Scott Burns' Co on the PP

[Reub]

The article seems to be entirely about a single 30-year period. This guy badly needs to visit Tyler's site.

The stagflationary 70's didn't happen for everyone. Essentially, the Baby Boomers have been driving the market consistently upwards into Overvaluation Nirvana since 401K funds became practical in 1989. The problem is the normal investing horizon is far too short to prioritize tank-like safety ala the PP to reach investment goals, unless you're already got a high paying job that makes saving have more than a marginal future impact or you already have a lot of financial assets.

As a Gen Xer, I'm very acutely aware of the irreparable damage that the absolutely spoiled Baby Boomers have done and continue to do to the U.S. economy and political system. Their greedy gains over the past 27 years is my permanent loss of capital risk. It's a very dangerous time right now as we zoom closer and closer to The Great Unwinding.

I really don't know what is going to happen to the "all weather" concept, but when you have 50% of the portfolio returning cash-like returns but with orders of a magnitude more risk, it doesn't really make rational sense to be in anything other than cash and gold. Short term gains are irrelevant because its how much you ultimately keep and not make in the interim while everyone is still partying it up. Recall, the PP had a -25% maximum drawdown in 1981 on "Fight Inflation" ballyhoo and the situation is now far beyond that in terms of destructive potential.

Did I just talk myself out of the PP again? I guess the real problem at this point is there's just not enough assets to invest in that are priced to deliver long-term returns to justify taking the risk. It's very frustrating.

You're a GenXer? I thought you were at least 75!

[Kbg]

I'm not sure it's really fair to compare the returns of a 60/40 portfolio (without cash) to the PP when cash is yielding around zero. Has anyone run numbers on a 33.3/33.3/33.3 PP without cash (maybe there is an existing thread on this forum about this)? I'm also curious about what the optimal re-balancing bands would be for that.

From 2005 to yesterday using ETFs...9.63 CAGR/-19.47 Max DD

Thanks! Where did you get that figure? How does it compare to a regular PP with cash? What re-balance rules did you use? I'd be interested to see it going all the way back to 1972. It can be done with peaktrough, but re-balancing options are limited. Perhaps 43/23 or 40/20 would work well?

The rebalance is HB's annual recommendation vice bands. I used Amibroker and Norgate data for the backtest with TLT, SPY and GLD as the ETFs.

Regular 4x25 adding SHY is 7.77/-13.98

[dualstow]

Written by Burn's colleague Andrew Hallam, the article give kudos to Craigr and MT [although refers to Craig as Greg]
...

Yeah, good ol' Greg Rowland...

I miss visiting that site, Gerlwng Road.

...
As a Gen Xer, I'm very acutely aware of the irreparable damage that the absolutely spoiled Baby Boomers have done...

You're a GenXer? I thought you were at least 75!

I thought I had him pegged at 60.

[sophie]

The comparison of the 60/40 returns to the 25x4 PP indeed isn't fair, because the owner of the 60/40 needs to hold cash. How much isn't clear, but most would recommend a sizeable enough chunk that it's a significant fraction of the stock/bond portfolio. Similarly, the 60/40 owner has to decide when to liquidate volatile assets during the drawdown phase.

Let's assume that our hypothetical Boglehead retiree holds 5 years expenses in cash, which is a common recommendation, and 20 years expenses in the 60/40 investment, as opposed to our hypothetical PP owner who simply holds 25 years expenses in the 25x4 PP. The actual Boglehead portfolio, then, is 20% cash, 48% stocks, and 32% bonds.

Using an extremely oversimplified but time-saving method of calculating returns, i.e. the ETFreplay with no rebalancing (sorry guys), here's the returns comparison from 1/3/2007 to today:

Boglehead 20/48/32: total return 63.1%, volatility 9.0%
PP 25x4: total return 82.5%, volatility 8.4%

Admittedly a time horizon that works especially well for the PP, but you get the picture. The lack of rebalancing actually stacks the deck in favor of the 60/40, since the PP benefits more than stock/bond portfolios from rebalancing.

