already been proven wrong." Can you elaborate a bit more?

Not so much here on this forum but many gold holders were betting on a big inflation coming because of charts like this:


The idea was that banks lend in direct proportion to the amount of reserves that they have, and that once things returned to normal we would have an explosion of credit and spending that would push prices up. Many people equated monetary easing and QE with "money printing" which I have found to not be accurate, at least when trying to connect it with its effect on inflation. People were buying gold based on these theories, and pushing the price up. We have seen a slow bleed in gold as holders have slowly come to recognize that their understanding of the connection between Fed policy and inflation is not as direct as they thought.

[barrett]

Thanks for clarifying, melveyr. I am way older that you and hyper aware of that Harry Browne rule that reminds us that we can't count on generating the same wealth a 2nd or 3rd time around. So, I'll accept a lower return over time and hope that the PP can reduce sequence of returns risk. I learned a lot about how low my late-career risk tolerance is last year when the PP had a drawdown of nearly 8%.

Most of my learnings are related to my own psychology as an investor. I am not trying to ring alarm bells about the PP. If you have been happy with it, then by all means keep going with it. I just have different risks that I am more comfortable taking than the risks that are within the PP.

I'm glad you made this clear. There seems to be a significant cohort on here that is really focussed on the 2nd half of the investing curve.

It's good to have you stop by and chat. You have been missed on here.

[buddtholomew]

Might as well ask here. Elsewhere you said, "I found that the main advocates for gold were using old models that have already been proven wrong." Can you elaborate a bit more?

Not so much here on this forum but many gold holders were betting on a big inflation coming because of charts like this:


The idea was that banks lend in direct proportion to the amount of reserves that they have, and that once things returned to normal we would have an explosion of credit and spending that would push prices up. Many people equated monetary easing and QE with "money printing" which I have found to not be accurate, at least when trying to connect it with its effect on inflation. People were buying gold based on these theories, and pushing the price up. We have seen a slow bleed in gold as holders have slowly come to recognize that their understanding of the connection between Fed policy and inflation is not as direct as they thought.

I don't recall HB commenting on the relationship between money supply and gold.
Gold responds to unexpected inflation is the theory not excess bank reserves stored at the FED.
The $ didn't reach those who could spend it and raise inflation.
Not sure the model is broken, perhaps misused but not broken.

[melveyr]

I don't recall HB commenting on the relationship between money supply and gold.
Gold responds to unexpected inflation is the theory not excess bank reserves stored at the FED.
The $ didn't reach those who could spend it and raise inflation.
Not sure the model is broken, perhaps misused but not broken.

I wasn't saying that the PP or Harry Browne's analysis were flawed. I was saying that people (not necessarily on this forum) had been using flawed models to justify higher gold prices. My statement about flawed models was a short/medium-term explanation on why gold has been in the dumps lately and could continue to drop as people abandon their old worldviews.

[barrett]

The idea was that banks lend in direct proportion to the amount of reserves that they have, and that once things returned to normal we would have an explosion of credit and spending that would push prices up. Many people equated monetary easing and QE with "money printing" which I have found to not be accurate, at least when trying to connect it with its effect on inflation. People were buying gold based on these theories, and pushing the price up. We have seen a slow bleed in gold as holders have slowly come to recognize that their understanding of the connection between Fed policy and inflation is not as direct as they thought.

I don't recall HB commenting on the relationship between money supply and gold.
Gold responds to unexpected inflation is the theory not excess bank reserves stored at the FED.
The $ didn't reach those who could spend it and raise inflation.
Not sure the model is broken, perhaps misused but not broken.

What he was very clear on is that he considered the USD to be the world's number one currency, and that when it came under threat that the best place to turn was number two (gold). For the most part I agree with what melveyr is saying but there is a little voice in my head (might just be Libertarian666!) saying that the inflation may still be coming.

[Libertarian666]

The idea was that banks lend in direct proportion to the amount of reserves that they have, and that once things returned to normal we would have an explosion of credit and spending that would push prices up. Many people equated monetary easing and QE with "money printing" which I have found to not be accurate, at least when trying to connect it with its effect on inflation. People were buying gold based on these theories, and pushing the price up. We have seen a slow bleed in gold as holders have slowly come to recognize that their understanding of the connection between Fed policy and inflation is not as direct as they thought.

I don't recall HB commenting on the relationship between money supply and gold.
Gold responds to unexpected inflation is the theory not excess bank reserves stored at the FED.
The $ didn't reach those who could spend it and raise inflation.
Not sure the model is broken, perhaps misused but not broken.

