Gyroscopic Investing

Hi all,

as we all know, cash is useful in times of recession. Until the economy decides where to evolve (depression, inflation or growth), we have this asset to buy other underperformed assets. But concretely, is in times when this three assets decrease in value (prices), that cash emerges as the king: you have cash to buy cheaper assets.

but as far as i am seeing on historic USA data, we never saw a time when this three assets were in negative. And cash doesn't have the kind of volatility that the other three assets have, and really work out when we change in economic cycle. Gold really protects us from inflation and political instability. Bonds and Stocks are obviously important. But cash?

i have made some simulations with PeaktoTrough sim with a portfolio of just 3 assets since 1975, where cash is 0%, and stocks is 50%. Some results:

1. the standard deviation grows from 6,2% to 8,67%. MaxDrawDown goes from -6,28% (PP) to -11,46% (1981 thanks to Volcker). The amount of negative years goes from just 3 to 7.

2. according to relative returns, PP CAGR is 8,54%, while the proposal portfolio goes to 10,17%.

in summary, the risk difference is not wide, and the difference of CAGR is just 1,63 points. But there is a big difference in absolute returns. Starting from 1.000$ in 1975, with PP you end up with a capital of 27.000$, while the second portfolio ends up with a capital of almost 50.000$.

So my question is obvious. Don't you feel cash as an asset that really drops portfolio performance? That i really doesn't provide almost any contribution to the portfolio in comparation to the other 3 assets? that cash could be seeing as spokes in our portfolio wheels that doesn't let us grow in nominal terms? don't you think that from now on, and in the future, central banks will never let interest rates spike like in the 80's, so cash will never work as it should anymore?

big regards :-)

Arturo wrote: ... don't you think that from now on, and in the future, central banks will never let interest rates spike like in the 80's, so cash will never work as it should anymore?

If central banks really could get everything they want, there wouldn't be the fear of deflation that is gripping many people at the moment. They have tried desperately to create a bit of inflation without succeeding. It follows that on the other end of the spectrum that they can't always control inflation when needed.

We will never know what central banks are up to, ten years from now when all bubbles popped cash may be king again.

Just a few thoughts on what you are proposing, Arturo:

1) Almost everyone ponders lowering the cash portion of the PP.
2) Lots of people juice their cash returns with a portion invested in savings bonds, slightly longer duration treasuries or whatever.
3) IF you are relatively young and still accumulating OR you have a massive portfolio, you may be able to have a lower percentage of cash in your PP provided that you are able to handle the extra volatility.
4) Don't underestimate the value of having dry powder in the event we have another 1987 or 2008-2009 situation on our hands. In both cases the window of opportunity was relatively small. I personally got caught with no cash in 2008 when stocks went on sale. LTTs took a about six weeks to really respond.

Others will most likely add to this or tell you to search other cash threads (which you should do if you haven't already).

Hope this helps and good luck with whatever you decide.

I can assure you that if the Fed starts increasing rates before we see a measurable uptick in inflation, we can see stocks, bonds, and gold all decline simultaneously.

A strong dollar is clearly bad for a lot of other things, like multinational companies' shares. But, if the dollar is so strong, it seems like there should be something beneficial in holding a few of them.

Anyway, Arturo, congratulations on being the 263,748th person to suggest dumping cash. Poor cash. 

barrett wrote: Just a few thoughts on what you are proposing, Arturo:

1) Almost everyone ponders lowering the cash portion of the PP.
2) Lots of people juice their cash returns with a portion invested in savings bonds, slightly longer duration treasuries or whatever.
3) IF you are relatively young and still accumulating OR you have a massive portfolio, you may be able to have a lower percentage of cash in your PP provided that you are able to handle the extra volatility.
4) Don't underestimate the value of having dry powder in the event we have another 1987 or 2008-2009 situation on our hands. In both cases the window of opportunity was relatively small. I personally got caught with no cash in 2008 when stocks went on sale. LTTs took a about six weeks to really respond.

Others will most likely add to this or tell you to search other cash threads (which you should do if you haven't already).

Hope this helps and good luck with whatever you decide.

Good questions, Arturo.

You know, I think it all depends on your investment objectives, and how it fits into your life plan. I agree with you, 25% cash seems heavy, so I started playing with the PeakToTrough backtester, and found that below 20% the volatility went up, the MaxDD went up, the # of DD events went up, and because I am in my 50s and recently unemployed (but I will be working very soon) I just didn't want to go there, especially if I have to retire earlier than expected. Also the Sharpe ratio stopped increasing as I decreased cash below 20%, which means the portfolio stops giving better risk-adjusted rewards... it stopped getting smarter with less cash, gave better returns, but at more risk. We all want better returns at same or less risk, right? Or same returns at lower risk.

