[librahall]

Right. These are the parameters of the problem as it has been studied so far.

This isn't to say that other methods cannot work. Maybe different rebalancing strategies, or living off dividends, are completely viable alternate solutions. However, these studied did not consider them.

Similarly, the kind of things I do (permanent portfolio / risk parity) have not been thorough studied either for withdrawal and capital depletion. I can't say conclusively that it's a good idea, or that it's any better than classic asset allocation for living off capital.

And if I was a professional, I would absolutely not be able to advise anyone to use these methods on just a hunch and my amateur analysis.

You can find a thorough study of PP together with other popular portfolios at Permanent Portfolio. According to the author of this website, the SWR(safe withdraw rate) is as high as 5.3% for 30-yrs retirement.

 

[librahall]

@J4B, I just spent two days reading this whole PP thread. I found them very helpful and practical. Thank you for writing up all the good thoughts and sharing it with us over the years.

Could you please comment on the following implementation of the PP in Canada? I have done some comparison and backtest in the past months. It seems US PP has outperformed CA PP for >1% CGAR in the past 20 years.

XUS.TO (CAD unhedged) 25%

ZTL.F (CAD hedged) 25%

ZFS.TO and GIC/CD ladder 25%

MNT.TO and Physical Gold 25%

My main questions are:
1) Currency hedge. After reading many articles, I tend to believe that I should not hedge S&P 500 ETF but should hedge US Long Term Bonds. Do you think so and why?
2) ZTL.F is newly released by BMO in Feb. this year, right at the start of the Covid-19 market crash. It's the first CAD hedged TLT in Canada. I was excited the first but when I looked at its performance in the past month, actually it behaved quite differently with TLT. I also found its trading volume is very low. I am hesitating to buy it for the bond part of PP now. Any alternative bond ETFs you would suggest?

Thank you in advance.

 

[librahall]

For Bond ETFs I'm using ZFL and ZPL... I was using VAB and XLB, BUT with their Corp exposure they were in a real BOG when the markets were stressed and thus I was not impressed. I will stick with ZFL for security and ZPL for a bit better yield. I am ~60% ZFL and ~40% ZPL (for my bonds - at this time). I know this is CAD and not US exposure but I don't feel that matters as much. Your MNT will basically work as USD exposure in my mind since the gold market operates on USD.

I just compared the return of these bond ind ETFs. It seems that TLT(US) is much better than its canadian alternatives. US long term gov bonds(>20 yrs) is much more sensitive to interest rate cut and has better hedge to US stock crash. Thoughts?

 

[librahall]

I wonder whether the PP makes sense when you have debt (mortgage etc). I always struggle with the idea of holding bonds/cash while having a mortgage.

That depends. Given the historically low-interest rate, the PP has a good chance to outperform the mortgage interest rate. My mortgage rate is 1.55% variable. The PP's CGAR is >6%. In addition, if the mortgage is for your investment(rental) properties, the interest is income tax-deductible.

 

[librahall]

But does it make sense to be long cash and short a mortgage?

librahall, I'm happy to hear you found this thread (and concept) interesting.

Interesting source for the SWR. I agree that it looks like PP is able to sustain higher withdrawals due to the added stability. However I think we should consider that gold has only traded freely since the 1970s, so there is limited pricing history for it. There is a much longer history of data for stocks and bonds, so SWR on things like 50/50 or 60/40 can probably be stated with higher certainty.

Since the historical SWR analysis with gold is only based on 48 years of gold prices, there may not be enough history to be very confident.

But gold as a good method of preserving value has been there for a few thousand years, longer than any fiat money.

 

[librahall]

But does it make sense to be long cash and short a mortgage?

I won't view holding cash as a pure way of "long". You can find the following explanation in the book of <The Permanent Portfolio> by Craig Rowland; J. M. Lawson.

"Most financial advisors recommend that investors keep some cash reserves on hand, but almost no investment strategies work these cash holdings into an overall investment strategy. However, the Permanent Portfolio is unique in that it calls for a 25 percent allocation to cash and these cash holdings are a fundamental building block of the overall strategy. Unlike the other Permanent Portfolio assets, which are designed to be volatile, cash is designed to act as a stabilizer to the portfolio during market volatility. The cash allocation also provides an investor with a place to store interest, dividends, and capital gains from the other assets, and provides “dry powder” for rebalancing purposes during market declines. Cash also occasionally serves as the leading asset in the portfolio when the stocks, bonds, and gold are all having a bad year. In addition to the functions described above, cash also acts as an emergency reserve for life's unexpected events, such as periods of unemployment or health emergencies. For those in retirement, the cash portion of the portfolio can be tapped for living expenses. Overall, the cash allocation in the Permanent Portfolio performs several important functions."

