Exiting the PP

[Kshartle]

There aren't any long periods of stocks and gold declining simultaneously that I've seen.

I'm about 40% global stocks, 20% gold, 15% silver and 20% miners. The other 5% is in the bank or money markets. I need to do another transfer soon but I've been holding back to fund a little busniess opportunity.

It's alot in the miners I know but I'm in a low price having purchased 50% or so in the past couple weeks.

[melveyr]

Also, just to make it clear.... Barbells do better in a rising rate environment than a bullet portfolio of the same duration. You might want to have a bullet bond portfolio for expected return reasons, but to do so because of fear of rising rates isn't quite appropriate.

http://en.wikipedia.org/wiki/Barbell_strategy

Note, this is assuming a parallel shift in interest rates (the shape of the curve not changing).

However, with the barbell portfolio you end up paying up for this privilege. This is why the sharpe ratio of bond returns decreases as you go out on the yield curve. I have gone back and forth on the bullet versus barbell debate about and what it means for the PP, and the barbell is still the winner in my mind because I can get above market rates for cash like instruments because of EE bonds and I-bonds and so I wanna grab that free lunch!

Melveyr,

I think I've seen you mention this before and I just want to confirm. For someone with limited tax-deferred space, assuming overall duration of bond holdings is the most important factor (notwithstanding the barbell vs. bullet debate), would one benefit from using zero coupon bonds (EDV) in tax deferred space and balance out the duration using either cash or short term-treasuries in taxable?

I have never owned the zeros because of the bid/ask spread (they might still be fine I am just not an expert).

However, I agree that the barbell has some significant tax advantages over the bullet because one can put the long bond in the tax deferred account (because long bonds generally have a higher yield) while keeping the cash in taxable. Furthermore, going with the barbell allows you to use EE/I-bonds as some of your cash. I think that EE/I-bonds offer a free lunch to the retail investor that is worth getting!

In the end the bullet vs. barbell debate is WAY less important than the duration. However, I am currently thinking that the barbell makes more sense for a retail investor that is more than maxing out retirement accounts and is willing to sub EE/I for T-Bills.

[iwealth]

I have never owned the zeros because of the bid/ask spread (they might still be fine I am just not an expert).

However, I agree that the barbell has some significant tax advantages over the bullet because one can put the long bond in the tax deferred account (because long bonds generally have a higher yield) while keeping the cash in taxable. Furthermore, going with the barbell allows you to use EE/I-bonds as some of your cash. I think that EE/I-bonds offer a free lunch to the retail investor that is worth getting!

In the end the bullet vs. barbell debate is WAY less important than the duration. However, I am currently thinking that the barbell makes more sense for a retail investor that is more than maxing out retirement accounts and is willing to sub EE/I for T-Bills.

Thanks Melveyr.  I'll have to look into EE bonds a bit more. I've maxed out I-bonds the past 2 years. From what I can tell EE bonds are guaranteed to double in 20 years, so if you hold them that long you are guaranteed approximately a 3.5% interest rate; however, current issues are yielding 0.20%, so early redemption of course wouldn't yield much.

I suppose there's always a math equation that can be done to determine whether or not you should exit an EE bond early at any particular time.

[moda0306]

There aren't any long periods of stocks and gold declining simultaneously that I've seen.

I'm about 40% global stocks, 20% gold, 15% silver and 20% miners. The other 5% is in the bank or money markets. I need to do another transfer soon but I've been holding back to fund a little busniess opportunity.

It's alot in the miners I know but I'm in a low price having purchased 50% or so in the past couple weeks.

Kshartle,

While nominally risk-free rates are obviously negative against inflation, they aren't enough so to offset the crushin effects of the will to deleverage in a balance sheet recession.  The reason it feels so $hitty is that savers were being heavily subsidized for 20 years from 1981-2000 via positive real interest rates with having to take no nominal risk.  And if there truly is some "natural" rate of interest, evidence elsewhere in the economy would indicate that the fed isn't far below it.  Lending isn't running amock.  The economy isn't over-heating... people are in fact really trying to save and deleverage.  Interest rates naturally collapse in this environment, even in a more traditional loanable funds model.

