75% Of PP assets have Zero or Negative Expected Real Return
Posted: Fri Oct 14, 2011 7:27 am
A post on Bogleheads today about gold having no real return sparked me to draft a response that I believe the PP community would enjoy:
I'd argue that Cash and Risk Free Bonds have zero (real) return too. In fact, the return may be negative.
Cash is yielding 0% to 1% depending on where you invest it. Inflation is 2% to 3% depending on how you calculate it. That's a real loss of purchasing power.
Risk Free Bonds are yielding 2% to 3% depending on duration. Compared to inflation, you are either netting 0 or have a slight loss.
TBM is not risk-free. Is has non-treasury bonds in it.
That said, I'm doing pretty well with the Permanent Portfolio of 75% assets that have a real return of 0. In fact, PP is beating just about every Boglehead portfolio out there. No guarantee it will continue going forward, but I'll take my chances.
Why is PP doing so good with 75% of assets producing nothing on an inflation adjusted basis? Because "Real" return of a single asset is meaningless. Here's why:
Gold responds to devaluation of the dollar. When this occurs, gold increases tremendously. When this happens, it triggers a rebalancing event so you sell some of the gold at a profit. Thus the return becomes positive.
Long Term Treasuries respond to drops in interest rates. When this occurs, bonds increase tremendously. This triggers a rebalancing event so you sell the bonds at a profit. Thus the return is positive.
Cash just sits there. Relative to cash, it's just cash and of course is neutral. But relative to other assets, holding cash provides "option value" to purchase assets that decrease. If the dollar strengthens, gold drops in price. If interest rates rise, bonds drop in price. When the economy sucks, stocks drop in price. There's "option value" in sitting on cash such that when another asset drops in price, you can purchase it with some of the cash, and "lock in" the low price, to eventually profit off it. Cash itself is losing money when looking at interest, But if you calculate "option value" of sitting in cash, it becomes positive when used as part of a whole portfolio.
If you buy a gold coin now, and in 30 years sell it when you need money, and use that money to buy something, you probably have 0 real return and could buy the same thing with that coin in 30 years that you could buy now.
If you buy a 30 year treasury bond now, hold it to maturity, and spend the proceeds plus interest payments, you can probably only buy the same thing in 30 years that you could buy now.
If you put a chunk of money into a savings account or CD and pull it out in 30 years, you will have slightly less purchasing power in 30 years than now.
Yet, the PP still manages to produce 10% CAGR over the last few decades. Why? Because of the reasons explained above. Assets should not be looked at in isolation They must be looked at with respect to being part of an entire portfolio where rebalancing events occur, trigger sales of assets prior to the "spending" phase.
I'd argue that Cash and Risk Free Bonds have zero (real) return too. In fact, the return may be negative.
Cash is yielding 0% to 1% depending on where you invest it. Inflation is 2% to 3% depending on how you calculate it. That's a real loss of purchasing power.
Risk Free Bonds are yielding 2% to 3% depending on duration. Compared to inflation, you are either netting 0 or have a slight loss.
TBM is not risk-free. Is has non-treasury bonds in it.
That said, I'm doing pretty well with the Permanent Portfolio of 75% assets that have a real return of 0. In fact, PP is beating just about every Boglehead portfolio out there. No guarantee it will continue going forward, but I'll take my chances.
Why is PP doing so good with 75% of assets producing nothing on an inflation adjusted basis? Because "Real" return of a single asset is meaningless. Here's why:
Gold responds to devaluation of the dollar. When this occurs, gold increases tremendously. When this happens, it triggers a rebalancing event so you sell some of the gold at a profit. Thus the return becomes positive.
Long Term Treasuries respond to drops in interest rates. When this occurs, bonds increase tremendously. This triggers a rebalancing event so you sell the bonds at a profit. Thus the return is positive.
Cash just sits there. Relative to cash, it's just cash and of course is neutral. But relative to other assets, holding cash provides "option value" to purchase assets that decrease. If the dollar strengthens, gold drops in price. If interest rates rise, bonds drop in price. When the economy sucks, stocks drop in price. There's "option value" in sitting on cash such that when another asset drops in price, you can purchase it with some of the cash, and "lock in" the low price, to eventually profit off it. Cash itself is losing money when looking at interest, But if you calculate "option value" of sitting in cash, it becomes positive when used as part of a whole portfolio.
If you buy a gold coin now, and in 30 years sell it when you need money, and use that money to buy something, you probably have 0 real return and could buy the same thing with that coin in 30 years that you could buy now.
If you buy a 30 year treasury bond now, hold it to maturity, and spend the proceeds plus interest payments, you can probably only buy the same thing in 30 years that you could buy now.
If you put a chunk of money into a savings account or CD and pull it out in 30 years, you will have slightly less purchasing power in 30 years than now.
Yet, the PP still manages to produce 10% CAGR over the last few decades. Why? Because of the reasons explained above. Assets should not be looked at in isolation They must be looked at with respect to being part of an entire portfolio where rebalancing events occur, trigger sales of assets prior to the "spending" phase.
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