Need Advice on 25% Bond Allocation

[Exocet]

Given my current Australian residence, I cannot buy TLT or US Treasury bonds directly.  I can't find a similar option - my options are:

1) Buy 10-year Australian Treasuries (AAA) directly
2) Buy a mutual fund of Australian Treasury (50%) plus Australian Federal and State Government bonds (mix of AAA and AA) with a 5 year duration
3) Buy a mutual fund of Australian Treasury, Government Bond and Corporate Bond (AA) with a 4 year duraction
4) Buy a mutual fund of global treasury and government bonds (33% Australian, 33% US, 33% European/Japan), AA-rated, 5-year duraction

None of these alternatives behaved as TLT did during the 2008 Lehman crisis. Therefore, I suspect that they won't provide me with the protection that HB intended for the 25% bond allocation against deflationary depression.

What is your recommendation as to what I should do with my bond allocation?

Thanks.

[AdamA]

I think you could probably buy the 10 year bonds directly, but make them 50% of your PP.  Make the rest 25% stocks and 25% gold.

[Ad Orientem]

Exocet
Are you an Australian citizen or an expat living there?  In general you would want to keep the bonds and cash portion of your portfolio in the currency of your country.

If you are an Aussie I would suggest going with the longest duration AAA rated government bonds you can buy.  I don't know how Australian government bonds work so their maturity options are a mystery to me.  But I do recall reading in Harry Browne's Fail Safe Investing a part that I haven't seen mentioned here.  In the section about bonds he said if people were comfortable with a slightly higher risk level for increased return that they could consider AAA rated corporates.  Under normal circumstances I would shy away from that.  But if long term government bonds are not a viable option you may wish to consider that as an alternative.  I would however stress the need to stick with AAA rated non-callable bonds if at all possible.

Another alternative might be PRPFX if you have any way of investing in US mutual funds.  It's not the HB PP but it is IMHO a good second choice when for whatever reason the HB PP is not doable.

[Exocet]

Thank you Adam and Ad Or.

I'm an Australian citizen.  I guess the real challenge is the lack of long-term maturities, whether treasury or AAA corporate.  The longest is 10 years.  The real problem is that this time horizon does not really protect against serious deflation - they do not behave like TLT.  I was reviewing the excellent bond FAQ here and I can definitely say that an Australian treasury 10-year bond did not behave like TLT did during the late 2008 (Lehman collapse).  If another world event like that happened, I wouldn't get the protection that TLT is meant to provide in the context of PP.

There are really good Vanguard bond mutual funds available in Australia, either 100% Au govt or world mix.  However, their duration hardly gets to 5 years.  This definitely defeats the purpose of my PP bond allocation.

[AdamA]

I was reviewing the excellent bond FAQ here and I can definitely say that an Australian treasury 10-year bond did not behave like TLT did during the late 2008 (Lehman collapse). 

How did they behave?

[D]

Just open a US-based brokerage account and you can buy US treasuries directly. See the post on how to buy them at Fidelity. 

[Exocet]

I was reviewing the excellent bond FAQ here and I can definitely say that an Australian treasury 10-year bond did not behave like TLT did during the late 2008 (Lehman collapse). 

How did they behave?

Whereas TLT went up as a result of safe haven buying during Sep 08 to Mar 09, 5-year bonds were almost perfectly correlated with gold and stocks (i.e., the three of them went down).  It defeated the purpose of having bonds to compensate for the loses on the other 25% allocations.

[AdamA]

As much as stocks and gold?  How long did it take them to recover?

[Exocet]

Just open a US-based brokerage account and you can buy US treasuries directly. See the post on how to buy them at Fidelity. 

A workmate (also Australian citizen) has a Fidelity account.  He's mentioned that he has had terrible problems in withdrawing funds via wire or any method other than issuing a check to himself.  The problem with this is that it takes 3 weeks' clearing time plus the exchange rate used when converting it to AU$ is a rip-off. 

[D]

Just open a US-based brokerage account and you can buy US treasuries directly. See the post on how to buy them at Fidelity. 