Once one realizes that real return (whether positive or negative) on risk-free financial assets is the main driver of the price of gold, they will also notice that for every 1% change in the real rate of return of safe assets, gold will go absolutely gangbusters one way or the other.  This is why, while I love the PP, that I think sometimes that with our gold allocation that we're treating chili powder like its flour (slight exaggeration... I'm still on Chapter 1 of MT's handbook on analogies).

So our rates aren't as "unnaturally low" as is commonly perceived, and even if they become so, gold is poised to behave in several multiples of the degree that you're losing money to inflation.  I'd also add that if we have another economic shock that sends us into overt CPI deflation, gold could likely fall sharply in nominal and even real value.

It's hard to feel like owning gold is using leverage, but when we are living in a world of currency issued by the most stable entity in the world bouncing between positive and negative real rates of return on risk-free assets, a monetary metal is going to behave like a leveraged mirror image to those movements.

This is all just my take of course.

[melveyr]

Thanks Melveyr.  I'll have to look into EE bonds a bit more. I've maxed out I-bonds the past 2 years. From what I can tell EE bonds are guaranteed to double in 20 years, so if you hold them that long you are guaranteed approximately a 3.5% interest rate; however, current issues are yielding 0.20%, so early redemption of course wouldn't yield much.

I suppose there's always a math equation that can be done to determine whether or not you should exit an EE bond early at any particular time.

Yeah TBH I-Bonds are probably the better deal when you take into account the flexibility they provide. However, treating EE bonds as cash but with a "call option" on rates staying low for a long time is an interesting play as well. I think both provide a unique form of free lunch compliments of the Treasury 

[MachineGhost]

And if there truly is some "natural" rate of interest, evidence elsewhere in the economy would indicate that the fed isn't far below it. 

It's called the Taylor Rule: https://en.wikipedia.org/wiki/Taylor_rule

they will also notice that for every 1% change in the real rate of return of safe assets, gold will go absolutely gangbusters one way or the other.

Interesting.  Do you know if anyone has quantified the bond equivalent duration of gold with regards to real rates?  I am guessing it would be negative to zero.

[buddtholomew]

Many board members have stories that drove them to the PP, but now have concluded that a composition other than the vanilla 4x25 allocation will result in either a more profitable outcome with some degree of acceptable volatility. I personally lose confidence in the investment philosophy when topics of this nature surface as alternative options. I sincerely hope that I am not making an error in judgement by adhering  to the 4x25 allocation woth 15/30 rebancing bands

[buddtholomew]

Many board members have stories that drove them to the PP, but now have concluded that a composition other than the vanilla 4x25 allocation will resut in a more profitable outcome with some degree of acceptable volatility. I personally lose confidence in the investment philosophy when topics of this nature surface as alternative options. I sincerely hope that I am not making an error in judgement by adhering to the 4x25 allocation and rebalancing between 15/30 bands.

[dualstow]

Many board members have stories that drove them to the PP, but now have concluded that a composition other than the vanilla 4x25 allocation will result in either a more profitable outcome with some degree of acceptable volatility. I personally lose confidence in the investment philosophy when topics of this nature surface as alternative options. I sincerely hope that I am not making an error in judgement by adhering  to the 4x25 allocation woth 15/30 rebancing bands

It's always been this way, Budd. There is more than one road to Dublin. And so what if they do wind up with a more profitable outcome? What matters is if you think the pp is a good strategy. For you.

You wrote

will result in either a more profitable outcome with some degree of acceptable volatility.

Was there an 'or' that was supposed to follow the 'either'?

[WildAboutHarry]

I don't think it is HBPP blasphemy at all.

Any portfolio that:

1. Invests in precious metals and
2. Invests in equities and
3. Invests in very safe bonds and
4. Periodically rebalances

is an HBPP to some degree.

[MachineGhost]

Many board members have stories that drove them to the PP, but now have concluded that a composition other than the vanilla 4x25 allocation will resut in a more profitable outcome with some degree of acceptable volatility. I personally lose confidence in the investment philosophy when topics of this nature surface as alternative options. I sincerely hope that I am not making an error in judgement by adhering to the 4x25 allocation and rebalancing between 15/30 bands.

Generally, the simpler and more robust an investment strategy is, the more sloppy risk it takes.  The PP is no exception.  Some of us just can't deal with that, but it doesn't invalidate the entire premise that certain assets do better in certain economic environments.  If you are uncomfortable about alternative weighting schemes, I suspect its because you haven't completely convinced yourself that you are fully comfortable with the risk of the PP before you first invested in it.  If you are not prepared to lose at least 20% of what you put into the PP during a drawdown, then you better re-evaluate because if you don't deal with it now, you will jump ship while it happens and solidify a loss because you originally jumped into the PP with the wrong expectations.