Between overall performance and the cash management aspect, I can't find much to like about the 60/40.

P.S. MG I also would never have guessed you were under 40.

[flyingpylon]

MG I also would never have guessed you were under 40.

Gen X birth years start in the early to mid '1960s, so he might not be under 40.

[Reub]

Then Methusala must be a GenXer too.

[iwealth]

The comparison of the 60/40 returns to the 25x4 PP indeed isn't fair, because the owner of the 60/40 needs to hold cash. How much isn't clear, but most would recommend a sizeable enough chunk that it's a significant fraction of the stock/bond portfolio. Similarly, the 60/40 owner has to decide when to liquidate volatile assets during the drawdown phase.

Let's assume that our hypothetical Boglehead retiree holds 5 years expenses in cash, which is a common recommendation, and 20 years expenses in the 60/40 investment, as opposed to our hypothetical PP owner who simply holds 25 years expenses in the 25x4 PP. The actual Boglehead portfolio, then, is 20% cash, 48% stocks, and 32% bonds.

If this Boglehead were smart, instead of holding 20% cash and 32% intermediate bonds which entirely changes the risk/return profile of the intended 60/40, they'd hold 20% long bonds and 20% cash. This achieves the risk/return of the 60/40 while holding 5 years of cash. This compares much more favorably with the PP over the time period you tested. There's still a good dinging in 2008, but that was never in dispute.

We can't forget that that the risk/return profile of the PP is nearly identical to that of a 25% stocks, 25% gold, 50% intermediate treasury portfolio. The PP just gets creative and splits the bond holdings into long bonds and cash. This provides some additional benefits without messing with the intended result.

[Dieter]

MG I also would never have guessed you were under 40.

Gen X birth years start in the early to mid '1960s, so he might not be under 40.

And/or 30ish using base 16....

(yes, Computer major, GenX)

[MachineGhost]

MG,

I have one small quibble on your DD stats for 1981...the hellaciously good returns the two years before. What was the max intraday DD not counting 1981?

1980 is when the big damage was done, so 1968 to 1979 was 11.42% CAGR and -13.78% MaxDD. Good returns is relative because after high inflation it was more or less the same real return as now. The PP is a frustratingly turgid non-growth portfolio with occasional hurricanes that takes a big chunk of flesh.

[MachineGhost]

Well, since you're not greedy for gains like we were everything should be all right then.

Quite the contrary, but y'all priced me out of the market. I've had to resort to desperate measures!

[MachineGhost]

You're a GenXer? I thought you were at least 75!

I am very wise beyond my years.

[MachineGhost]

The comparison of the 60/40 returns to the 25x4 PP indeed isn't fair, because the owner of the 60/40 needs to hold cash. How much isn't clear, but most would recommend a sizeable enough chunk that it's a significant fraction of the stock/bond portfolio. Similarly, the 60/40 owner has to decide when to liquidate volatile assets during the drawdown phase.

So, because a 60% stock, 30% bonds and 10% cash portfolio is currently priced to deliver less than 2% nominal returns over the next 10-12 years, that means the PP is now relying on gold to drive any further growth from this point on. Hence, why I'm having trouble pulling the trigger on unhedged overvalued equity and 5000-year lows in bond yields.

How do we know these distorted assets will continue to work in their expected fashion during such historically unprecedented circumstances? I would like to be fully invested in the PP by the end of the year, but frankly, we're purely speculating on the USA to be the last harbor in the storm. What happens when that harbor too goes bellyup? I don't want to suffer like iceland or Argentina and lose 75% of my wealth and still wind up with a loss if only because there's not enough gold to offset the other three assets imploding.

Grrr, you Baby Boomers have had it all too easy!

[Reub]

Go to your room young whippersnapper!