A workmate (also Australian citizen) has a Fidelity account.  He's mentioned that he has had terrible problems in withdrawing funds via wire or any method other than issuing a check to himself.  The problem with this is that it takes 3 weeks' clearing time plus the exchange rate used when converting it to AU$ is a rip-off. 

Then just go with InteractiveBrokers. You can buy treasury with them for a very low fee instead of free, and IB rocks for forex exchange and wires are cheap (I think 1 per month is even free).

[Ad Orientem]

Just open a US-based brokerage account and you can buy US treasuries directly. See the post on how to buy them at Fidelity.  

A workmate (also Australian citizen) has a Fidelity account.  He's mentioned that he has had terrible problems in withdrawing funds via wire or any method other than issuing a check to himself.  The problem with this is that it takes 3 weeks' clearing time plus the exchange rate used when converting it to AU$ is a rip-off.  

Exocet,
Sorry for the delay in getting back to you.  I have been a bit busy.  This sounds like a good opportunity to kill two birds with one stone.  I would suggest setting up your PP via an offshore bank account.  If your investment options are as limited as they sound from your posts in Australia, then look outside your country.  

Harry Browne strongly encouraged people to keep at least some of their money outside their home country.  There are a number of possibilities that are not too far from you.  Singapore and Hong Kong both have reputations as financial service centers for the Asian Pacific Region.  Be prepared to shell out a minimum investment that might be steep if you are just beginning to invest.  But beyond that there are a lot of banks that will be more than happy to take your money.  And you have the added advantage of not being a US citizen which in recent years has become a fast way to get bank doors slammed in your face.  (Thank you very much Mr. IRS.)  

Heck, if you really wanted to you could even open a Swiss Bank Account, something most of us Yanks no longer can do.  Again though, be prepared for a steep minimum investment and they charge account maintenance fees even on passively managed portfolios.  While true bank secrecy is pretty much dead, Switzerland is still probably the safest place to park money.  And then there is that whole Swiss Bank mystique lol.  

Here is a list of of offshore banking centers you can look into.  http://en.wikipedia.org/wiki/Offshore_b ... al_centres

[LonerMatt]

As much as stocks and gold?  How long did it take them to recover?

Interested in this answer, I am also having issues thinking about bonds in Australia - there are long term bonds (the longest available matures in 2030, but yields 2.75% :S) - I would like to understand whether or not this is a satisfactory option under the HBPP, or whether I need to consider alternatives.

[stone]

I suppose economies like Australia that have so much riding on commodity exports suffer big currency swings when a global down turn hits. Is it true that for Australians, gold (in Aus$ terms) did very well for the 2008 crash but hasn't grown much since? Does the extra swing for gold mean that the Australian PP still has low volatility (ie did the increase in gold balance the stocks and LTT)? I'd be very careful to check that putting US LTT into an Australian PP doesn't stop it working. With hindsight, one might say that, for a certain previous period, Japanese STT, Brazilian stocks  and US LTT or whatever would have been ideal but that is very different from saying that looking forward. If say the Australian currency gets very strong, then Australian stocks and gold might suffer but Australian LTT be very good and US LTT very bad in Australian$ terms.

[LonerMatt]

Is it true that for Australians, gold (in Aus$ terms) did very well for the 2008 crash but hasn't grown much since?

It looks like gold had a small fall in mid 2008, and then a HUGE run up ($950 to $1350). Now it's a around $1600, but earlier in 2011 it was around $1800 (figures are not perfect, I had to use a 5 year graph, so I'm sorry they are inexact). But, I think gold has done fine since 2008, from my uninformed perspective.

Exocet, can you buy US ETF's?

I'm not sure specifically what we can or cannot buy, but providers such as iShares have options for us (S&P 500) or Vanguard have an etf that follows to US market, too. So it's not impossible.

