Why Hold Cash?

[stuper1]

I'm still having trouble understanding why to hold cash, other than just say an emergency fund of 6-12 months of living expenses.  Please help me to understand this.  Here is a graph I made at the St. Louis Fed website that shows daily interest rates for 6-month T-bills, 20-year T-bonds, and 30-year T-bonds:



The rates for 20- and 30-year bonds were substantially higher than the T-bill rates almost all the time.  Even when the T-bill rates were a little higher, that only lasted for a very short period, and the T-bond rates were almost as high even in those periods.

Other than emergency cash, wouldn't it be better to hold say 1/3 stocks, 1/3 gold, and 1/3 long-bonds, and rebalance when indicated?  What am I missing here?  Please help me to understand.  Won't the value of long-bonds almost always be as large as the value of cash?  If so, why can't I just treat long-bonds as cash?

[dualstow]

Have you read the book? I'm not asking flippantly; you really need to start there, or at least at some of the cash threads or at crawlingroad dot com. You'll see very quickly that it's not about yield.

https://web.archive.org/web/20160324133 ... portfolio/

http://gyroscopicinvesting.com/forum/ht ... ic.php?t=5

[melveyr]

I think of cash as a way of "delevering" the portfolio.

Are you familiar with how margin trading works? It essentially allows you to buy more risky assets than you could otherwise by allowing you to "short" cash. You pay your broker the return that cash is getting plus a little extra to compensate them for the risk / effort.

So what would be the opposite of going on margin be? Holding cash. I have the belief that the amount of leverage (including negative leverage) is up to the discretion of the investor. So I wouldn't object to someone having 70% cash, 10% stocks, 10% gold, and 10% bonds nor would I object to 33% in stocks, bonds, and gold. It depends how much risk you are comfortable taking.

The one caveat is that occasionally the Fed punishes leveraged players (by hiking short term rates very aggressively) and other times it spoils them by holding them very low for extended periods (like what is happening right now).

However, with all of that said, it is somewhat concerning that you would see 30 year treasuries as being a substitute for cash. You should really study the PP and the returns of the assets before you implement this strategy. Long term treasuries that are perpetually rolled over (what the pp does) are extremely risky in isolation and are not very cash like. I think you have a lot of reading to do and ironically a 100% cash portfolio might be best for you until you hit the books! 

[dualstow]

If so, why can't I just treat long-bonds as cash?

However, with all of that said, it is somewhat concerning that you would see 30 year treasuries as being a substitute for cash

I agree.
stuper1, first and foremost: You do know that the value of those 30-year bonds -- never mind the yield -- the value of those long bonds can go up and down like stocks, right? You can't expect to sell them at the price you paid the way you can just withdraw $100 from the bank a year after depositing $100 in the bank. Not unless you hold them to maturity, i.e. for 30 years.
Secondly: you are not supposed to hold them for 30 years.

[craigr]

I will simply say this: Everyone hates cash up until the point when the markets are going crazy. Then it's the Belle of the Ball.

Having a solid anchor of cash gives a lot of peace of mind in volatile markets. It allows an investor to know that they can psychologically hold out during market gyrations because they can cover their near term living expenses without touching the other assets.

Then there is what I call the vulture investing aspect. During a market panic the people with cash can swoop in with rebalancing and completely clean up buying other assets at very good prices. Don't underestimate cash!

[stuper1]

Thank you for helping me understand this stuff.  No, I didn't know the difference between value and yield.  I think that's where I was misunderstanding.  I figured they were basically correlated, so that something with a good yield would have a good value also.

I certainly do have a lot of reading to do, and yes I do have the Bib . . . er, I mean book.  It's with me just about 24/7 these days.

It's a bit late for me to be 100% in cash, as I am glad to say that I am now almost 100% in the PP, which has to be a lot better than the 60/40 mix I've had for years.  I just need to get over a few more humps, and I'm sure I'll understand things well enough to leave them alone and let the PP do its thing.

Thanks again for helping to educate me.

[melveyr]

It's a bit late for me to be 100% in cash, as I am glad to say that I am now almost 100% in the PP, which has to be a lot better than the 60/40 mix I've had for years.  I just need to get over a few more humps, and I'm sure I'll understand things well enough to leave them alone and let the PP do its thing.

The PP is a fine portfolio. I just wouldn't want you to be surprised/scared when you realize how it actually functions. You are going to see those 30 year treasuries fluctuate in value a lot. But, that is why we hold them. We want that price volatility.

[dualstow]

Stuper, check out this primer on bonds' yield & price. http://www.investopedia.com/articles/bo ... _yield.asp

Although it's ultimately a flawed analogy, I think of cash as being like the spy piece in the board game Stratego.
Nearly every other piece will defeat the spy when the two come in contact.
However, the spy can defeat the highest-ranking (and most powerful) piece on the board. It has its special superpower,
and so does cash.

[melveyr]

Stuper, check out this primer on bonds' yield & price. http://www.investopedia.com/articles/bo ... _yield.asp

Although it's ultimately a flawed analogy, I think of cash as being like the spy piece in the board game Stratego.
Nearly every other piece will defeat the spy when the two come in contact.
However, the spy can defeat the highest-ranking (and most powerful) piece on the board. It has its special superpower,
and so does cash.

Is that highest ranking foe Volcker-like monetary policy? 

