Gyroscopic Investing

So we hold gold because it protects us from devastating inflation and negative real interest rates. In the face of slight-to-moderate inflation, we hold T-bills, which will (probably, hopefully) at least keep pace. But what if they don't? They certainly aren't right now. And historically, gold didn't do a lot to protect people from the moderate inflation in the 80s and 90s. A goldbug worried about the very real destructive power of 4-6% inflation would have been devastated.

I know TIPS are very unpopular here, on the basis that you can't rely on a government product that supposedly protects you from a government-created problem. I agree when we're talking about high inflation--a condition in which TIPS have never been tested. But TIPS have been tested pretty thoroughly under conditions of low to moderate inflation, and it seems like they've performed as expected so far.

This is just a thought, and I haven't implemented it (nor do I think I will), but has anyone considered dividing their gold holding between gold and TIPS on the theory that both together will provide a better hedge against all types of inflation than just gold, which protects you best during high inflation?

Backtesting reveals that this adjustment would have slightly reduced returns, but halved the volatility. Here's a portfolio that splits the gold allocation between gold and TIPS:



Compared to the standard PP:



Thoughts?

All the data on TIPS before 1997 is synthetic. I wouldn't trust any of it.

Pointedstick,

What happens if you replace the 12% in TIPS with 6% in both STT and LTT?

So you'll have:
25% Stocks
31% STT
31% LTT
13% Gold

TIPS should replace cash, not gold.  I-Bonds are even better.

Maybe for very big portfolios.

"Rich" people should use more instruments for the 4 ASSETS.

Right?

frugal wrote: Maybe for very big portfolios.

"Rich" people should use more instruments for the 4 ASSETS.

Right?

Ray Dalio of Bridgewater Associates says you get significantly increasing benefits by using as many as 15 different (uncorrelated) assets, see http://articles.businessinsider.com/201 ... ance-sheet.

On the other hand, Dalio's "All Weather" fund lost about 8.9% in 2008 vs. a loss of 2.1% for the PP.  See http://seekingalpha.com/article/878251- ... -portfolio for an analysis. Curiously, the All Weather fund has a better 10-year average return (9.5% vs. 9.1%) with a lower std dev (5.6% vs. 6.2%), but suffered both a larger max draw down (20% vs. 15.3%) and a larger loss in 2008.

It could be that the PP just got lucky in 2008.  Or it could be that the assets Dalio had in the All Weather fund weren't as uncorrelated as he thought.

Back to your question - should rich people use more than 4 assets?  Dalio's theory says yes.  Actual returns in 2008 arguably say no.

rickb wrote:

frugal wrote: Maybe for very big portfolios.

"Rich" people should use more instruments for the 4 ASSETS.

Right?

Ray Dalio of Bridgewater Associates says you get significantly increasing benefits by using as many as 15 different (uncorrelated) assets, see http://articles.businessinsider.com/201 ... ance-sheet.

On the other hand, Dalio's "All Weather" fund lost about 8.9% in 2008 vs. a loss of 2.1% for the PP.  See http://seekingalpha.com/article/878251- ... -portfolio for an analysis. Curiously, the All Weather fund has a better 10-year average return (9.5% vs. 9.1%) with a lower std dev (5.6% vs. 6.2%), but suffered both a larger max draw down (20% vs. 15.3%) and a larger loss in 2008.

It could be that the PP just got lucky in 2008.  Or it could be that the assets Dalio had in the All Weather fund weren't as uncorrelated as he thought.

Back to your question - should rich people use more than 4 assets?  Dalio's theory says yes.  Actual returns in 2008 arguably say no.

Good answer.

A person with money income growing will diversify more, using more than 2 portfolios.

And for each asset will use various ETF's.

Imagine you win now 1million, what would you do?

Interesting idea.  It would be nice to have some protection for preserving the buying power of cash in eras (like now) where interest rates are well below inflation. 

The only problem is that intermediate term TIPS funds behave a lot like bonds, and will only keep pace with inflation - not carry the rest of the portfolio.  I agree with MG about using I Bonds for cash, but what about using TIPS for a portion of the bond allocation, and leaving gold as is?  LTPZ (15+ year tips index fund) and TLT have performed similarly in the low inflation environment of the past year.

What did you conclude, PS?

BearBones wrote: What did you conclude, PS?

I didn't end up changing anything. The only thing I could bring myself to imaging replacing with TIPS was cash, but TIPS are doing just as badly or even worse than cash these days. And the longer-duration TIPS funds seem to have oddly stock-like behavior.

frugal wrote: A person with money income growing will diversify more, using more than 2 portfolios.

And for each asset will use various ETF's.

Why?

Imagine you win now 1million, what would you do?

Currently my PP is about 40% of my investable assets.  The 60% VP is mostly in silver, gold, and individual companies.

If I was handed a million dollars, I'd probably divide it between my PP and my VP, but probably my PP would get less than 40% (thus dropping the PP portion to less than 40% overall).  I don't imagine much change in my current investments, mostly just more of each.  (Re. ETFs or funds in general, I have VBK, TLT, EDV, SHY and CEF in my PP, CEF, GDX and GDXJ in my VP.  Sometimes I hold IAU and SLV.  I also have about 45-50 other individual companies but no other funds.)

