Gyroscopic Investing

Posted: **Wed Jun 04, 2014 7:38 pm**

hello all

is it considered acceptable to use strips in the bonds portion of the pp?

thanks

Posted: **Fri Jun 06, 2014 9:05 am**

No, you may need the income in a long-term Japanese-style deflation.

Posted: **Fri Jun 06, 2014 9:41 am**

Browne wrote about this in the originaly PP book.

Due to the additional volitility you get the bond benefit to the portfolio with fewer bonds.

This theoretically means you can have more Stocks/Gold/Cash as a percentage of the portfolio which keeps you better protected from inflation.

Posted: **Fri Jun 06, 2014 10:01 am**

Kshartle wrote: This theoretically means you can have more Stocks/Gold/Cash as a percentage of the portfolio which keeps you better protected from inflation.

That sounds similar to my Duration Hedged PP concept. The higher the bond duration, the less % you need.

Posted: **Fri Jun 06, 2014 10:10 am**

MachineGhost wrote:
Kshartle wrote: This theoretically means you can have more Stocks/Gold/Cash as a percentage of the portfolio which keeps you better protected from inflation.
That sounds similar to my Duration Hedged PP concept. The higher the bond duration, the less % you need.

Yes, it's in the "Best laid investment plans...."

Basically you get about the same portfolio dynamics/sharpe ratio or whatever with 27 VTI 27 GLD 27 SHY 19 ZROZ or something like that but now only 46% of your wealth is subject to total wipeout instead of 50% (due to hyperinflation).

Seems like a safer way to go than the standard PP which I consider pretty vulnerable to serious inflation.

Posted: **Fri Jun 06, 2014 10:37 am**

Kshartle wrote: Seems like a safer way to go than the standard PP which I consider pretty vulnerable to serious inflation.

Really? The PP performed excellently in a high inflation regime. It's deflation that is its Achille's heel. That's why I am experimenting with the Duration Hedged concept to see if more bond exposure would allow it to perform better during deflations. The root problem is cash doesn't move, so bonds have to pick up the slack.

Posted: **Fri Jun 06, 2014 10:48 am**

MachineGhost wrote:
Kshartle wrote: Seems like a safer way to go than the standard PP which I consider pretty vulnerable to serious inflation.
Really? The PP performed excellently in a high inflation regime. It's deflation that is its Achille's heel. That's why I am experimenting with the Duration Hedged concept to see if more bond exposure would allow it to perform better during deflations. The root problem is cash doesn't move, so bonds have to pick up the slack.

Really.

50% of the real value can be wiped out by inflation.

At the most deflation can temporarily hurt stocks and gold real value although the latter only on a very shallow basis.

There is very little deflation risk to the PP in real terms but significant inflation risk.

I think in terms of real value not nominal price.

Most people (by far) would rather see their portfolio go up 6% against 8% inflation than see it go down 6% with 8% deflation. Almost everyone can only comprehend the nominal price.

Posted: **Fri Jun 06, 2014 1:05 pm**

Kshartle wrote:
50% of the real value can be wiped out by inflation.

Not really. The "cash" is not dollar bills but short term treasuries. In a high inflationary environment this cash will be throwing off interest about at the inflation rate - so it basically "floats" with inflation (minus some tax).

See, for example, this analysis: http://blog.vizmetrics.com/2013/07/the- ... ising.html

Posted: **Fri Jun 06, 2014 1:20 pm**

rickb wrote:
Kshartle wrote:
50% of the real value can be wiped out by inflation.

Not really. The "cash" is not dollar bills but short term treasuries. In a high inflationary environment this cash will be throwing off interest about at the inflation rate - so it basically "floats" with inflation (minus some tax).

See, for example, this analysis: http://blog.vizmetrics.com/2013/07/the- ... ising.html

Have you ever heard of negative real interest rates? We have them right now. As inflation gets worse they will get more negative. The point is they are inflating because they can't collect enough in taxes. They certainly can't afford to pay enough in interest to cover the inflation or they would be losing money on the deal!!

Good point about the tax, makes it even worse.

Posted: **Fri Jun 06, 2014 2:13 pm**

Kshartle wrote:
rickb wrote:
Kshartle wrote:
50% of the real value can be wiped out by inflation.

Not really. The "cash" is not dollar bills but short term treasuries. In a high inflationary environment this cash will be throwing off interest about at the inflation rate - so it basically "floats" with inflation (minus some tax).

See, for example, this analysis: http://blog.vizmetrics.com/2013/07/the- ... ising.html
Have you ever heard of negative real interest rates? We have them right now. As inflation gets worse they will get more negative. The point is they are inflating because they can't collect enough in taxes. They certainly can't afford to pay enough in interest to cover the inflation or they would be losing money on the deal!!