 

[librahall]

There will certainly be differences in outcomes due to performance of assets in the specific countries (this will always fluctuate over time) and even the currency.



Some comments and first impressions. XUS is a good one for S&P 500 but I don't think it's a great idea to concentrate all your stock exposure into a single country. To some degree, this is chasing the recent performance of the S&P 500. It's probably a better idea to diversify the stocks somewhat. In mine, I mix Canada & US. Another method would be to split between Canada & XAW to get world exposure. At first glance, yes, this would drop the performance because the S&P 500 has performed the best, but you have to think of what might happen going forward.

And you really need some domestic stocks for the PP. The idea after all is to bring together assets which respond differently, counter-balancing economic conditions in YOUR country. If you mix up countries and currencies then you are losing that effect.

Next comment is on bonds. I don't think ZTL is a great idea, because (1) it's brand new with no track record (2) you should probably stick with bonds in your home country and (3) currency hedging has typically added performance drag on other ETFs. I think going with "TLT" or equivalent is also a form of chasing the recent performance of the US. American long term treasuries happen to have done well, but that doesn't make them inherently a better PP choice than, say, Canadian treasuries.

So I would be more inclined to go with 25% ZFL and that fund is very respectable; $1.6 billion assets under management and about 10 years of history.

I like MNT for gold but in recent times I have started diversifying some of that into CGL.C which serves the same purpose. I split mine between MNT & CGL.C for safety, because gold-tracking funds are a very new invention and I don't have full confidence in any of them. The bid/ask spreads on MNT have also been extremely wide lately, which makes it tricky to trade.

But overall, if I may suggest a slightly different take on what you posted, perhaps something like:

Stocks: 12.5% XUS, 12.5% XIC
Long bonds: 25% ZFL
Short bonds: 25% ZFS and GIC/CD ladder
Gold: 25% MNT, CGL.C, physical



It's true that foreign stocks should be unhedged. But the idea of holding foreign bonds and hedging them is quite a new concept, and I am not sold on the idea. As stated above, I think the PP idea would be to hold domestic (Canadian) fixed income. Consider for example, if there is runaway inflation in the US, but not in Canada. If you held this 25% TLT (US), currency hedged, you would see your "long bonds" part of PP crash in value as TLT would crash as interest rates soar in the US. Now, if you were in the US, you would have also seen your GOLD gain in value versus the USD. But notice that in your portfolio construction, you would suffer the US treasuries price crash without the balancing effect from gold, because if the same high inflation isn't happening in Canada, "gold in CAD" would not soar.

In my view, all the assets should be domestic in CAD. The only exception I have made in mine is some foreign stock component.



As mentioned above I think going the ZFL & ZFS route is superior.

First of all, thank you for writing back to me during the weekend. Happy Easter Day!

The reasons why I concentrate on the US stocks are:
1) US stock market accounts for 42% of the global market in size while TSX only accounts for 2.5%. Owning 50% CAD stocks seems a home-country bias IMO;
2) US stock market has a good intrinsic diversification across different industries and even different countries already;

• Many U.S. corporations have a global presence, with assets and revenues in foreign markets. ... At the country level, nearly 71% of S&P 500 revenue comes from the U.S., with the remaining 29% coming from foreign markets.
• S&P 500 contains companies from 11 different sectors, while TSX 60 is weighted heavily on Finance and Natural Resource.

3) US stock market outperforms other markets with a reason, because of its overall strength in technologies, innovations, attractions to talents, capital and so on. I think this momentum may not change in my lifetime. Of course, there will be fluctuations and value recorrections along the way.

To your comments on bonds, I agree that ZTL may not be a good choice. However, I am still not quite convinced that Canadian bonds are superior to TLT(US) to hedge the US stock market. At least no historical data support this. Maybe because investors tend to buy US treasures as safe haven during the US market crash, or because US treasures have a better structure? I don't know. I need more time to think it through.

Thank you again.