Why?

Because the more liquid assets I have, the lower proportion I need "safe" and the corollary, the higher proportion I can put at risk without risking my future.

It's somewhat comparable to insurance.  The more assets you have, the less insurance you need.  For example, most states will allow you to waive auto insurance (let you "self-insure") if you can demonstrate sufficient means (often posting a bond is required to ensure those assets remain available to meet any liabilities).  Or example 2, life insurance, if your family is accustomed to living off $50,000 per year and you have a liquid $2,000,000 portfolio, you most likely don't need life insurance.

I'm no longer in a position where I am waiting for more assets in order to add diversification.  While I might add another few companies, or maybe an ETF or two, in general I think my portfolio is sufficiently diversified.  (Or I might eliminate a holding or a few if the reason why I hold them no longer exists, with no urgent need to replace them.)

AgAuMoney wrote: Why?

Because the more liquid assets I have, the lower proportion I need "safe" and the corollary, the higher proportion I can put at risk without risking my future.

What's interesting is that the trend appears to reverse again once you have a really huge amount. At the point when you have, say, $100 million, you no longer really need to risk it much for greater gain. Most of the people with this much money seem to focus a lot more on capital preservation. Even a 1% loss could represent a million dollars disappearing!

Pointedstick wrote: The only thing I could bring myself to imaging replacing with TIPS was cash, but TIPS are doing just as badly or even worse than cash these days. And the longer-duration TIPS funds seem to have oddly stock-like behavior.

Indeed.

My problem with TIPS is two-fold:

1. The inflation computation they index is not a close match to my personal experienced inflation.
2. Even with #1, the operation of TIPS is extremely tax inefficient and will cause losses.  (Normally a gov't bill/note/bond is tax advantaged, but TIPS are not.

To me it seems like TIPS are provided solely to provide an expensive option for those who are desperate to hold large quantities of cash, or are stupid enough to use TIPS in spite of better alternatives.  (e.g. I-Bonds, amounts suitable for most individuals' and couples' cash needs.)

Pointedstick wrote:

AgAuMoney wrote: Why?

Because the more liquid assets I have, the lower proportion I need "safe" and the corollary, the higher proportion I can put at risk without risking my future.

What's interesting is that the trend appears to reverse again once you have a really huge amount.

That's true, for some people.  E.g. a few years ago it came out that Suze Orman had almost her entire portfolio in bonds, with about 1% in stocks, even tho she recommends people invest largely in stocks.

Not so true for others, e.g. Warren Buffett, George Soros, Donald Trump (not sure what his current mix is).

I think largely it is psychological.  Are you someone just looking to build up the "safe" pot to a certain target and cannot wait until it hits that target and you never have to deal with or worry about it again?  Or are you someone comfortable with businesses operating and producing for you, with some success and some failure, and just letting your investments continue in that model?

Desert wrote:

AgAuMoney wrote:Currently my PP is about 40% of my investable assets.  The 60% VP is mostly in silver, gold, and individual companies.

I'm curious, of your total portfolio, about what percentage is in gold + silver?

As of Friday, about 28.5%.  I don't have a breakdown how much is gold vs. silver, but since it is mostly in CEF and they generally run close to 1:1 (by value) it is probably close to that.  I've seen my percentage above 35%, but stocks have been on a tear lately, gold and silver not so much.

MangoMan wrote: AgAuMoney, what is your take on why mining stocks continue to do so poorly?

I attribute it primarily to uncertainty.

In this case, the cost of production figures are all over the map, and in large part because of energy costs.  Some of the big producers are quoting numbers that as recently as 5 years ago would have made them unprofitable.  They are currently profitable, but less than a year ago as gold and silver really haven't done much in a year, while costs have climbed.

Will gold and silver go up?  Faster than energy?

Or will we get the deflationary recession the Fed is frantically trying to prevent?

Or maybe the economy really is recovering and good days are on the horizon?

I don't think anyone has much certainty these days.

When future profitability is in this much doubt, it is hard to have much faith in mining companies and their ability to produce profits for investors.

Pointedstick wrote: ↑Mon Jan 07, 2013 11:41 am So we hold gold because it protects us from devastating inflation and negative real interest rates. In the face of slight-to-moderate inflation, we hold T-bills, which will (probably, hopefully) at least keep pace. But what if they don't? They certainly aren't right now. And historically, gold didn't do a lot to protect people from the moderate inflation in the 80s and 90s. A goldbug worried about the very real destructive power of 4-6% inflation would have been devastated.

I know TIPS are very unpopular here, on the basis that you can't rely on a government product that supposedly protects you from a government-created problem. I agree when we're talking about high inflation--a condition in which TIPS have never been tested. But TIPS have been tested pretty thoroughly under conditions of low to moderate inflation, and it seems like they've performed as expected so far.

This is just a thought, and I haven't implemented it (nor do I think I will), but has anyone considered dividing their gold holding between gold and TIPS on the theory that both together will provide a better hedge against all types of inflation than just gold, which protects you best during high inflation?

Backtesting reveals that this adjustment would have slightly reduced returns, but halved the volatility. Here's a portfolio that splits the gold allocation between gold and TIPS:



Compared to the standard PP:



Thoughts?

Pointedstick makes the case for holding TIPS.....

Vinny