Good point about the tax, makes it even worse.

Of course I've heard of negative interest rates. The point is that the hit on the cash portion on the PP is not as extreme as you're making it out to be (it floats "close" to the inflation rate, rather than decreasing at the full inflation amount). As the analysis I linked says - from 1977 to 1981, when interest rates went sky high, the PP overall did better than a 100% stock portfolio. Perhaps you're thinking the Fed can keep short term rates at 0% with inflation running at 10%. I think there's about a 0% chance of this. If inflation is running at 10% the short term rate is going to be at least 7-8%. Losing ground at a 2-3% real loss per year is not getting "wiped out".

Look at the asset by asset returns for 1977-1981 on Craig's performance history page, https://web.archive.org/web/20160324133 ... l-returns/ . These are nominal, not real (come to think of it, adding the yearly inflation rate would be a really nice addition to this table) - but the nominal losses in bonds and (presumed) real losses in cash were more than offset by the gains in stocks and gold. So much so, that the overall portfolio did better than a 100% stock portfolio over the 5 year period (and in each individual year except 1980).

The point is you don't get "wiped out" in an overall sense, and half your portfolio doesn't get "wiped out", and even long term bonds don't get "wiped out" (you're presumably rebalancing into these as the value drops, picking up the new higher long term interest rates).

Posted: **Fri Jun 06, 2014 2:25 pm**

RickB I'm talking about the risk of high inflation. Paper money has been wiped out many times and in short periods. I'm not saying it highly likely but the risk is present. The risk is reduced if you reduce the amount of fixed dollar assets you hold. You can do this while still maintaining the overall risk/reward of the profile by using zero coupon bonds instead, imo.

You are arguing that a possibility which is clearly possible is not possible, the possibility of haivng your dollar assets wiped out or mostly wiped out during a period of very high to hyperinflation.

If inflation is running 10% per year for ten years and you're getting maybe 6-7% interest and then paying tax on it to boot you are getting hammered. Not to mention rising rates are devasting your long bonds where the interest is of no consolation.

The the extent you hold more stocks/gold vs. bonds you are more protected from high inflation on up. I don't even know what you're trying to argue here.

Posted: **Fri Jun 06, 2014 4:59 pm**

Kshartle wrote: RickB I'm talking about the risk of high inflation. Paper money has been wiped out many times and in short periods. I'm not saying it highly likely but the risk is present. The risk is reduced if you reduce the amount of fixed dollar assets you hold. You can do this while still maintaining the overall risk/reward of the profile by using zero coupon bonds instead, imo.

You are arguing that a possibility which is clearly possible is not possible, the possibility of haivng your dollar assets wiped out or mostly wiped out during a period of very high to hyperinflation.

If inflation is running 10% per year for ten years and you're getting maybe 6-7% interest and then paying tax on it to boot you are getting hammered. Not to mention rising rates are devasting your long bonds where the interest is of no consolation.

The the extent you hold more stocks/gold vs. bonds you are more protected from high inflation on up. I don't even know what you're trying to argue here.

For those seriously worried about nasty spike in inflation, I suggest using VT instead of VTI. It beefs up your currency diversification and the added risk is not too extreme IMO.

Posted: **Sat Jun 07, 2014 8:03 am**

Kshartle wrote: I think in terms of real value not nominal price.

It's been a while since I looked at the PP in real terms, but I think you're woefully ignorant of how damaging higher real rates are to the PP. Higher real rates kills stocks and gold, cash doesn't move and bonds cannot completely pick up the slack for three stinkers. Inflation wise, gold is the most volatile asset so it can easily accomodate a trouncing of stocks, bonds and cash which is what it did in the 1970's. To wit:

PP Real Returns:
1971 7.60%
1972 14.62%
1973 5.85%
1974 -0.11%
1975 -0.79%
1976 5.96%
1977 -1.39%
1978 2.81%
1979 24.63%
1980 0.78%
1981 -14.10%
1982 18.63%
1983 -0.68%
1984 -1.30%
1985 16.16%
1986 17.71%
1987 2.62%
1988 -0.68%
1989 9.68%
1990 -4.54%
1991 8.87%
1992 0.49%
1993 10.31%
1994 -5.07%
1995 17.08%
1996 1.77%
1997 6.52%
1998 11.37%
1999 0.58%
2000 -0.45%
2001 -1.34%
2002 0.75%
2003 11.44%
2004 2.74%
2005 4.38%
2006 8.87%
2007 9.08%
2008 2.88%
2009 2.92%
2010 11.89%
2011 8.13%
2012 4.72%
2013 -3.93%

I'll take the inflationary 70's over the 1974-1975 Nifty Fifty deflation, 1981 Volcker recession deflation, the 1983-1984 Mexican default deflation, the post-1987 Black Monday deflation funk, the 1990 real estate recession deflation, the 1994 bond implosion deflation, the 2000-2001 dot.com implosion deflation and the 2013 QEternity deceleration deflation. The only reason the subprime deflation is not on here is gold and bonds synced differently that year unlike last year or now when they are in lockstep.