 

[librahall]

Happy Easter to you as well

You're right that TLT is the best hedge for the US stock market, but remember, the permanent portfolio's goal is to hedge more broadly than this. The intention is to create a hedge/balance between different economic conditions including currency devaluation. It's not just about the stock/bond pairing. For example there is also an important bond/gold pairing.

So yes I agree that TLT(US) and XUS go together just fine, but, there are other assets in the portfolio that need to be appropriately matched too.

Imagine that while the CAD is strong (low inflation), the US experiences high inflation, the USD weakens and treasuries fall sharply. Here's a possible response:

XUS falls due to USD falling [stocks down or weak]
TLT falls in reaction to high US inflation [bonds down]
Gold falls, since CAD is strong [gold down or flat]

In this scenario, the PP wouldn't work as desired because you've lost the ideal inflation or currency devaluation hedge. In particular, look at the bonds & gold relationship. Here, your US bonds suffered due to inflation but gold will not compensate.

To get the ideal response on the bond/gold pairing, they have to be against the same currency, which is why I'm arguing that the PP works best with domestic assets.

Interesting discussion.

I doubted that Canda and US will behave very differently in terms of inflation. Just found a historical chart as below.

It presents the inflation rates of Canada and the United States (using the CPI measure) for the period 1958 through 2008. These data are monthly and measure the inflation rate for each month as the percentage increase from the same month of the previous year. Note the remarkable similarity of the inflation rates of the two countries although they differ by as much as 2 percentage points on a few occasions for very short periods.

 

[librahall]

Earlier tonight I estimated the PP performance for those 3 years based on using US securities (XUS, TLT etc) vs domestic (XIU, XBB for broad bond mkt). I calculated roughly 5% CAGR using US stocks and treasuries... not horrible... but it would have been closer to 10% CAGR using domestic.

So let's call that "moderate" trouble in US dollar & treasuries, and it resulted in 5% CAGR performance loss over 3 years! That's pretty significant.

What if something like that happens again, but even more severely? I think it's a plausible scenario.

May I know which tickers you were using for the backtest? I tried to replicate the comparison but found XUS only has data available since May 2013.

 

[librahall]

I have a question about the bond part of PP. Is it still wise to hold bonds given the treasury rate is so low? In a recent discussion, I got the following argument from a popular stock YouTuber.

"Any NAV appreciation on TLT will come from lower treasury rates. The bondholders with TLT benefited from the hedge in Feb-March, but now that we are at much lower rates there is less possibility for NAV appreciation going forward (unless rates go negative), and you have the possibility of a decreasing NAV in TLT if rates rise. You can certainly own them, I just don't personally think the risk/reward (even as a hedge) is very favorable here. "

My response to him was "The future is unpredictable. I would not be surprised if one day the Fed decided to cut the interest rate to negative." But I'd love to hear your thoughts.

 

[librahall]

At any point in time, you'll always find someone making an argument for why one particular asset is a good buy, or not. The idea behind Browne's PP is that we have no idea what the future will bring, and trying to anticipate market direction is futile. We can't predict price direction or inflation. It's the same idea as couch potato investing and passive asset allocation in general: one does not adjust the formula (like 60/40) based on where we think bonds may be headed.

Is it wise to hold bonds? Once you decide on an asset allocation, it's wise to stick with whatever the weights are.

The return in bond funds does not come purely from interest rates dropping. It also comes from sources such as a yield curve steepness, and from reinvesting maturing bonds. In fact, if interest rates were to gradually rise over the years, bond funds will perform well. So it's incorrect, and overly simplistic, to say that bond funds need yields to drop, to produce a return. That's not how bond funds work.

Japan had treasury bond rates near 0% for many years, even lower than we have now. Bond funds in Japan have actually done quite well over the decades.

But I don't advocate investing in long term bonds. As you can see in my portfolio, I use XBB because ~ 10 years is a more reasonable maturity. TLT are US long term bonds and are much more volatile (and risky).

Hi James - Thanks for sharing your thoughts. Really learned a lot from your writings so far.

 

[librahall]

I have a practical question. How do you buy your PP through ETF trades?

Let's say if someone has $100K to invest and wants to use 3 ETFs (ZFL 25%, CGL.C 25%, XIU 25%) + Cash 25% to form his PP. Harry Browne once mentioned that only the portfolio as a whole can really protect your money. However, the price of XIU, ZFL, and CGL.C could be very volatile on a specific trading day. Unless you buy at a (close to) market price, you could easily miss some orders and your portfolio is then unbalanced as 25% for each part. Sometimes, I try to split the money into 3-4 orders at different prices.