I'm curious about the 40 (stock) and 60 ('bond) ratio. I had considered setting up something like this in Australia:

25 - Cash (high yield savings account, 6%)
25 - Stocks (ASX top 200)
25 - Gold (Perth Gold Mint has a gold etf)
25 - Bonds (here it's tricky, as I said there are long term bonds, but the returns are around half that of 7-10 year bonds, I don't think I quite understand the bonds part yet)

But, are you suggesting a change to something like this might be better (I'm not interested in retirement for a long time, more in preserving and growing my wealth)?

20 - AUD Short Term Government bonds (1-3 years, could this be replaced with Term Deposits?)
20 - Longer Term inflationary (still Government though) bonds (10-20 Years)
20 - Gold (Perth Mint ETF/Physical, is this a 'stock' or 'bond'?)
20 - US S&P Etf (or is small cap more beneficial?)
20 - AUS ASX 200 ETF (or maybe high dividends?)

I think getting the US bonds would be the hardest part, from where I'm standing, the other problem is that inflation here is significantly higher than that in the US - Australian bonds are typically around 4-6 per cent (except the longer term ones which are 2.5-4ish).

Just trying to fit your logic within the resources I have available, Clive.

[stone]

Loner Matt are you sure about the yields of Australian treasuries? When I googled,
http://www.bloomberg.com/markets/rates- ... australia/
that says 15 years are at 4.16% and ten years are at 3.73%.

Your inflation rate also seems not too bad at 3.5%
http://www.rateinflation.com/inflation- ... n-rate.php

So you are in the very enviable position of having an above inflation treasury interest rate.

The USD has been loosing ground to the Australian dollar for the past decade and may well continue to do so. Your yields are higher than US treasury yields by a significant amount. It might cost you badly to hold US LTT. It could also make your PP much more volatile in AUS$ terms (the US LTT and gold could both fall hard together whenever the Aus$ gains strength). I would think very hard before straying from a straight up 4x25% fully Australian PP.

I think Clive would readily aknowledge that his portfolio suggestion is definately not a PP. Clive is a PP sceptic and doesn't hold one himself. He keeps those that do on their toes justifying the PP approach -which is good .

[LonerMatt]

Loner Matt are you sure about the yields of Australian treasuries?

I check periodically, but I certainly don't have the rates memorised, but that information is over simplified. The Quarterly price is here: http://www.rba.gov.au/fin-services/bond ... index.html , some prices are higher than that 8 years around 5%) others much lower (18 years 2.5%).

I would think very hard before straying from a straight up 4x25% fully Australian PP.

Trust me, I am, I don't have capital to burn, so for beginning investing the more conservative and simpler the better. That being said, I want to try and learn about "PP" alternatives (although am I right in assuming these are all variations of asset allocation?)

I think Clive would readily acknowledge that his portfolio suggestion is definately not a PP. Clive is a PP sceptic and doesn't hold one himself. He keeps those that do on their toes justifying the PP approach -which is good .

Oh, thanks for the information - Clive you're a great help with all those figures and alternatives and critiques - I'm still not sure how owning US bonds would work (in terms of buying and then Australian/US tax although I think I could probably use an firm in Australia with funds in those areas which would simplify things), but it's food for thought, definitely.

I'm curious as to how much of an advantage the changes provide, though.

[LonerMatt]

Ok, thanks for the explanation.

I might try 1 Australia HBPP (since this I understand well) and then move into another different "PP" like you've suggested (which I'm more wary of because I'm not sure how each asset is negatively correlated).

If I am allowed to hazard a guess:

- Gold: works in uncertainty/economies where there is a lack of confidence and recession
- Cash: Deflation/Liquidity (although current interest rates in Australia for cash are around 6%, so that's nice growth too!
- Australian Bonds: Steady income and price goes up in deflationary circumstances (what times are 'ideal' for these, 3-5 years? or Less? Or a mixture of say, 1,3 and 5?)
- US Small Cap - In times of prosperity stocks RISE!!!!!!!!!!!! (any reason why small caps stocks are preferred?)
- US Long Dated Treasury - Protects against deflation, steady income.