What he was very clear on is that he considered the USD to be the world's number one currency, and that when it came under threat that the best place to turn was number two (gold). For the most part I agree with what melveyr is saying but there is a little voice in my head (might just be Libertarian666!) saying that the inflation may still be coming.

If price inflation isn't coming, it will be the first time in history that hasn't happened after destroying the link between currency and any actual object like gold.

More money has been lost on the notion that "this time it's different" than on any other mistaken notion.

[Reub]

Ryan,  I just wanted to welcome you back and say that you've been missed!

[BearBones]

Not so much here on this forum but many gold holders were betting on a big inflation coming because of charts like this...

The idea was that banks lend in direct proportion to the amount of reserves that they have, and that once things returned to normal we would have an explosion of credit and spending that would push prices up. Many people equated monetary easing and QE with "money printing" which I have found to not be accurate, at least when trying to connect it with its effect on inflation. People were buying gold based on these theories, and pushing the price up. We have seen a slow bleed in gold as holders have slowly come to recognize that their understanding of the connection between Fed policy and inflation is not as direct as they thought.

Thanks for clarifying. So it's not as much that gold may not be useful in inflation, but rather our ability to predict inflation is flawed. And the PP is too weighted toward gold for your tastes. I get that.

Yes, I vaguely remember the discussion several years back in which some, like MT, argued that all the "money printing" in the world (QE) would not necessarily translate into inflation if the macroeconomic fundamentals were not in place to cause the money to go into circulation. Seems that they were right. So far at least.

One more question:
So it seems that you have shifted from gold to TIPs for an inflation hedge. Do you think that is better than just a smaller allocation to gold? If so, can you elaborate?

[melveyr]

One more question:
So it seems that you have shifted from gold to TIPs for an inflation hedge. Do you think that is better than just a smaller allocation to gold? If so, can you elaborate?

If I wanted to inflation proof a retirement plan that was about to enter the withdrawal phase the first step would be home ownership, then having the majority of fixed income in TIPs, then making some of the equity exposure international, and then if I was still worried a small allocation to gold. Gold is still the only tool for hedging the extreme inflation risks, but I think it should be used after exhausting the other options.

Please keep in mind that I am personally more comfortable having a portfolio that consists of traditional asset classes, so that makes my portfolio more susceptible to the extreme inflation tail risks. A gold heavy portfolio is likely to be the best portfolio in an extreme inflation. I just don't like having a large amount of capital tied up in something that is such a small part of the global portfolio. The gold market is around $6 trillion in size whereas the size of the global equity and bond markets is closer to $300 trillion.

I am really not trying to give advice. Please just interpret this as what I am doing, not what you should. Every portfolio that generates decent returns takes risks and you have to make sure that it is aligned with your psychology. The PP is not aligned with mine so I stopped using it.

[melveyr]

Well, as I said before I am certainly not ringing the alarm bell on the portfolio. The performance since starting the blog has been decent considering the risk level. The sharpe ratio has beaten the vanguard 60/40 Balanced fund (VBINX). I just want to go with a more traditional approach with my assets going forward because I don't like the tracking error that the PP has with traditional portfolios. I always found myself comparing it with the BH approaches and it bothered me when it would underperform. This is a psychological thing. I also like that running a three fund portfolio makes managing my 401k very easy because no matter what company I switch to they are 90% likely to have funds that will work for me.

I still find the PP to be a very interesting portfolio and understanding how it works has given me a macro toolkit that I never would have had without it. The charts on my site will continue to update and I look forward to tracking its performance for many years.

[buddtholomew]

As Melveyr said, there are positives and negatives to every portfolio, so why choose?
I have chosen to adopt both a BH + PP portfolio to avoid future regret and allocated retirement (20-30 years) and taxable (short to intermediate term) investments accordingly.
There have been few surprises along the way, except one.
I too noticed that the PP lagged in times of prosperity.
To resolve this dilemma, I decided to raise the stock allocation in retirement accounts.
I dare not touch the PP allocations as the portfolio performs as advertised during the difficult times.

[Fred]

I am really not trying to give advice. Please just interpret this as what I am doing, not what you should. Every portfolio that generates decent returns takes risks and you have to make sure that it is aligned with your psychology. The PP is not aligned with mine so I stopped using it.

The problem is, as was debated a while back: What would make one abandon the PP? Consensus was, IIRC, that if Craig or MT gave up on it, then it was toast. I would put you in that class as well, what with a personal website/blog devoted to the PP and all of the mathematical reasons why it is so great.