Maybe it seems a kind of perfectionism. Always glad to hear your advice. Have a good day!

 

[librahall]

It's true that one must look at the portfolio as a whole, and think you're fine as long as you trades fill within the span of an hour. I always place limit orders, and start with the least liquid one in a group (whichever has the widest bid/ask spread, likely CGL.C) since this will be the most difficult one to fill.

What I'd do (edited, revised)

1. place one limit buy order on each ETF
2. wait 15 mins (or longer I suppose) but consider this a hard deadline
3. if something hasn't filled, modify the order and meet the asking price

In step 1, choosing a good limit price, with a high probability of being filled, is a bit of an art. For CGL.C and MNT, I would probably place my bid at the mid point between the bid & ask (half way). XIU is liquid and very active, so I might bid one or two cents below the current asking price. Bond ETFs have low volume and don't move much. I wouldn't get more ambitious than one cent below the asking price on a normal day.

After the 15 minutes are up, I would revisit any unfilled orders and change them so they are guaranteed to fill. At that point I would do a limit buy at the asking price or perhaps one or two cents above the asking price. There is no risk of overpaying when you do this, since you'll still get the lowest ask for the number of shares you want. Note that if you're buying a lot of shares, it may take more than the current asking price to fill all shares.

That's effectively a market order, but it's always safer to place limit orders.

In step 3, I think it's important to give up on trying to get bargains, and just buy. This prevents you from falling into the trap of "chasing the market" as prices move against you. My view is that you already took a stab at getting a bargain (step 1) and now it's time to complete the trade.


Aside 1: here's that portfolio in the Visualizer using ZFS for the cash component. That picture is nice because it starts in a bad year (where gold & long bonds fell hard) so you're getting a pessimistic view.

Aside 2: I'll backtrack on something I said earlier, and I think it's fine to have foreign diversification in the stocks. If you look at my own RRSP portfolio in #302 you'll see that I mix XIU & ZSP

Thanks for the step-by-step description. The idea of "start with the least liquid one" is very inspiring. The only thing I may want to add is to avoid placing orders in the first and last half hour of each trading day when the price could be very volatile.

Aside 2: I'll backtrack on something I said earlier, and I think it's fine to have foreign diversification in the stocks. If you look at my own RRSP portfolio in #302 you'll see that I mix XIU & ZSP

Thanks for the reminder. Yes, actually I am using a mix of XIU & ZSP for my stock part. Just wanted to simplify the question.

 

[librahall]

@librahall at the risk of complicating things, I'll mention that the PP is basically at an all time high value, again. You would be buying it pretty high. The same could be said on just about any day in 2019 or 2020, except for March.

This is one of those frustrations that can never be solved. There is no way to time a lower entry. Instead, I find it helpful to look at the historical record. Then, I remind myself: the PP routinely falls 5%. Even a 15% drawdown would be normal, and OK.

I most recently added to my RRSP on February 19. Practically the high. Then, I saw my portfolio immediately drop 11%. It's been a wild ride... but still milder than other portfolios.

Good point mentioned. I am also concerned about this all time high valuation of PP. That's why I decided to slowly buy into PP since this March. More dollar-cost-average than a lump sum. However, I never expected the market can bounce back so quickly. I still have 60% sitting in cash now. But I don't want to spend too much time watching the market every day, I may just add half of them into PP next week. I have studied and backtested PP for quite a while. I would just let PP take care of itself and look at the long term.

 

[librahall]

You'd think that the market would be more negative given that current financial data can't be good, aside from Amazon, Wal-mart, Loblaw, etc. the types of retailers that do well regardless of economic activity. I recall hearing some analyst saying that people are pricing stocks based on expectations next year as opposed to current... while I can understand to some degree, the fact of the matter is that a lot of balance sheets are not good and I'm sure a number of companies are on the knife's edge of bankruptcy.

Everyone knows that the stock market rallies mainly because the FED is printing money and buying everything. But, I still have a mixed feelings when I see most of my PP valuation growth offsetted by long term bond and gold recently. I know this is by design of PP, it will do the same when the market drops. Just can't stop thinking of it...

