TIPS to Maturity = "Deep Storage Cash" for PP

[TripleB]

Here's a thought I had today. MT has used the term "Deep Storage" for some cash portion that you can't touch immediately but is pretty good for cash. i.e. an IBond within the first year. As long as you don't have too much of your cash portion in deep storage, it's OK because there's enough other cash to rebalance from.

What if you bought a TIPS bond, 10 year duration, held to maturity, as part of your deep storage cash? The theory being that it's spitting off interest every 6 months, so you can rebalance your other positions from that 6 month coupon.

Additionally, if inflation hits hyperinflation, that coupon payment should be huge. In hyperinflation your bonds will probably be taking a dive, so you can rebalance your bonds from the higher coupon interest payment.

I'd think 10% to 20% of your cash portion could be in Deep Storage TIPS holdings without risking not having enough liquid cash to rebalance.

I wouldn't want to liquidate the bond itself before maturity because TIPS are very volatile and act unpredictably so there's a chance you could lose principal.

[MediumTex]

Although we are obviously off the PP reservation here, I think that targeting closer to 10% of the "deep" cash allocation for something like this and doing it in the form of a TIPS ladder AND doing it in tax deferred space would make the idea more appealing (though still obviously a departure from certain PP tenets).

Of course, I would only entertain something like this after maxing out my annual I-bond purchases.

I love this kind of PP shop talk, but I worry that anyone casually reading this forum isn't going to know WTF we're talking about.

The "deep" aspect of each asset class is a very interesting concept to me.

Gold: bullion is "deep"; PM ETFs are for rebalancing.

Stocks: index fund in taxable space is "deep"; index fund in tax-deferred space is for rebalancing.

LT Bonds: individual bonds are "deep"; TLT is for rebalancing.

Cash: I-bonds, CDs, (TIPS ladder in tax deferred account, as discussed above) are "deep"; SHY, SHV and maturing t-bills are for rebalancing.

The concept is that for each PP asset there is a declining marginal utility to each dollar when it comes to liquidity.  In other words, I am very unlikely to need 100% liquidity at all times in each PP asset class, so I can afford to have a little illiquidity in the cash portion, for example, by holding I-bonds if I can get a better return and it won't interfere with my ability to rebalance when I hit a band.

These are all just micro adjustments that might provide a little better returns and little better tax efficiency.  Please don't get preoccupied with any of this until you are comfortable with the basic strategy.  From my own past experience with new ideas, if I came upon the PP today for the first time I could easily see myself getting bogged down with making sure that my "deep to rebalancing ratios" were perfect in each asset.  If you are a new PPer don't fall into the trap of seeking this kind of precision or perfection--it doesn't exist. 

If this was an automotive forum, the discussion above would be the equivalent of discussing the effects of going from 35psi tire pressure to 36psi and its effects on overall vehicle performance.

[TripleB]

The concept is that for each PP asset there is a declining marginal utility to each dollar when it comes to liquidity. 

Exquisitely said.

[KevinW]

Taking this line of reasoning to its logical conclusion begs the following question:

If the defining trait of the "deep storage" assets are that they'll never be sold, do they even need to exist?

[MediumTex]

Taking this line of reasoning to its logical conclusion begs the following question:

If the defining trait of the "deep storage" assets are that they'll never be sold, do they even need to exist?

I wouldn't say they will never be sold, since the presumptive purpose of accumulating wealth (IMHO) is that it will one day be converted to consumption.

If, however, we can look forward and assume that the next 10 years or so will be primarily about accumulation of assets, I think that a "deep" asset approach might make sense.  Some of the deep assets will also be throwing off dividends that would probably not be considered "deep" assets themselves, so the "deep" assets would definitely serve a purpose in generating income that could then be used for rebalancing purposes.

PP metaphysics!  I love it.

[TripleB]

The concept is that for each PP asset there is a declining marginal utility to each dollar when it comes to liquidity.

I want to build on this a little further:

Liquidity is valuable. The ability to sell your assets easily is something desirable. Considering two investments, equal in all respects except for liquidity, the higher expected returning asset must be the one with less liquidity. Pretend Investment A was perfectly liquid. Investment B has a 6 month waiting period to sell, from the period you decide to sell. Both investments are "bonds" issued by the same entity, with equal creditor rights.

Investment B is expected yield more than Investment A, because people would require a higher return to accept the 6 month waiting period.