One part of the HBPP that appealed to me was the synergy between each asset (as one falls others rise, etc) - this seems more of a conservative growth Portfolio (which is fine, but as I am trying to understand it, quite different)

[smurff]

It's comforting to know that as a one-size-fits-all portfolio, the PP is pretty good.  I don't know of another portfolio that is good in all "normal" (non-SHTF) economic conditions, whether one is in retirement, half way through the third career, at university, or still in infancy with a portfolio managed by one's parents.  The PP still works well whether one knows a lot about investing, or is a beginner at it.  It's good no matter if one has a few hundred dollars/pounds/euros or a few million.  I consider myself blessed to have found it, and to have found the people at this forum from whom to learn more about it.

[LonerMatt]

As a one size fits all the PP is pretty good. That's not to say that tweaks aren't appropriate according to each investors individual needs and objectives.

Both of these are reassuring statements that contextualise a lot for me.

Thanks a lot for your work and effort with me, I'll do some backtesting tonight for the 2000s (only the 2000s because they are the only years I know about in terms of economics, but I think that apart from deflation, Australia went through the other economic conditions: recession, stagnation, prosperity, inflation (although not hyperinflation)).

That graph of the yields for bonds is pretty interesting, as I know a lot more about political history than economic, and seeing the spikes is quite fascinating (correlating to political upheavals/high spending governments/etc).

I tried to understand the Farma-French three-factor-model (which went way over my head, absolutely), and I really only grasp that it's a more complete method for analysing data - that being said, the explanation of why use Small Cap stocks makes perfect sense to me (in that, I assume smaller businesses are much more likely to grow quickly during a period of growth and prosperity).

[stone]

Loner Matt, I'm in a rush and will read through this later but there is something very very critical:
The TI series are indexed linked Australian treasuries. That is why the yields are low. You get that yield and then get the index linked uplift ontop of that.

TI408 2.50% 20 Sep 30 1.940 112.373 0.072 112.302 is your index linked treasury maturing in 2030.

TB133 5.50% 21 Apr 23 4.350 112.791 2.434 110.357  is the longest dated Australian conventional treasury.

I think if you are wanting an Australian PP, then hold TB133. Because it is only a 12 year rather than a 30year, perhaps hold a bigger pot (ie 35% TB133 and 15% cash rather than 25%:25%) and also get new 12 year bonds each year or so rather than keeping for 15 years as you would for 30year bonds.

If I was an Australian I would not hold US LTT.

[LonerMatt]

Thanks for the input Stone, there are definitely some great bond prices, and I could certainly 'over' weigh them/consider some bonds part of the "cash" part of my portfolio   .

Also, out of curiosity, why would you not hold US LTT?

[LonerMatt]

Clive, I'm going through some data to try and see how a $40,000 HBPP would have done from January 2000- December 2011.

I used this page (http://www.rba.gov.au/statistics/cash-rate.html) for cash rates, but I'm not sure I calculated them correctly.

My very amateur calculations showed that had I, in 2000, invested $10,000 in Gold, Shares (ASX top 200), a high, but not the highest Bond (11 years) and kept $10,000 in cash in a bank account with an interest rate equivalent to the average cash rate for each year I'd have ended up with $107,506.24.

My calculations have to be wrong. Although Gold is the biggest winner, in 2000 it opened the year at $282.72, and at the start of December 2011 closed at $1598.06. Gold alone accounts for more than 50% of the increases.

Note this incredibly basic version was done without rebalancing or draw downs. Just seeing if there was anything lagging. The stock market was the biggest 'flop', with an "end" of 50% profit over 10 years (5% a year).

Does this change anything?