I mean, if you're a lot younger than me, then maybe you can take the cash down to a much lower amount. Maybe you should be swinging for the fences. How many years do you have until retirement? But it will be a rougher ride, and you can simulate that in the backtesting tools. Whatever you do, have 10% gold at a minimum. I'd have 10% cash at a minimum. Just my gut feel. I haven't backtested those specifically. But you can.

Also consider that the cash part and usually the bonds part of the PP (unless interest rates are increasing) is a great place to hold your family emergency fund, and everyone needs that. I really helped myself before I got laid-off in the oil industry by putting together a 15 MONTH emergency fund, I had PP spread across taxable and tax-deferred accounts, and I'm getting a severance on top of that, so I can eat for almost until real retirement. I always knew the oil industry was fickle, so I've been prepping for years. Do the same if you're in a volatile industry.

iwealth wrote: I can assure you that if the Fed starts increasing rates before we see a measurable uptick in inflation, we can see stocks, bonds, and gold all decline simultaneously.

+1...  or at the end of uncontrolled inflation.

My standard advice about cash is to do enhanced cash management.  There's many ways to skin a cat.

And if you want to juice the portfolio returns, do it in the equity, nowhere else.

Arturo,

Instead of investing in the four PP assets, you can invest in only equities, bonds and gold.  Since cash is not paying any interest, you might as well invest it in the hopes of generating some return - assuming you do not need the cash.

Alternatively, you can invest the cash component in liquid preferred stock.  These pay a fixed interest amount, but tend to act like bonds.  Meaning the price goes down when interest rates increase and vice versa.  I suggest you look at quantumonline.com to learn about and search for preferred shares.

Lastly, you can also invest the cash component in REITs.  But again, there is risk with interest rate increases likely in 2015.

dualstow wrote: Anyway, Arturo, congratulations on being the 263,748th person to suggest dumping cash. Poor cash. 

OK show of hands....who hadn't thought about dumping the cash allocation when they first started off with the PP?  Hmm...can't see any hands.

All of us who have been posting for at least 6 months or thereabouts, hold the full cash allocation.  Check back in the cash threads to get an idea of how we got from A to B.  Maybe we should have a special stickied thread in the cash portion about this.  Something like:  "Cash really isn't trash" or "Cash:  the allocation everyone loves to hate."

Since I am retired, I use the cash portion of the portfolio to live on and rebalance when I get close to 15% (usually about 3 years). If I had a ways to go before retirement and a steady job or business, I might consider less cash. Those of us in or close to retirement would probably be best served with the correct allocations. Don't forget that cash is a good volatility dial for your portfolio. More cash, less volatility for those who don't want wild swings in your portfolio.

Even as a non-retiree, I really like holding cash as my emergency-fund-slash-unexpected-to-only-semi-unexpected-intermediate-term-expenses-fund. You withdraw money from cash and then make it up with your new contributions. Easy peasy way to take care of those expenses without having to dip into your volatile assets and either sell at a loss or trigger capital gains taxes.

Keep in mind your cash is most useful in a bad economy. Not only is it dry powder for rebalancing, but if your life gets caught up in the vortex of a falling market (like losing a job), or you have bad timing like getting injured, family emergency, etc. you won't have to sell depreciated assets to raise cash as you already have it there.

I continue to believe that cash is one of the most under-appreciated assets in investing. Backtested returns hide a lot of volatility and personal circumstances where having a pile of cash to fall back on can be a true life saver.

So no, I wouldn't get rid of my cash...

Hi all,

thanks you all for your answers.

i am a PP investor since some years, so as you can imagine, i have read tons of threads about everything in here. My question about cash (Tbills, CDS, dollars, or wherever) is not about how to allocate it, but if we really obtain a benefit from it.

The money we use for PP is for investment purposes. As far as i read about PP, the cash allocation shouldn't be used as our "cash emergency purposes", or "the wallet for our day by day live purposes". The "cash" allocation is an investment, like Gold or Stocks. Obviously everyone is totally free to use their portfolio the way they want, but in theory, it should be an investment vehicle through a Tbill. Having a 25% in TBills doesn't So is through this position were i sometimes doubt about the allocation. PP assets are designed to provide volatility in times of economic changing cycle. But cash do not provide nothing about it. Is not volatile, and its historic return is not spectacular.

We all know that normally PP gets its power from growth prosperity, and sometimes from other economic cycle periods, like deflation nowdays (look at Tbonds on 2014). But the king is growth, is what drives the human action, what provides real goods and services, what drives world GDP. So when i allocate 25% of my portfolio in an asset that normally do not provide nothing except liquidity in times of recession, is like i am missing a big pie of world growth, and at the same time, i am not getting a reward, like from Gold or TBonds on their economic and political circumstances.

i know that i will not obtain a perfect answer, because it doesn't exist. Like everything about investment, is a matter of risk-return-reward. If i want more CAGR diminishing cash, i will get more risk. Thats all. But i wanted to share my thoughts.

cheers!

But it's not all about CAGR, it's about risk adjusted return. If the Sharpe ratio does not increase as cash goes down, even though CAGR goes up, it means the portfolio is not getting smarter.