Thus, liquidity comes at a price. It's not "free." All else equal, you are sacrificing expected return for increased liquidity.

Add this to MT's brilliant statement, that there is diminishing returns for marginal utility for additional liquidity within a given asset in the PP, and we realize that there is an efficient sweet spot whereby one can maximize total return, according to liquidity-utility measurements.

For example, IBonds have a higher return than a CD, but you can't sell the IBond for the first 12 months. So there is initial illiquidity. You would be foolish to go 100% IBonds as your cash portion (ignore annual max limits for this example). However, you would be equally foolish to go 0% IBonds, because you are leaving money on the table by not taking on slightly reduced liquidity for a higher return.

There's some efficient point between 0% and 100% to be in "deep storage" within an asset. We could probably calculate it, at least historically, based on what percentage of any given asset the PP needed to sell at any given time. i.e. if the PP has historically never had to sell more than 50% of any asset to enable a rebalancing event, then the liquidity levels only need to be a 50%. In fact, one might argue to go 60% illiquid, because the probability of needing the full 50% is low, assuming 50% was the historical maximum.

The PP is all about simplicity, and I think it would be fine to ignore this thread if you are a beginner or not interested in tinkering slightly. However, I think we can potentially juice an additional 0.5% to 2% return per year, by considering this methodology, while keeping standard deviation nearly the same. In essence, it would be risk-adjusted free money compared to the regular PP.

For some examples, liquidity deep storage could be something like using a 3 year Treasury note instead of 1 year T-Bills for some of the cash portion. You get a higher return for pushing further out on the yield curve. There's more risk because the principal could fall if interest rates drop, but if it's deep storage and you hold until maturity, there is reduced risk. The risk comes from the fact that hyperinflation could push yields up on new T-Bills and by having your money locked up for 3 years you are forgoing that new higher issue rate.

That's why a TIPS might be a good thing for deep storage cash as well, since the coupon rate will vary based somewhat on inflation (depending on how the government decides to calculate it).

I don't think there's any deep storage opportunities for Long Term Bonds or Gold. I understand MT's point that the physical bonds are "deep storage" because it's more of a hassle to sell than an ETF like TLT, but there's substantial liquidity in the bond market, so you're not really gaining value from a liquidity standpoint. Same with gold. The value you gain by holding actual physical gold or directly owning bonds, is not from accepting decreased liquidity, but the value comes from reduced counterparty risk. There is a cost associated with reducing counter party risk, and that cost is measured in expense of selling treasuries on the secondary market (in both your time, and potentially brokerage fees), and the spread on gold bullion being much higher than the spread on ETFs.

There may be liquidity-value to gain in stocks but one would have to own private equity. Typically PE is less liquid than publicly traded stocks, and the expected return is higher to compensate for the reduced liquidity. The problem is most people can't access PE because you'd likely need at least $10k+ to find a business worth owning to sell you shares. And then diversification becomes a problem since you'd have to have several hundred thousand dollars in stocks to really diversify among PE and still have a large enough chunk of your stocks in liquid public positions.

If I had a lot of money, I'd put about 10% to 20% of my stock allocation into 2 to 3 different hedge funds that focused on private equity, and had steep liquidity restrictions. I'm talking if my portfolio overall exceeded $10M because then 20% of my stock portion is still only 5% of $10M so if I lost it all, I'd still have $9.5M. And hedge funds require huge initial investments, so I'd need a $10M total PP to make 5% of that total be worthwhile to a hedge fund manager.

[yankees60]

Although we are obviously off the PP reservation here, I think that targeting closer to 10% of the "deep" cash allocation for something like this and doing it in the form of a TIPS ladder AND doing it in tax deferred space would make the idea more appealing (though still obviously a departure from certain PP tenets).

Of course, I would only entertain something like this after maxing out my annual I-bond purchases.

I love this kind of PP shop talk, but I worry that anyone casually reading this forum isn't going to know WTF we're talking about.

The "deep" aspect of each asset class is a very interesting concept to me.

Gold: bullion is "deep"; PM ETFs are for rebalancing.

Stocks: index fund in taxable space is "deep"; index fund in tax-deferred space is for rebalancing.

LT Bonds: individual bonds are "deep"; TLT is for rebalancing.

Cash: I-bonds, CDs, (TIPS ladder in tax deferred account, as discussed above) are "deep"; SHY, SHV and maturing t-bills are for rebalancing.