 

[librahall]

This pandemic is a kind of accelator for online adoption i.e. SaaS(Shopify, Square), online education(Zoom), streaming, ecommerce(including offline to online) and Cloud services(CDN, Security and etc). Although someone may argue that the PE ratio is as high as the Internet bubble in 2000, the penetration/influence of technodege to our life has changed quite a bit. My Variable Portfolio is mainly focusing in these sectors plus some geo diversifications. It has been doing pretty good this year.

 

[librahall]

Anyone here has the experience of buying Canadian Long-term Bonds? I use ZFL for my previous PP with Questrade. Recently, I have a relative bigger amount of money to deal with. Therefore, I am trying to buy Canadian Long-term Bonds(25-30 year-to-maturity) for the bonds part of my new PP implementation. I checked RBC and found the price/100 CAD for $50k CAD PAR value of purchase is about $145 CAD, including an estimated commission of $250. See the screenshot below.

It seems that RBC is selling 2% higher than its public price.

What is the best way to buy Canada Long-term Bonds in Canada? Thanks in advance.

 

[librahall]

Here's another iTrade example that I think illustrates why iTrade is amazing for government bonds.

Government of Canada, 2051/12/01 with 2.00 coupon. Marketwatch quotes this at a price of 127.03125 but it's hard to find actual quotes from a reliable third party and I'm not sure how accurate that quote is. Instead I want to show you the bid/ask spread.

25,000 face value
Buy price 127.103
principal = 31,775.75
commission = 25.00
accrued int = 67.12
total purchase cost = 31,867.87

If I sell this, the price is 126.954
principal = 31,738.50
commission = 25.00
accrued int = 67.12
total proceeds of sale = 31,780.62

The difference between buying and selling tells us everything, because a broker absolutely will not pay me more for a bond than it's worth in the open market.

Notice here the spread between the buy and sell price is only 0.1% so this is an incredibly tight spread. And in fact the mid point of the two iTrade prices is the Marketwatch quote, so I think we can believe here that iTrade really is giving us an honest market quote with minimal bid/ask spread.

What would happen if you bought this and then immediately sold it back? Looking at the total purchase and selling costs, you would lose only $87 in the round trip transactions. This is truly incredible! Look at how liquid this bond is. If you want to sell it to get access to cash ... that costs you an effective 87/2 = $44 fees.

I have spot checked iTrade quotes a few times over the last few years and have generally found their pricing, and bid/ask spreads, to be very good. Sadly it is still difficult to calculate and verify how good the prices are, but iTrade has earned my confidence for fixed income.

Thank you, James4beach. Your response is always so clear and comprehensive. I am glad that I asked before buying those bonds with RBC. I'll definitely look into iTrade.

One more question. In the US, people can buy gov bonds directly from the government at treasurydirect.gov. Is there a similar approach in Canada?

 

[librahall]

Yes, this is what I thought. I checked with RBC client manager just now and he also told me that any bond purchase has to go through the brokers in Canada.

ETFs are more flexible. However, I am willing to take a little more efforts to avoid the risks. The banks are more vulnerable than they look. The pandemic, very low interest rate, geo-political conflicts and so on, they all have negative impact to banks. My plan is to use my bond ETFs for rebalancing and keep my direct owned bonds intact.

 

[librahall]

RBC is charging you $783.50 more in fees and spreads. Even if they actually include accrued interest, the overall fees are still dramatically higher than iTrade.

Sorry, it seems that I misunderstood. RBC didn't charge higher as I thought but just added ~2% for the "approximate price/100 CAD" when I place the order. The actual transaction price was a market price.

I placed multiple buy and sell orders using RBC's practice account on Thursday and Friday. (Unlike stocks, the bond trading order status won't show until the next day. ) As you can see in the below screenshot, the actual order price on July 16 was 142.155 per 100 CAD face value for 10,000 principal, including $100 CAD commission.

However, RBC does charge higher commission than Scotia iTrade for orders < 25,000 CAD. Commission applies for both buy and sell.

RBC:
Commission is included in the quoted price:

• $100 CAD for 10,000 principal
• $250 CAD for 50,000 principal
• Minimum commission: $25 per transaction
• Maximum commission: $250 per transaction

iTrade:
Commission-style pricing at $1 a bond ($1 per $1,000 FACE VALUE, $24.99 min/$250 max)**


Figure-1 When I placed the order, it shows 145.1485 CAD for "Approximate Price/100".

Figure-2 The actual order price was 142.155 CAD for the order above.