Understanding Cash Will Make You a Happier Investor (Tyler)

[Jeffreyalan]

Do most of you keep your cash in Treasury Direct? Or in a brokerage?

[Jack Jones]

Brokerage for me.

[dualstow]

Brokerage for me.

Me too.

[dualstow]

Could you guys explain how you're calculating it? I don't know how it's done.

I just know that I have bills and notes (up to 3-year notes), so I can see individually how they're doing.
For example, the $10,000 block ending in ~LF4 2017-Jun-29 (bought as a 26-week t-bill) is up $27.
The $10,000 block ending in ~R44, due 2019-MAY-15 (bought as a 3-year note) is down $84.
Yes, I'm going to get my money back, but when I add up everything (cost vs holding value, but not interest paid), it's down...

Well it's up now ;-)

[grapesofwrath]

Could you guys explain how you're calculating it? I don't know how it's done.

I just know that I have bills and notes (up to 3-year notes), so I can see individually how they're doing.
For example, the $10,000 block ending in ~LF4 2017-Jun-29 (bought as a 26-week t-bill) is up $27.
The $10,000 block ending in ~R44, due 2019-MAY-15 (bought as a 3-year note) is down $84.
Yes, I'm going to get my money back, but when I add up everything (cost vs holding value, but not interest paid), it's down...

Well it's up now ;-)

This is another reason I prefer holding my bills/notes at treasury direct rather than a brokerage. A brokerage tends to prominently display the daily current market value of each of your bill/note/bond. As far as I'm aware TD doesn't show this (or I haven't seen it and not looked for it). As interest rates rise/fall above what you bought your bill/note/bond for its value on the market (if you tried to sell it) will fall/rise. This daily loss/gain displayed in reds and greens is a distraction to me and fear it may tempt me to do something stupid like figure out which way interest rates are headed... I'm trying to get into a mode of been oblivious and trying not to care.

[dualstow]

Or you could always ... not look. ;-)

[sophie]

Do most of you keep your cash in Treasury Direct? Or in a brokerage?

Deep cash at Treasury direct. "Shallow" cash in bank savings account. All other cash in brokerage as autorolled T bills. But that's not a hard and fast plan. I figure I'll be moving more cash into Treasury Direct, especially given that autorolled T bills will give approximately the same return as the bank savings account & CDs, after taxes.

Banks should be ashamed of themselves...interest rates have barely budged despite the jump in Treasuries.

[eufo]

Banks should be ashamed of themselves...interest rates have barely budged despite the jump in Treasuries.

Agree. Chase keeps sending me a deal for $200 to deposit $15,000 into one of their savings accounts and leave it for 90 days. It's actually a good deal except that I will have to pretty much instantly close the account because of the 0.03% APY. Is it worth $200 to have to move money around, open the account, wait 90 days, monitor until the money goes in, close the account and shuffle money back where I want it? No.

Hey, Chase... up the interest rate on your savings and I'll just have a savings account with you instead of somewhere else. It's that simple.

[grapesofwrath]

Tyler, Didn't you once include TIPs in your Portfolio Charts and then they disappeared, or am I mistaken ? I would think TIPs would be an insightful asset class to include given their performance/correlation is (supposedly) relatively unique. Even though TIPs are relatively recent invention I understand "synthetic" data exists for how they likely would have performed earlier. (But a question would be what duration..) Thanks.

[Tyler]

Tyler, Didn't you once include TIPs in your Portfolio Charts and then they disappeared, or am I mistaken ?

Yep -- I used to have TIPS on the site. Late last year a group of smart guys on the Bogleheads forum (including the guy I really trust who manages the Simba spreadsheet) sought to reproduce the study that reconstructed all of the synthetic data and basically determined that the data was junk. And it wasn't just the methodology of a single study but the nature of TIPS themselves.

The thing about TIPS is that because of the additional value of the guaranteed inflation adjustment their yields are lower than normal treasuries of the same maturity. That makes sense, otherwise nobody would purchase normal bonds. However, the difference is not tied to a measurable inflation number but is instead equal to whatever the market believes is the expected inflation over the life of the bond. Believe it or not, TIPS were invented at least in part to try to predict inflation. You can probably guess how well that has worked out.

Basically, to accurately model the behavior of TIPS you have to quantify the emotional belief of the market at a given point in time regarding expected future inflation. Studies have tried to do that but none I'm aware of have come close in any repeatable way. So while I haven't totally given up on the idea, for now I don't trust it enough to use synthetic data and there's not enough real data to make backtesting worthwhile.