The concept is that for each PP asset there is a declining marginal utility to each dollar when it comes to liquidity.  In other words, I am very unlikely to need 100% liquidity at all times in each PP asset class, so I can afford to have a little illiquidity in the cash portion, for example, by holding I-bonds if I can get a better return and it won't interfere with my ability to rebalance when I hit a band.

These are all just micro adjustments that might provide a little better returns and little better tax efficiency.  Please don't get preoccupied with any of this until you are comfortable with the basic strategy.  From my own past experience with new ideas, if I came upon the PP today for the first time I could easily see myself getting bogged down with making sure that my "deep to rebalancing ratios" were perfect in each asset.  If you are a new PPer don't fall into the trap of seeking this kind of precision or perfection--it doesn't exist. 

If this was an automotive forum, the discussion above would be the equivalent of discussing the effects of going from 35psi tire pressure to 36psi and its effects on overall vehicle performance.

Just came across this.

It seems to go the most into depth I've read anywhere in the forum regarding the nuances of the "deep to rebalancing ratios".

Vinny

Vinny

[yankees60]

The concept is that for each PP asset there is a declining marginal utility to each dollar when it comes to liquidity.

I want to build on this a little further:

Liquidity is valuable. The ability to sell your assets easily is something desirable. Considering two investments, equal in all respects except for liquidity, the higher expected returning asset must be the one with less liquidity. Pretend Investment A was perfectly liquid. Investment B has a 6 month waiting period to sell, from the period you decide to sell. Both investments are "bonds" issued by the same entity, with equal creditor rights.

Investment B is expected yield more than Investment A, because people would require a higher return to accept the 6 month waiting period.

Thus, liquidity comes at a price. It's not "free." All else equal, you are sacrificing expected return for increased liquidity.

Add this to MT's brilliant statement, that there is diminishing returns for marginal utility for additional liquidity within a given asset in the PP, and we realize that there is an efficient sweet spot whereby one can maximize total return, according to liquidity-utility measurements.

For example, IBonds have a higher return than a CD, but you can't sell the IBond for the first 12 months. So there is initial illiquidity. You would be foolish to go 100% IBonds as your cash portion (ignore annual max limits for this example). However, you would be equally foolish to go 0% IBonds, because you are leaving money on the table by not taking on slightly reduced liquidity for a higher return.

There's some efficient point between 0% and 100% to be in "deep storage" within an asset. We could probably calculate it, at least historically, based on what percentage of any given asset the PP needed to sell at any given time. i.e. if the PP has historically never had to sell more than 50% of any asset to enable a rebalancing event, then the liquidity levels only need to be a 50%. In fact, one might argue to go 60% illiquid, because the probability of needing the full 50% is low, assuming 50% was the historical maximum.

The PP is all about simplicity, and I think it would be fine to ignore this thread if you are a beginner or not interested in tinkering slightly. However, I think we can potentially juice an additional 0.5% to 2% return per year, by considering this methodology, while keeping standard deviation nearly the same. In essence, it would be risk-adjusted free money compared to the regular PP.

For some examples, liquidity deep storage could be something like using a 3 year Treasury note instead of 1 year T-Bills for some of the cash portion. You get a higher return for pushing further out on the yield curve. There's more risk because the principal could fall if interest rates drop, but if it's deep storage and you hold until maturity, there is reduced risk. The risk comes from the fact that hyperinflation could push yields up on new T-Bills and by having your money locked up for 3 years you are forgoing that new higher issue rate.

That's why a TIPS might be a good thing for deep storage cash as well, since the coupon rate will vary based somewhat on inflation (depending on how the government decides to calculate it).

I don't think there's any deep storage opportunities for Long Term Bonds or Gold. I understand MT's point that the physical bonds are "deep storage" because it's more of a hassle to sell than an ETF like TLT, but there's substantial liquidity in the bond market, so you're not really gaining value from a liquidity standpoint. Same with gold. The value you gain by holding actual physical gold or directly owning bonds, is not from accepting decreased liquidity, but the value comes from reduced counterparty risk. There is a cost associated with reducing counter party risk, and that cost is measured in expense of selling treasuries on the secondary market (in both your time, and potentially brokerage fees), and the spread on gold bullion being much higher than the spread on ETFs.

There may be liquidity-value to gain in stocks but one would have to own private equity. Typically PE is less liquid than publicly traded stocks, and the expected return is higher to compensate for the reduced liquidity. The problem is most people can't access PE because you'd likely need at least $10k+ to find a business worth owning to sell you shares. And then diversification becomes a problem since you'd have to have several hundred thousand dollars in stocks to really diversify among PE and still have a large enough chunk of your stocks in liquid public positions.

