Using LTTs in place of STTs for cash?

[Pointedstick]

So we know that in a debt-based monetary system bonds are cash... why bother holding short-term treasuries in the cash portion; why not just go with the long-term treasuries instead? The markets for both are highly liquid and you shouldn't have any trouble selling your bonds to redeem them for actual cash. And both of the treasuries will have similar interest rate risks, and identical brokerage counter-party risk too if you don't hold the cash in actual bills. Is it just because short-term bonds will be a bit more stable, or to account for an inverted yield curve situation? School me!

[MachineGhost]

So we know that in a debt-based monetary system bonds are cash... why bother holding short-term treasuries in the cash portion; why not just go with the long-term treasuries instead? The markets for both are highly liquid and you shouldn't have any trouble selling your bonds to redeem them for actual cash. And both of the treasuries will have similar interest rate risks, and identical brokerage counter-party risk too if you don't hold the cash in actual bills. Is it just because short-term bonds will be a bit more stable, or to account for an inverted yield curve situation? School me!

"Tight money (pre)recession" aka inverted yield curve, or to "break the back of inflation".  We'll see it again in about 8 years, unless the dollar fades away into oblivion first.

The answer you're looking for for the cash portion is I-Bonds.

[hoost]

So we know that in a debt-based monetary system bonds are cash... why bother holding short-term treasuries in the cash portion; why not just go with the long-term treasuries instead? The markets for both are highly liquid and you shouldn't have any trouble selling your bonds to redeem them for actual cash. And both of the treasuries will have similar interest rate risks, and identical brokerage counter-party risk too if you don't hold the cash in actual bills. Is it just because short-term bonds will be a bit more stable, or to account for an inverted yield curve situation? School me!

First I would say that bonds are not cash.  Bonds must be sold to get cash.  The reason to hold short term treasuries as cash is their liquidity, price stability, and lack of default risk.  In a recession, money is normally tight and firms are typically squeezed for cash.  A typical money market fund holds commercial paper and other short term financial instruments that are subject to default risk.  If the firm whose paper your fund holds goes under, you will likely see substantial losses.  You might get some of the money back eventually through the bankruptcy proceedings, but the idea is that in a recession you need the cash now.  I think someone on here posted a link or had a first hand experience with something like this during the Lehman collapse.

If you hold the money in a bank that goes bankrupt, even though your account is FDIC insured, the money might be tied up for a fairly long period of time while the FDIC sorts through everything.  This also assumes that Congress allocates the extra funds for FDIC to cover extra losses (FDIC is horribly under-funded).  All of this takes time and reduces the safety of your cash position.  I'm of the mind that it also doesn't hurt to have some cash and silver coins on hand at the house in case of a bank holiday or natural disaster where you can't get to your money.

Regarding short term vs. long term, short term bonds are less volatile.  For an example, let's take a 1 yr bond, $1000 par value, 5% coupon.  If the interest rate goes to 6%, the bond price drops to $990.  For the same scenario with a 30 yr bond, the price drops to $860.  You want stability with your cash, which is why HB advocated the short term t-bills.  Also, a 3 yr bond drops to $972, so not a crippling loss if you have to cash out. 

I used Investopedia's calculator found here: http://www.investopedia.com/calculator/ ... z1urhxZtvM

[WildAboutHarry]

As hoost said, the differences in volatility between LTTs and cash are astounding.  Compare a chart of EDV (LT zero coupon treasury fund) with SHY (ST Treasury Fund). 

EDV vs. SHY

When LTTs are good they are very good, but when they are bad...  You want the cash portion of the portfolio to be there 24x7, not some fraction of the cash portion.

MachineGhost is right about using I-Bonds for cash.  In today's market, I-Bonds, even though they are currently paying 0% real, are a great deal compared to other cash-type holdings, most of which have negative real yields.

Clive has had several posts about combining the 25% ST plus 25% LT treasury components into a single 50% 5-year treasury ladder.  Not an orthodox HBPP, but past results have been comparable.

[Pointedstick]

EDV is a lot more volatile than TLT, which is what I'm using. A long-term graph of TLT against SHY actually doesn't look quite so bad. It's rarely underperforming SHY, and TLT currently has a dividend yield five times higher, which I'd imagine helps to offset the possible short-term losses you could incur using it as a pseudo-cash-ish asset.

