3 Part PP - Where are the Bands?

[tylerrr]

Need some opinions here....

Instead of a 4 part Permanent Portfolio, I operate a 3 part PP with part of my investments.

1/3 bonds, 1/3 stocks, 1/3 gold

In the classic 4 part PP, they say to rebalance once a part of the portfolio breaks either 15% or 35% of the total portfolio.

Where would you make the % limits for rebalancing on a 3 part PP if it were you?

Thanks!

[Tyler9000]

When the PP holds 25% of an asset and sets the bands at 15 and 35, that represents a 40% rise or fall of that asset (35/25=1.4). Using the same 40% rule with a 33% allocation would put the bands right around 20 and 45.

[vexed87]

T9000 beat me to it! I was thinking along the same lines.

Why no cash?

[tylerrr]

When the PP holds 25% of an asset and sets the bands at 15 and 35, that represents a 40% rise or fall of that asset (35/25=1.4). Using the same 40% rule with a 33% allocation would put the bands right around 20 and 45.

thanks!

My math is showing 20 and 46....

??

[Tyler9000]

Yeah, I rounded for simplicity. I don't think there's anything magical about a precise 40%.

[tylerrr]

T9000 beat me to it! I was thinking along the same lines.

Why no cash?

Just because a 3 part has better performance historically and I don't need the cash in that part of my overall portfolio.

[userqname]

Cash is the most useless part of the original PP. During a stock market decline, you use the other three assets to buy into the down market. The three part version has ~8% more equity. That's where the better performance comes from.

[Tyler9000]

Stocks, bonds, and gold do occasionally decline together in recessionary times that Harry Browne referred to as "tight money", so I wouldn't call cash useless. Even aside from the investment perspective, I personally love cash in my portfolio for its practical utility. It's pretty terrific to be able to pay off a mortgage or live off the cash for a while in retirement without selling stocks, and the flexibility has saved me a good amount of taxes over the last few years.

[jacob]

@userqname - If you don't hold cash, you will probably only have one asset to use to liquidate to buy into a recession, namely LT bonds, as gold and stocks will both be down as people sell them to fund cost of living or pay off their margin calls. Keep in mind that "cash" refers to investments in the short end of the yield curve (duration <1 year). Cash is now underappreciated since short-term yields have been close to 0% for over 5 years which is longer than most people can remember.

A three-asset approach would render the PP more volatile. The leveraged approach (corresponding to negative or short cash) even more so.

[userqname]

A three-asset approach would render the PP more volatile.

More volatile by what measure? By dollar value? Then yes, the 4 part PP will be less volatile.

Some dry powder on hand is great to pay your bills when the only thing going up is correlation. But, if you're using the 4% rule, then a quarter of your portfolio works out to 6.25 years of cash. With a 3% WR, its >8 years of cash. No recession in US history has lasted longer than 5.5 years, and the vast majority of them are around a 2 year duration. The higher volatility in exchange for being more fully invested sure seems like a fair trade.

To clarify; I'm not against cash, and I'm not smack-talking Harry Browne. I just think that so much uninvested capital is wasted opportunity.

[jacob]

By standard deviation for sure ... maybe even by alpha. Since Tyler9000 has the numbers, maybe we can get some backtested alpha numbers for

• PP
• PP ex cash
• PP ex cash with 0--50% margin (accounting for the margin-calls would require some programming)

[userqname]

Without any additional programming, Tyler9000's Benchmark calculator shows the "ex cash" portfolio outperforms the as-published permanent portfolio three times as often as the reverse.

Inputs:
TSM 33%, LTT 33%, Gold 33%, TMM 1%
vs.
TSM 25%, LTT 25%, Gold 25%, TMM 25%

There will be more volatility. The PP thrives on the volatility of four uncorrelated assets, and OP tylerrr has removed the least volatile asset.

[Tyler9000]

To clarify; I'm not against cash, and I'm not smack-talking Harry Browne. I just think that so much uninvested capital is wasted opportunity.

No worries! I'm admittedly a cash fan.

Just a small nitpick -- in the PP, cash is not uninvested money under the mattress. It's an investment in government debt that has historically generated a decent return in its own right, protects against certain economic conditions that hurt the other three assets, and also has a lot of practical utility in everyday money management. Cash has its benefits!

Lowering the cash percentage does raise the average return, but everything has a tradeoff. So the ultimate balance that works best for you may be different than what works for someone else, and I have no problem with people dialing cash up or down to meet their needs.

@Jacob -- I don't have alpha numbers handy, but I'll add that to my to-do list.

[tylerrr]

To clarify; I'm not against cash, and I'm not smack-talking Harry Browne. I just think that so much uninvested capital is wasted opportunity.

No worries! I'm admittedly a cash fan.

Just a small nitpick -- in the PP, cash is not uninvested money under the mattress. It's an investment in government debt that has historically generated a decent return in its own right, protects against certain economic conditions that hurt the other three assets, and also has a lot of practical utility in everyday money management. Cash has its benefits!

Lowering the cash percentage does raise the average return, but everything has a tradeoff. So the ultimate balance that works best for you may be different than what works for someone else, and I have no problem with people dialing cash up or down to meet their needs.

@Jacob -- I don't have alpha numbers handy, but I'll add that to my to-do list.

Agreed , the utility of cash should be considered. That's why I have some liquidity in other areas outside my 3 part PP.

For automatic management purposes and convenience, the 4 part PP is attractive when you consider the system of putting all monthly savings/contributions into the Cash part of a 4 part PP. Then, you just rebalance the whole portfolio once your Cash position hits 35% band.