If I had a lot of money, I'd put about 10% to 20% of my stock allocation into 2 to 3 different hedge funds that focused on private equity, and had steep liquidity restrictions. I'm talking if my portfolio overall exceeded $10M because then 20% of my stock portion is still only 5% of $10M so if I lost it all, I'd still have $9.5M. And hedge funds require huge initial investments, so I'd need a $10M total PP to make 5% of that total be worthwhile to a hedge fund manager.

And, this one is an excellent add-on!

Vinny

Vinny

[yankees60]

Although we are obviously off the PP reservation here, I think that targeting closer to 10% of the "deep" cash allocation for something like this and doing it in the form of a TIPS ladder AND doing it in tax deferred space would make the idea more appealing (though still obviously a departure from certain PP tenets).

Of course, I would only entertain something like this after maxing out my annual I-bond purchases.

I love this kind of PP shop talk, but I worry that anyone casually reading this forum isn't going to know WTF we're talking about.

The "deep" aspect of each asset class is a very interesting concept to me.

Gold: bullion is "deep"; PM ETFs are for rebalancing.

Stocks: index fund in taxable space is "deep"; index fund in tax-deferred space is for rebalancing.

LT Bonds: individual bonds are "deep"; TLT is for rebalancing.

Cash: I-bonds, CDs, (TIPS ladder in tax deferred account, as discussed above) are "deep"; SHY, SHV and maturing t-bills are for rebalancing.

The concept is that for each PP asset there is a declining marginal utility to each dollar when it comes to liquidity.  In other words, I am very unlikely to need 100% liquidity at all times in each PP asset class, so I can afford to have a little illiquidity in the cash portion, for example, by holding I-bonds if I can get a better return and it won't interfere with my ability to rebalance when I hit a band.

These are all just micro adjustments that might provide a little better returns and little better tax efficiency.  Please don't get preoccupied with any of this until you are comfortable with the basic strategy.  From my own past experience with new ideas, if I came upon the PP today for the first time I could easily see myself getting bogged down with making sure that my "deep to rebalancing ratios" were perfect in each asset.  If you are a new PPer don't fall into the trap of seeking this kind of precision or perfection--it doesn't exist. 

If this was an automotive forum, the discussion above would be the equivalent of discussing the effects of going from 35psi tire pressure to 36psi and its effects on overall vehicle performance.

Another MediumTex "gem"!!!


Vinny

[StinkyToes]

Although we are obviously off the PP reservation here, I think that targeting closer to 10% of the "deep" cash allocation for something like this and doing it in the form of a TIPS ladder AND doing it in tax deferred space would make the idea more appealing (though still obviously a departure from certain PP tenets).

Of course, I would only entertain something like this after maxing out my annual I-bond purchases.

I love this kind of PP shop talk, but I worry that anyone casually reading this forum isn't going to know WTF we're talking about.

The "deep" aspect of each asset class is a very interesting concept to me.

Gold: bullion is "deep"; PM ETFs are for rebalancing.

Stocks: index fund in taxable space is "deep"; index fund in tax-deferred space is for rebalancing.

LT Bonds: individual bonds are "deep"; TLT is for rebalancing.

Cash: I-bonds, CDs, (TIPS ladder in tax deferred account, as discussed above) are "deep"; SHY, SHV and maturing t-bills are for rebalancing.

The concept is that for each PP asset there is a declining marginal utility to each dollar when it comes to liquidity.  In other words, I am very unlikely to need 100% liquidity at all times in each PP asset class, so I can afford to have a little illiquidity in the cash portion, for example, by holding I-bonds if I can get a better return and it won't interfere with my ability to rebalance when I hit a band.

These are all just micro adjustments that might provide a little better returns and little better tax efficiency.  Please don't get preoccupied with any of this until you are comfortable with the basic strategy.  From my own past experience with new ideas, if I came upon the PP today for the first time I could easily see myself getting bogged down with making sure that my "deep to rebalancing ratios" were perfect in each asset.  If you are a new PPer don't fall into the trap of seeking this kind of precision or perfection--it doesn't exist. 

If this was an automotive forum, the discussion above would be the equivalent of discussing the effects of going from 35psi tire pressure to 36psi and its effects on overall vehicle performance.

Well put. This is a good idea.