We should all be grateful that at least Mr. Melvey isn't doing a Mathjak on us.

[ochotona]

Mel, I'm just curious, what is your approximate age and years left until your retirement target date?

[melveyr]

I am 24 with no retirement date in mind. But I still save pretty aggressively (max out 401k, Roth, HSA, just starting to do taxable). If my health permitted and I could see myself working late into my life but using the portfolio's supplemental income to "go baller".

I am literally just doing a vanilla three fund portfolio with age in bonds/CDs. It's not very exciting or exotic, but it works for me. Ironically the more I studied CFA the more evidence I found pointing me back to Taylor Larimore's simple portfolio.

[ochotona]

Oh well, the PP is way too tame for you at 24, you're doing the right thing. I am 55, I have about 10 more years to accumulate data on the SWR of the PP before I have to commit to some kind of allocation for my distribution phase. I would like to find a high SWR portfolio that is lazy. It is very interesting to me that SWR and CAGR don't always coincide.

[stuper1]

Melveyr,

Good to hear from you again.  The way I look at the gold allocation in the PP is that about half of the allocation makes sense in terms of providing a nice, non-correlated asset that can help to counterbalance the portfolio, and provide some rebalancing opportunities, when both stocks/bonds are going down.  The other half of the gold allocation I see as providing financial insurance against major catastrophes (black swan events) that are pretty unlikely, but not impossible.  Things like major solar flares that could knock out the electrical grid for months and stuff like that, along with currency collapse or really bad inflation.  Of course, for this insurance to be reliable, I need to hold the gold as physical gold and not as shares of an ETF.  To have this insurance, I have to be ready to give up some CAGR on my investments, but to me it's worth it.  I don't want all of my assets to just be a bunch of binary data on a computer server located thousands of miles away from me.

[Matthew19]

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.

I'm just now starting to fund my IRA's after neglecting them for years. I have a solo 401k set up for my business (roth option through vanguard, expenses are high though) and some personal Roth IRAs. how big of a difference is it to just do a 4x25 portfolio for each account? It would be much more simple for me, and it seems like I've read that on the boards before.

[sophie]

The risk of the PP is that lately it has actually gone down when things look very rosy and had it's largest spikes when things get bad. It also is more correlated with gold than the other assets (true historically as well) so the 3 way split is not exactly balanced. I think that gold has the lowest theoretical underpinnings for long term returns, so I don't like that the PP is most correlated with that asset.

Whew, so we're not missing anything fundamental then.  I thought there was something more to it when you were talking about "old models".  These are concerns that many have voiced.  If I may restate them:

1. The PP's tracking error with respect to the stock market or a conventional portfolio (especially in the past few years)
2. Having 25% of your capital in gold is distinctly uncomfortable, and it probably is the case that it is overweighted in the PP.

Regarding the tracking error:  reactions to this are personal.  I decided that the tracking error is a small price to pay for more even returns, and indeed those two features are flip sides of the same coin.  Since I want the even returns, I have to be OK with tracking error.

I also suspect that part of the gold bubble in the years after 2008 had nothing to do with the PP's fundamentals - it was large-scale gold purchases in China and India fueled by their economic expansion.  That led to temporarily outsized gains in the PP, and it was inevitable that those gains would reverse.  It's unfortunate that many here bought into the PP at the height of that gold bubble.

I do agree that the PP is slightly overweighted in gold.  One day I may decide to limit the PP to 15% or 20% gold, but I wouldn't go lower than that, and I also wouldn't do this until retirement.  If you check out Tyler's charts, you'll see that 10% gold isn't enough to carry you through a 1970's stagflation era.  I suspect that Harry Browne knew this, but kept gold at 25% for several reasons.  First, simplicity, in an era where most financial work was done with pencil and paper.  Second, physical gold is an awesome bit of asset insurance, simply because it's held outside the financial system.  This is perhaps more attractive to me than it might be to many of you, because as a physician I am way more exposed to personal financial risk.  Finally, gold's volatility makes for some great opportunities to capture benefits from rebalancing.

I hope the above is a helpful summary.  Ryan, if there's anything I missed please comment!

[Libertarian666]

The risk of the PP is that lately it has actually gone down when things look very rosy and had it's largest spikes when things get bad. It also is more correlated with gold than the other assets (true historically as well) so the 3 way split is not exactly balanced. I think that gold has the lowest theoretical underpinnings for long term returns, so I don't like that the PP is most correlated with that asset.