[sophie]

The comparison of the 60/40 returns to the 25x4 PP indeed isn't fair, because the owner of the 60/40 needs to hold cash. How much isn't clear, but most would recommend a sizeable enough chunk that it's a significant fraction of the stock/bond portfolio. Similarly, the 60/40 owner has to decide when to liquidate volatile assets during the drawdown phase.

Let's assume that our hypothetical Boglehead retiree holds 5 years expenses in cash, which is a common recommendation, and 20 years expenses in the 60/40 investment, as opposed to our hypothetical PP owner who simply holds 25 years expenses in the 25x4 PP. The actual Boglehead portfolio, then, is 20% cash, 48% stocks, and 32% bonds.

If this Boglehead were smart, instead of holding 20% cash and 32% intermediate bonds which entirely changes the risk/return profile of the intended 60/40, they'd hold 20% long bonds and 20% cash. This achieves the risk/return of the 60/40 while holding 5 years of cash.

That's part of the issue with the 60/40: the bond allocation is an "index" containing a mix of Treasuries and corporate bonds plus things like mortgage-backed securities, junk bonds, and other mystery items. Total bond funds like Vanguard's are great, but they only serve to dilute volatility somewhat - unlike Treasuries, they don't provide negative correlation with stocks. Frankly I never really understood the point of a bond "index", when what you want out of it is safety.

A more interesting way to do a 60/40 is exactly what you suggested, or using intermediate Treasuries as in the Desert Portfolio. Oddly enough, this difference between Treasuries and other types of bonds isn't recognized over at that other investing forum. We learned that from Grandpa Harry.

[MachineGhost]

Go to your room young whippersnapper!

Oh yeah? You and what army???

[MachineGhost]

That's part of the issue with the 60/40: the bond allocation is an "index" containing a mix of Treasuries and corporate bonds plus things like mortgage-backed securities, junk bonds, and other mystery items. Total bond funds like Vanguard's are great, but they only serve to dilute volatility somewhat - unlike Treasuries, they don't provide negative correlation with stocks. Frankly I never really understood the point of a bond "index", when what you want out of it is safety.

It's more the low-moderate duration than anything else. Treasuries are also the majority allocation. Not my first fund choice for safety, but it manages to work. If I was going to throw in some Grade A corporate bonds to mitigate soveriegn risk, I would pick a much purer fund though than a total market. Surprisingly, there's a real dearth of funds like that. The one PS mentioned from Vanguard is far from ideal but its as relatively clean as you can get. I also dig Reub's Wellesly also but its 66% bonds/33% stocks so it dilutes your greed. But the bonds are of higher quality than PS's off the top of my head.

When the gooroos say a 50/50 allocation will survive the worst case 4% SWR historically, they are definitely not talking about 30-year Treasuries.

EDIT: Just came across this...

We used a simple benchmark for our analysis: a balanced ETF model portfolio of 60% stocks (NYSEARCA:VTI) and 40% bonds (NYSEARCA:BND). This is #39, indicated by the green arrow on Figure 2, below. This 60-40 balanced allocation performs better than many of the 65 allocations, but is still outpaced by 9 tactical portfolios with dynamic allocations and 3 strategic portfolios with fixed allocations. The yellow-bordered region in Figure 2 contains these portfolios with lower risk and higher return. These include Templeton Global (#56, GIM), a Harry Browne-inspired ETF portfolio (#42) and Vanguard Wellesley (#31, VWINX), all indicated with orange arrows.



http://seekingalpha.com/article/1970041 ... m-drawdown

[KevinW]

The comparison of the 60/40 returns to the 25x4 PP indeed isn't fair, because the owner of the 60/40 needs to hold cash. How much isn't clear, but most would recommend a sizeable enough chunk that it's a significant fraction of the stock/bond portfolio.

Hear, hear.