How old are you? If young, go partway PP. I am almost 54, and 50% PP. In ten years maybe all PP, or 75%. By age 80 definitely 100% and managed by a robot service, or my daughter.

Arturo, stop thinking in nominal returns and start thinking in real returns.  Then you'll perceive cash as providing a nice return during certain economic environments.  Cash is an investment.  Its a short duration, debt instrument.  The PP is a wealth preservation vehicle, not a growth.  Focus your efforts on the equity and VP if you want to increase reward.

MachineGhost wrote: Arturo, stop thinking in nominal returns and start thinking in real returns.  Then you'll perceive cash as providing a nice return during certain economic environments.  Cash is an investment.  Its a short duration, debt instrument.  The PP is a wealth preservation vehicle, not a growth.  Focus your efforts on the equity and VP if you want to increase reward.

thanks for your advice ;-).

cheers

Make PP cash do double duty as your 3 - 6 month emergency fund, and you will find it not burdensome at all. You cannot pay bills with stock certificates.

MachineGhost wrote: The PP is a wealth preservation vehicle, not a growth.  Focus your efforts on the equity and VP if you want to increase reward.

Actually the PP does both.  Over time, the returns are not far behind what you get with a 100% stock portfolio.  The big difference with the PP, though, is that those returns are more likely to be realized.  Poor investment decisions like dumping stocks after a big crash happen far too often, and all of us have realized that we are not immune to making those mistakes.  I see a lot of avowed Bogleheads churning stock funds to realize theoretical small gains, when what they are probably doing in reality is chasing the latest high performer - which is a recipe for buying high and selling low.  Investment mistakes have a far greater impact on returns than the half point or so of CAGR.  People who sold stocks in 2009, for example, probably haven't regained their losses to this day.  These points are well articulated in CraigR's/MT's book.

Basically what I'm saying is...simplicity and a fixed allocation is worth at least a couple percentage points of CAGR to me.  Perhaps I wouldn't think so if I were a full time investment professional, or had the time to put in to become a true investment expert.  But (also per HB's rules) my time is better spent advancing my career, which should bring me a far better return than trying to divide my time between that and investing.  (and this forum :-).

An important rule of investing is: don't get greedy.
I've live through two >30% stock market declines, I guess a lot of people would have been happy to have had a 25% cash allocation at the time.
With all the central banks intervening all the time now, it's hard to remember bear markets in stocks, spanning for years. Like Germany in the mid-2000s, stocks declining for two or more years.

Can we even imagine that anymore? Stocks declining for years?

But I'm convinced we all will see another bear market in our lifetime.

And isn't it a good feeling to have a large wad of cash, ready to be spent? Unlike stocks or bonds, where one always wonders when to get out.

Pfanni wrote: An important rule of investing is: don't get greedy.

So true

And isn't it a good feeling to have a large wad of cash, ready to be spent? Unlike stocks or bonds, where one always wonders when to get out.

I always remind myself that ultimately, cash is the goal. It's why we invest in the first place.

I love cash. It's one of the reasons I prefer the PP over other options.

Having a substantial cash buffer can sometimes generate a financial premium over other investment vehicles once you consider taxes and expenses that exceed income. For example, when I first bought my house, I made more that year by taking the down payment out of cash than I would have by selling stocks or bonds and paying the associated taxes. And now that I'm at least temporarily retired, having cash to live on while only trading once a year to smartly rebalance (in a way that completely negates taxes) is awesome and enhances my financial life.

Every asset has strengths and weaknesses, and as en engineer I enjoy having a well-stocked tool chest. Cash is an essential tool in my collection.

I haven't read all the responses as I would never consider lowering the allocation to cash. Has anyone raised the point that cash lowers the overall fixed income duration by 50%?

Arturo wrote: The money we use for PP is for investment purposes. As far as i read about PP, the cash allocation shouldn't be used as our "cash emergency purposes", or "the wallet for our day by day live purposes".

I personally think it should be.  That's how Harry Browne used it.  I think it makes sense.  It's when you have 25% + an emergency fund + checking account +, +, +, that you start to look like "gee, I sure have a lot of cash."

As for "does cash really provide a benefit" it sure seems like it could, in theory:

Shannon's Demon

Arturo wrote: The money we use for PP is for investment purposes. As far as i read about PP, the cash allocation shouldn't be used as our "cash emergency purposes", or "the wallet for our day by day live purposes".

I think whether to count PP cash as emergency fund depends on how disciplined you are. If you call "Mayday, Mayday" regularly and spend that cash, then don't count it as PP, and I would submit you don't really have an emergency fund, and you really need to make one, or maybe it's not big enough, or maybe your budget is out of control.

We're at the end of secular bond bull market; stocks have been in a bull market without a major correction for years and are getting choppy; IMHO gold is still a sick man. I don't think it's a good time to trim back on cash. Not now.