25% cash, money market or treasury?

[SanMiguel]

I don't really understand the 25% cash part of the PP.
Some say this should be in a high interest bank account, some say you buy short dated treasuries but then you already have 25% in treasuries in another part of the portfolio.
Is there any problem with holding 50% of the PP in an ETF like IGLT where you have long and short dated treasuries?

[SanMiguel]

anyone?

[Indices]

Use short dated treasuries. In the event of a market crash or some catastrophe the government is going to pay off its own debts first and then will deal with banks. Harry Browne talks about this a great deal in his books. Always buy debt directly from the government, not indirectly through deposit insured accounts issued by private banks.

[moda0306]

The long dated treasuries in the rest of your portfolio are very sensitively subject to interest rate risk.  If inflation hits and/or rates rise considerably, they're bound to drop like crazy, regardless of their reliability of repayment.

You hold very short-term treasury bonds for cash (or a treasury MM fund (basically super short term bonds managed by a company like Vanguard to keep an even value) because under no circumstances do you want it to lose nominal value.

Some MM funds in 2008 were running considerable risk of losing principle.

There's a great podcast of bonds that applies to cash as well, stating that loaning money to anything but an extremely safe entity under extremely safe terms is the equivalent of not having your cake and not eating it, either.  For instance, if a corporation does well and you're a bondholder vs stockholder, you're just going to get paid your interest.  If the company fails, you may have lost almost just as much as the stockholders.  Designing a portfolio around risk/reward means realizing when you are being properly rewarded for the risk your taking, not just in terms of that asset but in terms of the whole portfolio.

Since you hold cash for recessions, it's pointless to loan that cash to the same shaky institutions that are part of the reason for the recession.  Luckily (or unluckily) despite how much the gov't may be the culprit in recessions, as long as they have a printing press, a military, and a huge stock pile of gold, it's very much in their best interests to pay you back, and requires very little effort on their part.  This can't be said about entities of the private sector.

That said, use SHV or short-term treasuries as your cash.  Even FDIC insured accounts are questionable in terms of how quickly you'll get paid in the event of a bank run.

[SanMiguel]

Use short dated treasuries. In the event of a market crash or some catastrophe the government is going to pay off its own debts first and then will deal with banks. Harry Browne talks about this a great deal in his books. Always buy debt directly from the government, not indirectly through deposit insured accounts issued by private banks.

Short term like 6 months or longer?
Every time I make a purchase within a SIPP, it costs me £10 so is there any point in buying short term treasuries at all? May as well just save up the cash as cash and keep adding to lagging parts of the PP.

From my SIPP provider:
Please be advised that when buying Gilts you will be charged one dealing fee per trade no matter how large the deal.
So, each gilt is £1,000 - that's a lot of commission, which makes buying the ETF much much cheaper.

[stone]

SanMiguel, when icesave (the icelandic bank operating in the UK and Netherlands) went bust in 2008, depositors had to wait for many months before getting any money out (I'm not sure whether they all have managed to yet).
http://en.wikipedia.org/wiki/Icesave
Personally I think a treasury ETF is even less secure than a bank account (the ETF providers lend out the treasury holdings and either the ETF provider or the people they have lent the treasuries to could go bust). Holding treasuries directly does seem safer though.

[SanMiguel]

SanMiguel, when icesave (the icelandic bank operating in the UK and Netherlands) went bust in 2008, depositors had to wait for many months before getting any money out (I'm not sure whether they all have managed to yet).
http://en.wikipedia.org/wiki/Icesave
Personally I think a treasury ETF is even less secure than a bank account (the ETF providers lend out the treasury holdings and either the ETF provider or the people they have lent the treasuries to could go bust). Holding treasuries directly does seem safer though.

In theory, you have the right to claim the physical underlying assets if any ETF goes bust.

[Lonestar]

What about a short term treasury fund like Vanguard?  Still looks like it might take a while to recover funds.

Assuming one buys individual US short term bonds (2 years or less), new issue or on secondary market, held in a brokerage account, it might be as difficult to liquidate as a bond mutual fund.  I guess Treasury Direct might be the only direct way to hold treasuries.

I've given thought to this before and I am concerned as to what could potentially happen in a financial crisis.

[SanMiguel]

What about a short term treasury fund like Vanguard?  Still looks like it might take a while to recover funds.

Assuming one buys individual US short term bonds (2 years or less), new issue or on secondary market, held in a brokerage account, it might be as difficult to liquidate as a bond mutual fund.  I guess Treasury Direct might be the only direct way to hold treasuries.

I've given thought to this before and I am concerned as to what could potentially happen in a financial crisis.

Short term treasuries still seem pointless. Why not find a bank account that pays fixed interest for 12 months? These are almost always higher than short term treasuries/gilts?

[KevinW]

Short term treasuries still seem pointless. Why not find a bank account that pays fixed interest for 12 months? These are almost always higher than short term treasuries/gilts?

Because bank accounts have credit risk, and short term treasuries do not.

[SanMiguel]

Short term treasuries still seem pointless. Why not find a bank account that pays fixed interest for 12 months? These are almost always higher than short term treasuries/gilts?