Whew, so we're not missing anything fundamental then.  I thought there was something more to it when you were talking about "old models".  These are concerns that many have voiced.  If I may restate them:

1. The PP's tracking error with respect to the stock market or a conventional portfolio (especially in the past few years)
2. Having 25% of your capital in gold is distinctly uncomfortable, and it probably is the case that it is overweighted in the PP.

Regarding the tracking error:  reactions to this are personal.  I decided that the tracking error is a small price to pay for more even returns, and indeed those two features are flip sides of the same coin.  Since I want the even returns, I have to be OK with tracking error.

I also suspect that part of the gold bubble in the years after 2008 had nothing to do with the PP's fundamentals - it was large-scale gold purchases in China and India fueled by their economic expansion.  That led to temporarily outsized gains in the PP, and it was inevitable that those gains would reverse.  It's unfortunate that many here bought into the PP at the height of that gold bubble.

I do agree that the PP is slightly overweighted in gold.  One day I may decide to limit the PP to 15% or 20% gold, but I wouldn't go lower than that, and I also wouldn't do this until retirement.  If you check out Tyler's charts, you'll see that 10% gold isn't enough to carry you through a 1970's stagflation era.  I suspect that Harry Browne knew this, but kept gold at 25% for several reasons.  First, simplicity, in an era where most financial work was done with pencil and paper.  Second, physical gold is an awesome bit of asset insurance, simply because it's held outside the financial system.  This is perhaps more attractive to me than it might be to many of you, because as a physician I am way more exposed to personal financial risk.  Finally, gold's volatility makes for some great opportunities to capture benefits from rebalancing.

I hope the above is a helpful summary.  Ryan, if there's anything I missed please comment!

I thought you were an academic, not a physician who treats patients, which should reduce your personal financial risk to relatively normal levels. Did I get that wrong?

But if I were in an occupation that exposed me to such risks as practicing physicians do face, I would make sure that all my significant assets were in something that creditors couldn't attach, like an LLC. Have you considered that?

Note: not a lawyer or financial professional, do your own diligence, etc.

[BearBones]

I hope the above is a helpful summary.  Ryan, if there's anything I missed please comment!

Very nice summary, Sophie. Thanks!

Yes, I think that many of us bought into the PP when gold was hot. Many are disillusioned by "tracking error" (i.e., doubt, jealousy) and have turned toward equities again. Perhaps at the wrong time? I'm even more bullish on bonds. Probably means that I should be in cash...

If I were in Ryan's shoes I'd not be 25% gold. I might have a PP bucket, but I'd have a more conventional VP. The goal of the PP is primarily wealth protection, IMO. And if one is tin he wealth accumulation phase, one might want to be more aggressive. Less likely to get burned if one is dollar cost averaging over decades. Different issue if one is trying to protect a life's savings.

[BearBones]

I'm just now starting to fund my IRA's after neglecting them for years. I have a solo 401k set up for my business (roth option through vanguard, expenses are high though) and some personal Roth IRAs. how big of a difference is it to just do a 4x25 portfolio for each account? It would be much more simple for me, and it seems like I've read that on the boards before.

I went through this a few years ago and did something like that. Too much of a hassle otherwise. Problem is that, although nice in theory to put all the LTTs in tax deferred and all of gold in taxable, you are eventually going to have one account needing to be bought or sold to rebalance, and you can't. So I like having a PP somewhat evenly divided.

Here is what I did:
Taxable: 20/20/20/40 with 40% cash
Tax deferred 30/30/30/10 with 10% cash

I like having cash easily accessible for emergency. I wont be as happy about this distribution when/if cash is ever earning high %, since I will then wish more was in tax deferred.

I keep a taxable PP about equal to my tax deferred savings. Any excess I call my VP, and I do stupid things with it like invest in energy ETFs when oil >$100/barrel 

[barrett]

Please keep in mind that I am personally more comfortable having a portfolio that consists of traditional asset classes, so that makes my portfolio more susceptible to the extreme inflation tail risks. A gold heavy portfolio is likely to be the best portfolio in an extreme inflation. I just don't like having a large amount of capital tied up in something that is such a small part of the global portfolio. The gold market is around $6 trillion in size whereas the size of the global equity and bond markets is closer to $300 trillion.

I am really not trying to give advice. Please just interpret this as what I am doing, not what you should. Every portfolio that generates decent returns takes risks and you have to make sure that it is aligned with your psychology. The PP is not aligned with mine so I stopped using it.

Hey Ryan,

OK, so the gold market is relatively small compared to bond and equity markets. Why does that matter? Couldn't an argument be made that if investors really started to move into gold, there is potential for a big upside move based on the respective sizes of these markets?