It seems that liquidity isn't a concern since the government bond market of a currency sovereign is going to be highly liquid for bonds with any maturity date, no? If the government is in imminent danger of collapse I can see why folks might not be buying 30-year bonds, but in that case, you're better off with your physical assets (gold, guns, canned food, building materials, etc). So isn't the real difference just volatility? I'll admit to never having read any of HB's investing books (on my to-do list), and I don't have a great idea of what situations cash would do best in. Not saying I'm gonna replace my SHY with TLT, I'm just playing devil's advocate here.

Also, what's the big advantage of I-bonds over TIPS? In both cases you're buying inflation insurance from an inflationist…

[Pointedstick]

Or is the advantage instead that in a rising interest rate environment, the LTTs would let you take advantage of the higher rates faster due to the shorter maturity dates? I'd imagine that a fund of STTs would recover the hit to NAV caused by the rising rates faster than an LTTs fund, and it would also be able to raise its dividend faster than an LTT fund, right?

[melveyr]

The main reason to hold STT is because of rising interest rates. Normally, this rise is accompanied by either economic growth (stocks) and/or inflation (gold).

However, sometimes the Fed attempts to engineer a recession and the rise in interest rates is a pure manipulation. IMO that is why you hold STTs, as a hedge against a Fed engineered recession because in that environment LTT, gold, and stocks will all be dropping.

[hoost]

Or is the advantage instead that in a rising interest rate environment, the LTTs would let you take advantage of the higher rates faster due to the shorter maturity dates? I'd imagine that a fund of STTs would recover the hit to NAV caused by the rising rates faster than an LTTs fund, and it would also be able to raise its dividend faster than an LTT fund, right?

It's easiest to look at it in terms of a single bond, because a fund is simply a large collection of single bonds (at least that's how I look at it).  LTT's are significantly more volatile with respect to interest rate changes than STT's.  The intent of the cash portion is to provide stability for the portfolio and a buffer in times of tight money (recession).  LTT's are anything but stable; they are highly sensitive to interest rate changes and benefit from deflation (falling interest rates).  If interest rates are slowly climbing, LTT's can do okay because the interest payments (paid twice a year) can help sustain the losses to principle; in this type of environment stocks are usually pulling the portfolio.

[WildAboutHarry]

EDV is a lot more volatile than TLT, which is what I'm using.

Right, but recent times have been especially kind to LTTs.  Looking at long-term treasury bonds on the other side of 1981 is not pretty, and if (and I emphasize if) rates rise, LTTs will get hammered.

Also, what's the big advantage of I-bonds over TIPS? In both cases you're buying inflation insurance from an inflationist…

There are a bunch of threads on TIPS on this forum.  In general, most here do not care for them, precisely because of who you are buying inflation insurance from.

I-Bonds are kind of a special case, though, when compared to TIPS.  First, they have real yields that exceed even 10-year TIPS (10-year TIPS are currently yielding less than 0% real).  Second, after a year I-Bonds have a "put" feature that allows you to get all of your money out (less three months interest).  That interest penalty goes away after five years.  Third, the interest on I-Bonds can accrue tax-deferred for up to 30 years.

[MachineGhost]

I-Bonds are kind of a special case, though, when compared to TIPS.  First, they have real yields that exceed even 10-year TIPS (10-year TIPS are currently yielding less than 0% real).  Second, after a year I-Bonds have a "put" feature that allows you to get all of your money out (less three months interest).  That interest penalty goes away after five years.  Third, the interest on I-Bonds can accrue tax-deferred for up to 30 years.

And the principal will never decline in an deflation, i.e. the variable rate has a floor of 0%.

[WildAboutHarry]

And the principal will never decline in an deflation, i.e. the variable rate has a floor of 0%.

Another factor favoring I-Bonds.

A problem with the whole I-Bond/EE-Bond program is how often the Treasury messes around with the terms and conditions.  For a while there it seemed the purchase limit would be $5,000 per year after the demise of paper bonds (the Treasury subsequently raised the annual limit to $10,000).  And while you can currently get up to $5,000 in paper I-Bonds as your income tax refund, I suspect this will last right up to the point that stocks of blank I-Bonds run out.