What about VTIPX or VTIP for Cash?

[lazyboy]

Since there such a low return using the Vanguard Short Term Treasury Fund, VFISX, or similar, why not use the new Vanguard Short Term Inflation Protected Securities Fund= VTIPX or the ETF version= VTIP for at least part of the cash holdings? The durations are similar to the Short Term Treasury Fund,  they have the same government backing and the yield has been better on these bonds by about 2 points. I know this issue has been discussed before and I admit to being dense on the subject of bonds but I still don't see a real problem. It's seems that there is little downside and there may be some modest upside potential. Also note, I'm only interested in funds and not into buying individual TIPS especially for the cash portion. I'm retired and want the funds to be highly liquid. So I'm open to finding out from the experts to comment on or compare these contrasting types of funds-  ST Treasuries vs. Inflation Protected ST Securities.  What's the real deal here? 

[melveyr]

You should first ask yourself what role cash plays in the portfolio. From my perspective the 4 way split Permanent Portfolio is basically a watered down risk parity portfolio.

If you think about a 3 way split between Stocks, 30 year Treasuries, and Gold, you are actually employing a form of leverage. The 30 year bond is nearly identical to 10-15 year bond that was bought on margin at the risk free rate.

One could replicate a 3 way PP's returns by doing:
33% Stocks
33% Gold
66% 15 year Bond
-33% cash (borrowed at the risk free rate)

However, because we don't have access to the risk free rate it makes more sense to do:
33% Stocks
33% Gold
33% 30 year Treasury

However the conventional PP is:
25% Stocks
25% Gold
25% 30 year Treasury
25% Cash

The cash effectively introduces a negative leverage that cancels out some of the leveraged effect of a high duration bond. This can be useful because sometimes the Fed raises interest rates to a level where all asset classes get beaten down and the leveraged players get hurt (1981).

If I were considering using a short-term TIPS fund, I would be asking myself if I would be changing this dynamic. For what its worth, I don't think that cash is a necessary part of the PP, the very fact that one is holding a 30 year bond and holding T-Bills is somewhat of a contradiction. It's kind of a personal thing of how much negative leverage you want to have.

[lazyboy]

Thanks melveyr, for a thoughtful reply, even though it's a bit beyond my econ. 1 level of understanding. I see the need for cash as portfolio balast and since I'm in withdrawal mode, I need to have it ready and stable. My cash tends to hover nearer the 15% rebalancing levels because of how the portfolio has been working and also because I'm drawing it down from that bucket for living expenses. Right now it's at around 17%.
I'm not really sure how a short terms tips fund would change the dynamic of "negative leverage" that cash provides. My simplistic understanding is that it would function as a slightly leveraged bet for short term inflation. I'm not sure how that would actually play out in the 1981 scenario that you mentioned. It should theoretically respond favorably compared to cash, although I'm not sure that can be proven since these bonds didn't, to my knowledge, exist then. 

[melveyr]

Thanks melveyr, for a thoughtful reply, even though it's a bit beyond my econ. 1 level of understanding. I see the need for cash as portfolio balast and since I'm in withdrawal mode, I need to have it ready and stable. My cash tends to hover nearer the 15% rebalancing levels because of how the portfolio has been working and also because I'm drawing it down from that bucket for living expenses. Right now it's at around 17%.
I'm not really sure how a short terms tips fund would change the dynamic of "negative leverage" that cash provides. My simplistic understanding is that it would function as a slightly leveraged bet for short term inflation. I'm not sure how that would actually play out in the 1981 scenario that you mentioned. It should theoretically respond favorably compared to cash, although I'm not sure that can be proven since these bonds didn't, to my knowledge, exist then.

This is a new way of thinking about leverage for me as well (I didn't come up with it!) but it makes sense to me. Kind of interesting to think about how perpetually rolling over a 30 year bond has a very similar effect as borrowing money at the risk-free rate to perpetually roll over a 15 year bond. Using duration, the bond market allows us to effectively borrow at very low rates! Harry Browne was a very smart man 

FWIW I have adulterated my cash allocation with some I-Bonds... They are just such a sweet deal 

[melveyr]

melveyr, please clarify. Since the 3x33 example above using 30y LTT is a leveraged PP, and the OP was asking about using ST Tips to increase cash returns slightly, wouldn't a better solution be to use:

25% TSM
25% Gold
50% Intermediate term Treasuries

or, has anyone considered

25% TSM
25% Gold
25% ITT
25% IT TIPs

Assuming the weighted duration ends up being the same, the 50% ITT would probably have a slightly higher return than splitting it into 25% T-Bills and 25% 30 years. When splitting it up, you are paying for leverage at a rate slightly higher than the risk-free rate (think of the 30 year as borrowing money to buy a 10 year), but are then subsequently buying an investment that returns the risk free rate.