[dualstow]

MG, what do you mean by "sloppy risk"?

[buddtholomew]

Sure, as long as you modify the percentages held in each asset to suit your expectations of future outcomes. Either you hold the PP or you dont.

[MachineGhost]

MG, what do you mean by "sloppy risk"?

Unbalanced.  Outsized gains typically come from overweighted risk exposure that only becomes obvious in hindsight after a crushing loss.  Wall Street is full of such failures.

[buddtholomew]

Many board members have stories that drove them to the PP, but now have concluded that a composition other than the vanilla 4x25 allocation will resut in a more profitable outcome with some degree of acceptable volatility. I personally lose confidence in the investment philosophy when topics of this nature surface as alternative options. I sincerely hope that I am not making an error in judgement by adhering to the 4x25 allocation and rebalancing between 15/30 bands.

Generally, the simpler and more robust an investment strategy is, the more sloppy risk it takes.  The PP is no exception.  Some of us just can't deal with that, but it doesn't invalidate the entire premise that certain assets do better in certain economic environments.  If you are uncomfortable about alternative weighting schemes, I suspect its because you haven't completely convinced yourself that you are fully comfortable with the risk of the PP before you first invested in it.  If you are not prepared to lose at least 20% of what you put into the PP during a drawdown, then you better re-evaluate because if you don't deal with it now, you will jump ship while it happens and solidify a loss because you originally jumped into the PP with the wrong expectations.

So, if Im not comfortable with a 20% drawdown, what should I do today, tomorrow, a week, year or decade from now? Become an active manager and adjust allocations based on perceived economic conditions? Seems like a recipe for disaster to me and the reason why an established allocation was so attractive in the first place.

[iwealth]

So, if Im not comfortable with a 20% drawdown, what should I do today, tomorrow, a week, year or decade from now? Become an active manager and adjust allocations based on perceived economic conditions? Seems like a recipe for disaster to me and the reason why an established allocation was so attractive in the first place.

Budd you seem like the kind of guy that may be interested in a lower-volatility, yet still sort of a PP mix.

Maybe for stocks use a low-beta fund like SPLV (compare it to VTI or SPY, you may like the charts). Hold a 5-yr treasury bullet instead of the barbell. And gold, well, not totally sure what to do about gold. Maybe just hold less of it - or sell out of the money covered calls on it. That way it'll still provide some protection when gold rises. But when it is falling, you are at least pulling some "income" out of it. Worst case scenario is gold goes gangbusters, and it gets called away from you. You still got some of the gains, and hopefully your low-beta stocks and intermediate treasuries were low volatility enough that you didn't get smoked in that scenario.

Just some thoughts, and something I've considered doing myself.

[buddtholomew]

So, if Im not comfortable with a 20% drawdown, what should I do today, tomorrow, a week, year or decade from now? Become an active manager and adjust allocations based on perceived economic conditions? Seems like a recipe for disaster to me and the reason why an established allocation was so attractive in the first place.

Budd you seem like the kind of guy that may be interested in a lower-volatility, yet still sort of a PP mix.

Maybe for stocks use a low-beta fund like SPLV (compare it to VTI or SPY, you may like the charts). Hold a 5-yr treasury bullet instead of the barbell. And gold, well, not totally sure what to do about gold. Maybe just hold less of it - or sell out of the money covered calls on it. That way it'll still provide some protection when gold rises. But when it is falling, you are at least pulling some "income" out of it. Worst case scenario is gold goes gangbusters, and it gets called away from you. You still got some of the gains, and hopefully your low-beta stocks and intermediate treasuries were low volatility enough that you didn't get smoked in that scenario.

Just some thoughts, and something I've considered doing myself.

Thanks for the comments, but I am a staunch advocate of 4x25. The balance of my portfolio (VP) is 60/40. I am arguing against modifying the vanilla PP percentages as some have suggested if it was not clear from previous posts in this thread.

[MachineGhost]

So, if Im not comfortable with a 20% drawdown, what should I do today, tomorrow, a week, year or decade from now? Become an active manager and adjust allocations based on perceived economic conditions? Seems like a recipe for disaster to me and the reason why an established allocation was so attractive in the first place.