The time spent accumulating the cash emergency fund needs to be account for too. The prototypical Boglehead advice is to first save about 1 years' expenses in cash, then start investing. If you consider the case of a young professional starting out broke with no debt and a 20% savings rate, they'll spend 4 whole years investing in 100% cash. In the fifth year they'll be roughly 80% cash and 20% in an "age in bonds" portfolio. So if this scenario started at age 22, at age 27 they are 80% cash, 5% bonds, 15% stocks. This is a very low-return portfolio, which really ought to be factored into lifetime returns and "the power of compound interest."

Honestly, I think financial authors and pundits are so accustomed to giving advice to people that have already accumulated some wealth, that they completely overlook checking whether their advice actually works for people starting from scratch.

[dualstow]

I like to keep an eye on overall pp gains without the cash component. Just one cell on the spreadsheet.

You're a GenXer? I thought you were at least 75!

I am very wise beyond my years.

Wise-ass beyond your years, you mean.

[Dieter]

The comparison of the 60/40 returns to the 25x4 PP indeed isn't fair, because the owner of the 60/40 needs to hold cash. How much isn't clear, but most would recommend a sizeable enough chunk that it's a significant fraction of the stock/bond portfolio. Similarly, the 60/40 owner has to decide when to liquidate volatile assets during the drawdown phase.

Let's assume that our hypothetical Boglehead retiree holds 5 years expenses in cash, which is a common recommendation, and 20 years expenses in the 60/40 investment, as opposed to our hypothetical PP owner who simply holds 25 years expenses in the 25x4 PP. The actual Boglehead portfolio, then, is 20% cash, 48% stocks, and 32% bonds.

If this Boglehead were smart, instead of holding 20% cash and 32% intermediate bonds which entirely changes the risk/return profile of the intended 60/40, they'd hold 20% long bonds and 20% cash. This achieves the risk/return of the 60/40 while holding 5 years of cash.

That's part of the issue with the 60/40: the bond allocation is an "index" containing a mix of Treasuries and corporate bonds plus things like mortgage-backed securities, junk bonds, and other mystery items. Total bond funds like Vanguard's are great, but they only serve to dilute volatility somewhat - unlike Treasuries, they don't provide negative correlation with stocks. Frankly I never really understood the point of a bond "index", when what you want out of it is safety.

A more interesting way to do a 60/40 is exactly what you suggested, or using intermediate Treasuries as in the Desert Portfolio. Oddly enough, this difference between Treasuries and other types of bonds isn't recognized over at that other investing forum. We learned that from Grandpa Harry.

There are some 'over there' who talk about only using Treasury's on the bond side, but yeah, the majority are Total Bond.

Would be nice if my 401(k) had any sort of all-treasury bond fund option other than TIPS though.

[sophie]

The comparison of the 60/40 returns to the 25x4 PP indeed isn't fair, because the owner of the 60/40 needs to hold cash. How much isn't clear, but most would recommend a sizeable enough chunk that it's a significant fraction of the stock/bond portfolio.

Hear, hear.

The time spent accumulating the cash emergency fund needs to be account for too. The prototypical Boglehead advice is to first save about 1 years' expenses in cash, then start investing. If you consider the case of a young professional starting out broke with no debt and a 20% savings rate, they'll spend 4 whole years investing in 100% cash. In the fifth year they'll be roughly 80% cash and 20% in an "age in bonds" portfolio. So if this scenario started at age 22, at age 27 they are 80% cash, 5% bonds, 15% stocks. This is a very low-return portfolio, which really ought to be factored into lifetime returns and "the power of compound interest."

Honestly, I think financial authors and pundits are so accustomed to giving advice to people that have already accumulated some wealth, that they completely overlook checking whether their advice actually works for people starting from scratch.

Brilliant, KevinW. The only wrinkle is that the age in bonds portfolio will get a bit of a head start through the young professional's retirement program. Not much of one though. Between car purchases, student loans and saving for a house, retirement savings will likely only be up to the company match, or a single digit rate, and taxable cash will be earmarked for spending rather than invested, for probably quite a few years, into their thirties in most cases.