Because bank accounts have credit risk, and short term treasuries do not.

Not in UK. All bank accounts are protected up to 50k by the government.
In fact, I believe the US have similar coverage for banks that go bust.
Short term treasuries have risk that the value may go down although they will be paid in full at redemption, the coupon is almost always lower than what a fixed bank account pays.

[Lone Wolf]

Not in UK. All bank accounts are protected up to 50k by the government.
In fact, I believe the US have similar coverage for banks that go bust.
Short term treasuries have risk that the value may go down although they will be paid in full at redemption, the coupon is almost always lower than what a fixed bank account pays.

Right, the United States has the similar "FDIC" program that insures all bank accounts.  However, the FDIC fund only has enough money to cover a tiny, tiny fraction of all outstanding bank deposits.  It's not nearly enough to withstand a full-scale bank panic.  That much is a given.

The question then becomes what happens afterward.  While it seems somewhat unlikely that depositors would take a "haircut" in the true sense, it seems reasonable to prepare for money in an insolvent bank to be frozen for an indefinite period of time.  That's where stone's example of Icesave is relevant.

I'll be the first to point out that these risks are probably somewhat remote.  Still, it's important to point them out and consider them when deciding how you'll invest.

On the other side of the coin, deposit insurance is clearly an enormous government subsidy.  No private company would offer this kind of insurance for what banks pay into the FDIC fund.  Thus, you get the benefit of this subsidy when you deposit your money into the banking system.

Personally, I like to have the vast majority of my cash in T-bills and T-notes, but I personally don't sweat having a slice in FDIC-insured accounts so long as it's not an excessive amount.

[SanMiguel]

Not in UK. All bank accounts are protected up to 50k by the government.
In fact, I believe the US have similar coverage for banks that go bust.
Short term treasuries have risk that the value may go down although they will be paid in full at redemption, the coupon is almost always lower than what a fixed bank account pays.

Right, the United States has the similar "FDIC" program that insures all bank accounts.  However, the FDIC fund only has enough money to cover a tiny, tiny fraction of all outstanding bank deposits.  It's not nearly enough to withstand a full-scale bank panic.  That much is a given.

The question then becomes what happens afterward.  While it seems somewhat unlikely that depositors would take a "haircut" in the true sense, it seems reasonable to prepare for money in an insolvent bank to be frozen for an indefinite period of time.  That's where stone's example of Icesave is relevant.

I'll be the first to point out that these risks are probably somewhat remote.  Still, it's important to point them out and consider them when deciding how you'll invest.

On the other side of the coin, deposit insurance is clearly an enormous government subsidy.  No private company would offer this kind of insurance for what banks pay into the FDIC fund.  Thus, you get the benefit of this subsidy when you deposit your money into the banking system.

Personally, I like to have the vast majority of my cash in T-bills and T-notes, but I personally don't sweat having a slice in FDIC-insured accounts so long as it's not an excessive amount.

What about governments defaulting on their debt, there is some credit risk there also.
Although it seems everyone gets a bailout anyway

[Lone Wolf]

What about governments defaulting on their debt, there is some credit risk there also.
Although it seems everyone gets a bailout anyway

Sure, you're right that this is a risk to think through.  This is particularly important for members of the Eurozone (as they lack the ability to unilaterally print up a bunch of money to pay their debts the way that the United States federal government can.)  In the United States, I'd expect the government to prefer printing up the money and risking inflation rather than outright default.

Regardless of whether the printing press is available to any given government, keep in mind that banks are going to be holding a great deal of sovereign debt.  If a government throws up its hands on paying off its own debt, banks and pension funds throughout that nation (and beyond!) are instantly going to be in big trouble.  For example, if the US government were to decide it was defaulting (something I see as extremely unlikely), I think that my FDIC-insured savings account would be at great risk as well.

[SanMiguel]

The 25% cash is still a little odd.
"They" say it is used in times of deflation as it gains value but then why does it have to be in bonds at all.
If the only reason not to put it in a bank account is due to credit risk, well if EVERY bank in the country fails, there are going to be a lot more problems than caring about your 25% cash.
Fixed interest seems better than swapping bonds every 6 months.
If it's about the ease of getting hold of your cash then I could understand but this is investment over 30years plus so why would we want to get hold of the cash at all until retirement?

[Lone Wolf]

"They" say it is used in times of deflation as it gains value but then why does it have to be in bonds at all.

Cash is a good thing to have during a deflationary episode but it's your long-term bonds that are supposed to be the really big winners here.

If the only reason not to put it in a bank account is due to credit risk, well if EVERY bank in the country fails, there are going to be a lot more problems than caring about your 25% cash.
Fixed interest seems better than swapping bonds every 6 months.

I see your point but it actually brings me to the opposite conclusion.  When every bank in the country is failing is exactly when you will most want to be able to access your funds.  If things really got that chaotic in the banking system, employment may be challenging to find.  The problem is that even if I had to stop working, my family wouldn't stop eating.  I'd want assurances that I could get to my cash if I needed it.