Now, this analysis ignores the rebalancing effects that having them separated can offer. Additionally, I like being able to surgically place different parts of the yield curve into tax/non-tax accounts so I don't mind paying up for the leverage. Finally, when you use savings bonds/i-bonds as your cash you probably do come out ahead splitting out the Treasuries allocation into the barbell over simply going 50% intermediate.

Sorry if this is veering in strange directions. Ironically, the cash allocation is one of the most complicated parts of the portfolio theoretically as well as for execution.

[lazyboy]

Thanks for the replies and information, everyone. The responses, so far, show that there doesn't seem to be any strong argument for or against using a short term inflation protected bond fund like VTIPX for cash. I'm inclined to give it a try for part of my cash position.

[frugal]

hi,

cash can be with 1-3 years germany bonds?

IBCA:xetr
iShares € Government Bond 1-3


Tks

[Pointedstick]

hi,

cash can be with 1-3 years germany bonds?

IBCA:xetr
iShares € Government Bond 1-3


Tks

Sure, I think that's safe. I have some cash in a 1-3yr U.S. bond fund and I don't sleep poorly at night. Just keep in mind that the longer the duration of the bonds, the more interest rate risk you take on, even though you can squeeze out a bit more yield... there's no free lunch!

[frugal]

hi,

cash can be with 1-3 years germany bonds?

IBCA:xetr
iShares € Government Bond 1-3


Tks

Sure, I think that's safe. I have some cash in a 1-3yr U.S. bond fund and I don't sleep poorly at night. Just keep in mind that the longer the duration of the bonds, the more interest rate risk you take on, even though you can squeeze out a bit more yield... there's no free lunch!

So it doesn't have to be all CASH less than 1 YEAR?

We can mix 1-3YEARS with < 1 YEAR  ?

Can you explain me the reason behind this options?


Thank you very much.

[Pointedstick]

So it doesn't have to be all CASH less than 1 YEAR?

We can mix 1-3YEARS with < 1 YEAR  ?

Can you explain me the reason behind this options?


Thank you very much.

Ask yourself what purpose cash and bonds serve in the portfolio. Protection during tight money recessions and deflation, respectively. But why do they offer this protection? What is it that changes their value? The answer is interest rates. During deflation, rates are typically falling, while tight money recessions are characterized by rapidly rising rates. So we can say that bonds rise in value when interest rates fall, while cash adjusts quickly to rising interest rates. That's why we hold both: to hedge our bets regarding whether interest rates will rise or fall.

Knowing this, we can manipulate our bond and cash allocations according to our tolerance for various interest rate risks. If you have 3-month bonds, you'll be receiving lower coupon payments, but in a rising rate situation, you also only have to deal with a three months of rising rates before those short-duration bonds return your capital to you and you can purchase new bonds at the higher rate. Shorter duration bonds therefore let you adjust more quickly. 3-year bonds, on the other hand, are at the long end of what's acceptable, and in a rising interest rate situation, you'd have to wait 3 years before those bonds returned your capital and you could buy new ones at the higher interest rates.

So ask yourself: are you okay with the possibility of giving up as many as 3 years of higher interest rates in exchange for a slightly higher coupon payment today? There's no right or wrong answer; it depends on your own tolerance for interest rate risk and belief in the likelihood of rates rising anytime soon.

[frugal]

So it doesn't have to be all CASH less than 1 YEAR?

We can mix 1-3YEARS with < 1 YEAR  ?

Can you explain me the reason behind this options?


Thank you very much.

Ask yourself what purpose cash and bonds serve in the portfolio. Protection during tight money recessions and deflation, respectively. But why do they offer this protection? What is it that changes their value? The answer is interest rates. During deflation, rates are typically falling, while tight money recessions are characterized by rapidly rising rates. So we can say that bonds rise in value when interest rates fall, while cash adjusts quickly to rising interest rates. That's why we hold both: to hedge our bets regarding whether interest rates will rise or fall.

Knowing this, we can manipulate our bond and cash allocations according to our tolerance for various interest rate risks. If you have 3-month bonds, you'll be receiving lower coupon payments, but in a rising rate situation, you also only have to deal with a three months of rising rates before those short-duration bonds return your capital to you and you can purchase new bonds at the higher rate. Shorter duration bonds therefore let you adjust more quickly. 3-year bonds, on the other hand, are at the long end of what's acceptable, and in a rising interest rate situation, you'd have to wait 3 years before those bonds returned your capital and you could buy new ones at the higher interest rates.

So ask yourself: are you okay with the possibility of giving up as many as 3 years of higher interest rates in exchange for a slightly higher coupon payment today? There's no right or wrong answer; it depends on your own tolerance for interest rate risk and belief in the likelihood of rates rising anytime soon.

Thanks.

Using ETF's for Cash and Bonds what you explained is completly equal? Because price is moving everyday, not as Direct Bonds which I suppose we have to wait until the end of maturity.