Here's an interesting simulation for somebody to do (Tyler): contrast early investing strategies for money outside of the main employer 401K - this can include Roth IRAs. Option A: 3 months cash cushion then start a 25x4 PP. Option B: 1 year cash cushion then start an 80/20 portfolio. At various starting years, what are the annual portfolio returns over the first 10 years?

[Tyler]

Here's an interesting simulation for somebody to do (Tyler): contrast early investing strategies for money outside of the main employer 401K - this can include Roth IRAs. Option A: 3 months cash cushion then start a 25x4 PP. Option B: 1 year cash cushion then start an 80/20 portfolio. At various starting years, what are the annual portfolio returns over the first 10 years?

Hmm... interesting problem. I like the idea of quantifying the effect of the traditional emergency fund on a startup portfolio. I'll have to think about that.

[KevinW]

The only wrinkle is that the age in bonds portfolio will get a bit of a head start through the young professional's retirement program. Not much of one though.

True.

What is the "default" advice for a young professional starting a PP from scratch? Browne said to maximize tax efficiency, but hold gold directly, so I think he'd say to hold gold coins directly (taxable) and put the rest in the 401(k) with match. I think I'd suggest something different, holding cash in taxable for emergency liquidity, and putting the other 75% in 401(k with match, at least until there are many months' worth of taxable cash accumulated.

Between car purchases, student loans and saving for a house, retirement savings will likely only be up to the company match, or a single digit rate, and taxable cash will be earmarked for spending rather than invested, for probably quite a few years, into their thirties in most cases.

Yes, starting at a 20% save rate at 22 is a rosy scenario. Without getting into the blame game of "why," the fact is that most of my friends didn't have the means to start saving until their 30s, and some are just getting started in their 40s.

[curlew]

Well, since you're not greedy for gains like we were everything should be all right then.

Quite the contrary, but y'all priced me out of the market. I've had to resort to desperate measures!

Are you saying that my generation got all the gains and now there's nothing left for you? If so, then I have to say that for someone showing such erudition in all of his posts, even though I sometimes don't know what you are talking about, that sounds pretty damn stupid.

To quote Gordon Gecko, "Greed, for lack of a better word, is good".

And as Thomas Sowell said, "Blaming economic crashes on greed, is like blaming plane crashes on gravity".

Every generation wants to better their lives and yours is no different (I still have a millenial living under my roof which is shaking my confidence but I still believe this is true).

[MachineGhost]

Are you saying that my generation got all the gains and now there's nothing left for you? If so, then I have to say that for someone showing such erudition in all of his posts, even though I sometimes don't know what you are talking about, that sounds pretty damn stupid.

...

Every generation wants to better their lives and yours is no different (I still have a millenial living under my roof which is shaking my confidence but I still believe this is true).

At the moment yes. 2% nominal returns over the next 10-12 years on 50%+ of a portfolio isn't gonna fund any of my investment goals. And I can't possibly save any more than the 50% I am already! So while I wait for values to revert back to common sense levels so I can load the boat, I'm getting older. The Baby Boomers didn't have to wait to do that. They got everything handed to them as they went along in life. And neither did they have to face the damn reality of a turgid job market, QEternity, negative yields, perpetual bonds and helicopter money. I can begin to understand why suicide rates are so high in Japan.

For the ordinary person that is nowhere as intelligent as my fine self, imagine how they are feeling if I am feeling frustrated. To be fair, most of the frustration is because I can't be completely lazy and just do the vanilla PP because of the permament loss of capital risk. It's not that big of a deal, but at first it was just equity, but now it is bonds, so the game the Baby Boomer's have been playing all along is rapidly running out of steam. I've no intention of being the bagholder.

[dualstow]

The Boomers were enviably lucky in many ways, but this is different than saying that we are hurting because of the Boomers.
Which do you mean?