There's certainly nothing wrong with mixing methods together.  Personally, I have an FDIC-insured checking account, an old CD ladder, an HSA account, and a ladder of Treasury Bills and Notes for my cash portion.  In all likelihood, going 100% into bank accounts probably isn't that big of a deal.  I just like keeping my FDIC exposure limited.

If it's about the ease of getting hold of your cash then I could understand but this is investment over 30years plus so why would we want to get hold of the cash at all until retirement?

Yeah, this is one of those things that cuts both ways.  I know that when interest rates were high, people often kept much of the "cash" slice sheltered in a retirement account.  Browne recommended this in one or more versions of "Fail-Safe Investing".

On the other hand, I very much like having the "cash" portion of the portfolio accessible for unforeseen expenses.  It's nice to have a "unified" view of your finances into which you can fit things like your checking account and "emergency fund".

[SanMiguel]

I suppose the thing is that I see the PP as an investment until I retire...
and when I retire, I will transform the whole portfolio into an income portfolio.
So, holding cash during the current stage seems of little point.
If the cash is supposed to cover a deflation scenario then may as well put all the money into long term bonds in the first place?
After retirement I can see the benefit of having some cash and income drawdown.

Any cash I have from my job goes into rent, bank account anyway.

[Lone Wolf]

I suppose the thing is that I see the PP as an investment until I retire...
and when I retire, I will transform the whole portfolio into an income portfolio.

What did you have in mind for an income portfolio?  I'm curious because although my retirement plans are off in the far future, the PP seems to still fit them quite well.

If the cash is supposed to cover a deflation scenario then may as well put all the money into long term bonds in the first place?

The slight benefit in deflation is secondary for cash.  The cash's main role is to cushion volatility and to provide liquidity and protection during times when all of the assets go down for a (usually brief) period of time.  1981 was a good example and the one that Browne tended to use.  Browne believed that this was mostly likely to happen when the Fed raised interest rates substantially.

When this happens, the cash "softens the blow" and allows you to buy these assets after they have fallen.

Lots of people here have considered what a 3x33 pseudo-PP of stocks, bonds, and gold would look like.  It's an effective (and sometimes tempting) portfolio, but the standard PP happens to suit me just fine.

[SanMiguel]

I suppose the thing is that I see the PP as an investment until I retire...
and when I retire, I will transform the whole portfolio into an income portfolio.

What did you have in mind for an income portfolio?  I'm curious because although my retirement plans are off in the far future, the PP seems to still fit them quite well.

If the cash is supposed to cover a deflation scenario then may as well put all the money into long term bonds in the first place?

The slight benefit in deflation is secondary for cash.  The cash's main role is to cushion volatility and to provide liquidity and protection during times when all of the assets go down for a (usually brief) period of time.  1981 was a good example and the one that Browne tended to use.  Browne believed that this was mostly likely to happen when the Fed raised interest rates substantially.

When this happens, the cash "softens the blow" and allows you to buy these assets after they have fallen.

Lots of people here have considered what a 3x33 pseudo-PP of stocks, bonds, and gold would look like.  It's an effective (and sometimes tempting) portfolio, but the standard PP happens to suit me just fine.

Something like this I think for income: http://www.the-diy-income-investor.com/ ... ramid.html

[AdamA]

Something like this I think for income: http://www.the-diy-income-investor.com/ ... ramid.html

Harry Browne wrote that he thought the PP would work fine for retirement.  He estimated you could withdraw around 4% a year without effecting the principle.

[SanMiguel]

Something like this I think for income: http://www.the-diy-income-investor.com/ ... ramid.html

Harry Browne wrote that he thought the PP would work fine for retirement.  He estimated you could withdraw around 4% a year without effecting the principle.

Except that you can easily get more than 4% through other methods.

[stone]

San Miguel, you need to be wary of whether those "other methods" simply amount to your holdings dissolving into "income" rather than maintaining an inflation proof source of income with the nominal income growing in line with inflation. If you want to draw down your savings faster than the PP throws off "income" then you can always sell whichever asset is overweight (eg sell gold if gold is overweight or whatever).

[SanMiguel]

San Miguel, you need to be wary of whether those "other methods" simply amount to your holdings dissolving into "income" rather than maintaining an inflation proof source of income with the nominal income growing in line with inflation. If you want to draw down your savings faster than the PP throws off "income" then you can always sell whichever asset is overweight (eg sell gold if gold is overweight or whatever).

Have a look at: http://www.the-diy-income-investor.com/ ... ramid.html
Structured income, dividends, coupons.
Normally, you'd expect stock dividends to increase with inflation.
You could hold gold if you had to but I would rather hold it as insurance by retirement.

[stone]

SanMiguel: "Normally, you'd expect stock dividends to increase with inflation."
Everything depends on that being true, and basically the whole point of the PP is that that can not be relied on. 

[SanMiguel]

SanMiguel: "Normally, you'd expect stock dividends to increase with inflation."
Everything depends on that being true, and basically the whole point of the PP is that that can not be relied on. 

So, what would you do for income in a year when the PP doesn't make any money or makes a loss? You'd have to take out capital.