BTW, several of the people who looked into modeling TIPS left the exercise swearing them off with their own money.

[grapesofwrath]

Thanks for the reply Tyler. I had been wondering if a short term TIPS fund (eg VTAPX) or a ladder of 5yr discrete TIPS bonds held to maturity would be a suitable/sensible substitute for a cash component in a portfolio (if one didn't want immediate liquidity). My naive understanding is the yield might be slightly lower/comparable than that of regular bonds of same duration, but they would offer better protection if there were a substantial rate rise - hence decent alternative to cash. I've seen some portfolios (Swedroe ?) where the (heavy) treasury bond/note allocation is split equally between regular bonds/notes and TIPS of comparable duration. Seems like doing this is hedging one's bets on rates ? My other understanding is holding TIPS only really makes sense in tax deferred accounts, correct ? Further comments from others much appreciated.

[sophie]

Tyler, that's the best summary of TIPS I've heard anywhere. We'd had previous threads about keeping TIPS funds as an extra inflation hedge, but it always looked to me like you had to give up too much in order to get it.

Anyway, it's not really needed. The PP provides consistent enough returns over inflation that you don't really have to worry about it.

[eufo]

BTW, several of the people who looked into modeling TIPS left the exercise swearing them off with their own money.

Wow, that is very telling about TIPS. I remember liking the concept of protection against inflation in a bond, but I never really cared for their ultimate performance. Plus, the conspiracy theorist in me suspects the government will always fudge inflation numbers to their own benefit, so how can I trust that I'm going to have any protection against my own perception of real inflation?

[Tyler]

My naive understanding is the yield might be slightly lower/comparable than that of regular bonds of same duration, but they would offer better protection if there were a substantial rate rise - hence decent alternative to cash.

I definitely wouldn't use TIPS as a substitute for cash. Think about it this way:

Bonds are affected by basically one thing -- interest rates. Values rise when rates fall and fall when they rise, and they pay out the coupon along the way.

TIPS are affected by three things -- interest rates, measurable inflation, and the market guess of expected future inflation. So there are multiple variables involved, and just because TIPS are adjusted for measurable inflation does not mean they track it particularly well. They are harmed by rising rates just like normal bonds, and the market guess for future inflation can be wildly wrong. That's how intermediate TIPS had a real return of -10% in 2013 and how short term TIPS trailed normal short term treasuries three out of the last four years (compare VTIP to VFISX).

All that said, you might want to read books by Swedroe, Swensen, and Israelsen to understand why they like TIPS. While they're not the automatic inflation-protecting vehicles they're made out to be, TIPS are an interesting asset and I think they can be fine in certain portfolios.

[grapesofwrath]

That's how intermediate TIPS had a real return of -10% in 2013

With my limited understanding isn't such a loss just a consequence of selling in a TIPS fund?
What if you hold the Note or TIPS from issue to maturity ? Looking at typical numbers for a 5yr Treasury Note vs 5yr TIPS :
A 5yr Treasury Note currently has a nominal yield of ~1.8% which is pretty much zero real yield with current inflation, so if inflation remains unchanged you get all your money back (in real terms) at end of 5years (ignoring tax). If inflation increases/decreases over the period your 5yr Note will lose/make money (in real terms). i.e. you are not protected against inflation.
Now a 5yr TIPS bond has an interest of ~0.125% (negligible). My understanding this yield is on the principle value, and this underlying principle value of the TIPS bond increases/decreases to track inflation. i.e. the TIPS guarantee to give you a (currently negligible) positive real return at the end of 5years regardless of how inflation moves. i.e. you are protected against inflation.
So if you laddered the TIPS and held them from issue to maturity how would that be a bad substitute for cash or short term fund ? Thanks.

[Tyler]

Yes, holding TIPS to maturity bypasses the interest rate risk. There's still the future-inflation-guessing risk, though, as normal bonds held to maturity will pay a higher yield and will be a better deal if future inflation is below current expectations. For example, using your numbers it would only make financial sense to prefer a 5-year inflation-adjusted bond paying 0.125% over a non-adjusted alternative paying 1.8% if you expect inflation to average more than 1.675% over the next 5 years. In that context, buying TIPS is just a wager that inflation is currently under-priced. It's a speculative investment.

In any case, I'll amend my previous statement and clarify that I don't think short term TIPS are automatically a poor substitute for cash. Just perhaps unnecessarily complex. Going back to the link in the OP, cash already tracks inflation pretty well on its own without the extra layer of uncertainty.

[Tyler]

Good point! The treasury market is remarkably efficient in balancing things out.