Posted: **Sat Jun 07, 2014 8:09 am**

Kshartle wrote: If inflation is running 10% per year for ten years and you're getting maybe 6-7% interest and then paying tax on it to boot you are getting hammered. Not to mention rising rates are devasting your long bonds where the interest is of no consolation.

I agree in theory, but we hold T-Bills, CD ladders and I-Bonds instead of FRN's under a mattress. They pay at or above the rate of inflation based on history. It's a wash or a small gain. The free market isn't stupid. A lot of ignorant people think the bond bear was only from 1977-1981 which is false; thats just when the disastrous experiment with Monetarism juiced up inflation, culminating with Volcker jacking short term nominal rates way up to 20% or so "break the back of inflation". The real bond bear started right after WWWII when short term nominal rates were held at zero.

Posted: **Sat Jun 07, 2014 5:36 pm**

workingatit wrote: hello all

is it considered acceptable to use strips in the bonds portion of the pp?

To answer the original question...yes you can use zeros, but be aware of a few things:

- They are more volatile than equivalent nominal bonds (as several posters have already said). I made use of them to offset part of my bond holdings that were in VUSTX, which is less volatile. Otherwise, you're effectively increasing the power of the bond allocation, which you may or may not want to do.
- The buy/sell spread tends to be higher than it is for nominal bonds.
- They generate no cash until you sell (as MG pointed out).
- Most importantly: YOU OWE TAXES ON INTEREST which is generated every 6 months just like a regular bond. So you almost certainly do not want these in a taxable account.

One way around some of these drawbacks is to invest in the iShares fund EDV, although that fund is also a bit of a problem for a taxable account as it tends to throw off large gains/dividend payments at the end of each year.

Posted: **Mon Aug 18, 2014 5:01 pm**

MachineGhost wrote:
Kshartle wrote: I think in terms of real value not nominal price.
It's been a while since I looked at the PP in real terms, but I think you're woefully ignorant of how damaging higher real rates are to the PP. Higher real rates kills stocks and gold, cash doesn't move and bonds cannot completely pick up the slack for three stinkers. Inflation wise, gold is the most volatile asset so it can easily accomodate a trouncing of stocks, bonds and cash which is what it did in the 1970's. To wit:

PP Real Returns:
1971 7.60%
1972 14.62%
1973 5.85%
1974 -0.11%
1975 -0.79%
1976 5.96%
1977 -1.39%
1978 2.81%
1979 24.63%
1980 0.78%
1981 -14.10%
1982 18.63%
1983 -0.68%
1984 -1.30%
1985 16.16%
1986 17.71%
1987 2.62%
1988 -0.68%
1989 9.68%
1990 -4.54%
1991 8.87%
1992 0.49%
1993 10.31%
1994 -5.07%
1995 17.08%
1996 1.77%
1997 6.52%
1998 11.37%
1999 0.58%
2000 -0.45%
2001 -1.34%
2002 0.75%
2003 11.44%
2004 2.74%
2005 4.38%
2006 8.87%
2007 9.08%
2008 2.88%
2009 2.92%
2010 11.89%
2011 8.13%
2012 4.72%
2013 -3.93%

I'll take the inflationary 70's over the 1974-1975 Nifty Fifty deflation, 1981 Volcker recession deflation, the 1983-1984 Mexican default deflation, the post-1987 Black Monday deflation funk, the 1990 real estate recession deflation, the 1994 bond implosion deflation, the 2000-2001 dot.com implosion deflation and the 2013 QEternity deceleration deflation. The only reason the subprime deflation is not on here is gold and bonds synced differently that year unlike last year or now when they are in lockstep.

So your theory is that these negative-return years were caused by deflations, and furthermore that holding more powerful deflation protection in the form of longer effective-duration bond funds (which means zero coupon treasury funds) would have avoided those dips.

But is there any proof of this? Can we look back at the performance of the Benham Target Maturities Trust funds and see if this is actually true? Or, a lot easier: let's just multiply the bond performance numbers by about 1.5. Would doing this make it a more even ride?

Or is this theory just that: a theory, and one which is contradicted by the facts?

Gyroscopic Investing

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