Some problems with my methods:
- I only looked at prices for gold 3 times a year (January, July and December)
- I chose a single bond available in 2000 that expired in December 2011 that was yielding 6% and chose it (there were higher bond prices that ended sooner - I think if I were to do it, I'd have split the money between a 10 year bond at 6% and a short term, 3 year bond at 10%!)
- When calculating the cash rate, I looked at the RBA website above, calculated the average rate for each year and used that as a compound interest rate. That doesn't take into account the massive run up and then "crash" in 08 very well, but even in a decline, cash is still growing.
- The stocks were the hardest for me: none of the ETFs I'd considered had been around since earlier than 2009, so the ASX website has a tracker of the stock market's performance called XJO (well, top 200 companies), not the small caps we'd discussed, Clive, and I basically took the starting 'rate' (2800) and the ending rate (4200) and used that for calculating. I would have liked to produce something more in depth, but the ASX's chart was tiny, and didn't allow much interaction, so I couldn't tell what exactly the prices were at different points. I'm unhappy with this. There would have been definite declines though, absolutely.

[LonerMatt]

My very amateur calculations showed that had I, in 2000, invested $10,000 in Gold, Shares (ASX top 200), a high, but not the highest Bond (11 years) and kept $10,000 in cash in a bank account with an interest rate equivalent to the average cash rate for each year I'd have ended up with $107,506.24.

My calculations have to be wrong. Although Gold is the biggest winner, in 2000 it opened the year at $282.72, and at the start of December 2011 closed at $1598.06. Gold alone accounts for more than 50% of the increases.

Doesn't look wrong to me. Were you expecting more, or less?

107K end / 40K start = 2.675 gain factor over 11 years

2.675^(1/11) = 1.094 or 9.4% annualised.

If you'd just bought $10K into each of stocks, cash, bonds and gold in 2000 and held as-is until more recent, then (very approximately) you might have seen gains something like

66% from cash, 72% from bonds, 95% from stocks (total returns including income) and a whopping 465% from gold. Average 174% over the 11 years = 2.74 gain factor ^ (1/11) = 9.5% annualised.

The PP has quite a high correlation to gold. i.e. stocks and LTT's tend to somewhat counter balance each other, cash paces inflation, and gold runs somewhat by itself and either adds or detracts.

I didn't have expectations, per se.

I supposed I was shocked by the figure that was accumulated through essentially doing nothing (no rebalancing, at all).

I think if the time period test was the 90s the stocks would have been the bigger increase (although in the early90s I think bonds would have performed well, double digit inflation/interest rates).

I could put together what starting with $10,000 split 4 ways, and adding another $10k to that each year would have looked like, but the equation becomes harder because that money earns interest before it's distributed.

Still, I'm pretty interested in those results, they are pretty cool. The gold price is so high now, it's tempting to wait awhile before doing anything, but then, in 2007, gold wasn't that special (well 33% increase over 4 years isn't BAD), but then it just skyrocketed.

[LonerMatt]

If you go for a PP you go all-in all at once.

For sure, but as we've discussed, it's not as simple as that in Australia (and presumably in the UK/England), choosing the assets isn't difficult, but making sure the right ones are chosen,a dn the right reasons for choosing them maintained, takes a bit more information than I originally had.

[LonerMatt]

which would have uplifted a 10 year treasury with a 6.75% coupon yield (assuming one had existed and been bought perhaps in January 2008, up to around a 20% higher price a year later (9 years remaining). Combined with a 6.75% yield, I'd approximate the gain having been around 27% in total at the time of the large dip down in stock prices.

One thing that's confusing me here is where the 20% higher price comes from - is that from selling the bond to someone else, or the relative worth of the bond and its yield?

I'm not sure how $5000 @ 6.75% is worth 20% more because newer bonds are only being sold at 4%.

That's what I've been struggling with the most.

I agree with your logic regarding the globally diversified PP, but it's something I need to consider more and perhaps add to my stock/bond allocation after learning more about it. The ins and outs of the HBPP still eludes me (as does the application thereof in Australia, to some extent, but that's OK) and the tax situation will be complex, for me.

Once I have a handle on that I will think about branching out. USD is always useful, but thinking about Japan, or even a developing nation (Indonesia's close to home) is also interesting for me. Or is it more PP like to stick with a massive power like US/Japan, rather than an up and coming, yet unproven, place like Indonesia?