[dualstow]

It's whatever you want it to be. 
For me, it's the allure of high flying stocks, gold and even bonds. And the related temptation to only hold them.

[MachineGhost]

Other than emergency cash, wouldn't it be better to hold say 1/3 stocks, 1/3 gold, and 1/3 long-bonds, and rebalance when indicated?  What am I missing here?  Please help me to understand.  Won't the value of long-bonds almost always be as large as the value of cash?  If so, why can't I just treat long-bonds as cash?

Cash outperformed bonds during the inflationary 1948-1981 period.  You are suffering from the anchoring bias.

[Kshartle]

So everyone knows I think the PP is far too exposed to the USD and will not do well if/when inflation really picks up. If the FED kicks it into overdrive (which I expect) you will be feeling the pain in real terms. To the extent you want low volitility 1/3stocks 1/3gold 1/3dollars works great, should have decent returns over any significant period with low volitility and a lot less inflation risk. The dollars should be in cash at these rock bottom rates because the risk of rising rates is a lot greater than the upside of falling rates. Historically when rates are this low you see cash outperforming bonds over the long-run. When rates get back up around 8-10% or at least a couple points above inflation switch to the Long-term or ease into it by lengthening the maturity as rates rise. Good rule of thumb might be keep your bond maturities around double the 10-year rates. That means 4 year maturities now. If it hits 10% hold 20s, so on so forth.

I know practically everyone disagrees I just think the risk of rising rates and inflation is really being underestimated right now.

Yeah if stocks sell off and people pile into treasuries in a panic you might lose a couple more points (as opposed to the PP) in the short run depending on what gold does but you will definately still be in a position to by stocks at a bargain while most investors are going broke.

50% in dollars at these negative rates is just trading any hope for significant gains for a super smooth ride - my opinion.

[dualstow]

I know practically everyone disagrees I just think the risk of rising rates and inflation is really being underestimated right now.

I don't disagree- I merely think it's market timing and it's not a pp.

Every month, or perhaps every couple of weeks, someone (Not stuper1) comes along and says, "I've got this great idea, guys. The pp without cash." Or, "I'm not holding cash because the yield is low." Or "Personally, I think interest rates are going to rise. It will happen." As if traditional HBPP holders are blind to the situation. We're really not. We're just sticking to the plan. Or at least, I am. Maybe it's easier for me because my variable portfolio is still larger.

[Kshartle]

Every month, or perhaps every couple of weeks, someone (Not stuper1) comes along and says, "I've got this great idea, guys. The pp without cash." Or, "I'm not holding cash because the yield is low." Or "Personally, I think interest rates are going to rise. It will happen."

It's more like everyday.

If you've got a VP then all bets are off. For people who have all their investment in a PP....well good luck to you. That's an awful lot of dollar promises at crushingly low rates. Little hope for gain I'm afraid. Hey, maybe we have a deflation and the US can still cough up the dough on it's bonds and yields fall. I think that's a less than 1% chance though from here. Could be proved wrong.

[dualstow]

If you've got a VP then all bets are off.

I have to admit, I'm not putting my money where my mouth is any more so than those with altered pp's. But I could lose my ass in the stock market while those with 100% pp's will do better. No one knows.

[craigr]

Funny thing about currencies. If you live in a country you may think it stinks and somewhere else is better. But with lack of knowledge of the foreign currency political scene and economy we just don't know. Indeed, even reading news articles about a remote place is misleading and likely to make investors succumb to confirmation bias. Ultimately, you just have to visit the place and stay there a while to get a good idea of what it's really like and even then this is fraught with peril in terms of being able to correctly interpret things.

Five-six years ago for instance people were discussing the greatness of the Euro and the dollar was doomed. But now the Euro is showing its problems and likely going to get worse. In fact, people like Peter Schiff were advocating non-dollar assets before the 2008 crash and people that followed that advice got crushed much worse than U.S. investors.

So these things are really unpredictable and the dollar does have problems, but going outside it as a U.S. citizen has a ton of risk as well. There's a reason for instance that most large U.S. companies hedge their funds held in overseas currencies. I suppose I may change my tune when I see U.S. companies starting to hedge their dollars, but that's not what usually happens today.

[smurff]

Five-six years ago for instance people were discussing the greatness of the Euro and the dollar was doomed. But now the Euro is showing its problems and likely going to get worse.

I remember those days.

The dollar was so "bad" compared to the Euro that lots of stores here in NYC were accepting Euros in addition to (sometimes, instead of) dollars.  Even fashion models from abroad were demanding to be paid in Euros instead of dollars when they worked during Fashion Week.

How times have changed.

[rocketdog]

Five-six years ago for instance people were discussing the greatness of the Euro and the dollar was doomed. But now the Euro is showing its problems and likely going to get worse.

I'm not saying I have a crystal ball, but I just knew from the moment I heard of the "Euro" that it was a bad idea.  I didn't see how it could possibly work long-term.  So many different countries, with different economies, different natural resources, different political cycles, different legal systems, different languages, etc. 

At first when the Euro started doing well I remember thinking, "Well, I guess I might have been wrong," but I still couldn't make sense out of how it could survive in the long run.  I think now the chickens are coming home to roost. 

The Europeans would have done well to heed the words of Henry Ford:

"It is well enough that people of the nation do not understand our banking and monetary system, for if they did, I believe there would be a revolution before tomorrow morning."