I think you misunderstand what the alternative strategic weightings are for.  They're not for responding to economic conditions or predicting the future, but to reduce the portfolio risk of the vanilla PP.  That's all.  Don't add more to it than there really is.  The simplest solution is just to increase cash and decrease the other assets proportionately to a risk target you're comfortable with.  You don't have to get all fancy with risk parity portfolios or what not.  There's nothing magical about the 25x4 -- it was a simplified portfolio thrown together in 1987 by HB for mainstream investors.  His great contribution is correlation of asset classes to economic conditions, not equal weighting a portfolio.

[buddtholomew]

So, if Im not comfortable with a 20% drawdown, what should I do today, tomorrow, a week, year or decade from now? Become an active manager and adjust allocations based on perceived economic conditions? Seems like a recipe for disaster to me and the reason why an established allocation was so attractive in the first place.

I think you misunderstand what the alternative strategic weightings are for.  They're not for responding to economic conditions or predicting the future, but to reduce the portfolio risk of the vanilla PP.  That's all.  Don't add more to it than there really is.  The simplest solution is just to increase cash and decrease the other assets proportionately to a risk target you're comfortable with.  You don't have to get all fancy with risk parity portfolios or what not.

Who says adding more cash decreases portfolio risk? 25% seems like a good enough amount of cash to me. There is no optimal allocation, but changing proportions based on some analysis is prohibitive since future outcomes are unknown. Im not trying to be argumentative, but active management doesnt allow us to achieve the CAGR that the PP has earned over the last 40 or so years. Asset classes fall out of favor from time to time. We cant predict which one or when.

[MachineGhost]

Who says adding more cash decreases portfolio risk? 25% seems like a good enough amount of cash to me.

I say it does and you can easily verify it.  But I sense you're acting defensive and anchoring to your vanilla PP, so I'm bowing out of this thread.

[buddtholomew]

Who says adding more cash decreases portfolio risk? 25% seems like a good enough amount of cash to me.

I say it does and you can easily verify it.  But I sense you're acting defensive and anchoring to your vanilla PP, so I'm bowing out of this thread.

Of course Im anchoring, thats the point. I believe in the allocation. Good luck in predicting which assets will outperform moving forward based on your analysis. I wish you the best.

[Libertarian666]

I think it's amusing that there are still people who seem to believe that cash is riskless.
To some extent, you have a choice of which types of risk you want to take, and in which proportions, although of course there are always unknown risks as well.
But the most important point is that there is no such thing as a riskless investment.

[Pointedstick]

Who says adding more cash decreases portfolio risk? 25% seems like a good enough amount of cash to me.

I say it does and you can easily verify it.  But I sense you're acting defensive and anchoring to your vanilla PP, so I'm bowing out of this thread.

Of course Im anchoring, thats the point. I believe in the allocation. Good luck in predicting which assets will outperform moving forward based on your analysis. I wish you the best.

MG isn't saying anything of the sort. He's just saying that if you want a portfolio that preserves the theory behind the PP, you can underweight all the non-cash assets equally and overweight the cash. The role of cash in the PP is that it does well in tight-money recessions, but for any portfolio--the PP included--it serves another role as well: replacing volatile assets with cash will reduce the volatility. So that's what MG is suggesting. I think it's a perfectly sensible suggestion for someone who wants to avoid the (still low by comparison to other portfolios) volatility of a 4x25 HBPP.

For example: 55% cash, 15% stocks, gold, and LTTs:



You'd still have very PP-like performance, but would sacrifice a bit of returns for dampened volatility.

[buddtholomew]

Funny, I dont see any mention of this composition in the literature, HB's or CR's. Backtesting may prove out this allocation, but check the sticky on the merits of using such a strategy. Posts like these are a disservice to new PP investors in my opinion.

[Tyler]

No need to worry, Budd.  In my experience, it's human nature for people to constantly be looking for ways to optimize investments.  That goes triple for anyone in engineering or finance, as it's how they're hard wired to think (I struggle with this often). You won't find a single investment in the world that someone isn't trying to improve upon. 

Find what you're comfortable with, and don't sweat the calculations of others.  For me, the standard HBPP is already so much better than how I invested before that I'd prefer to redirect any additional fine-tuning brainpower to other things in life with a higher payoff.