We don’t know which way interest rates are going to go. Yes it is safer to hold the shorter treasuries though if you think interest rates will rise. HB recommended using only a Treasury MMF for cash for this and other reasons. I also advocate using Treasury MMF for your cash, but *optionally* if you want to take a little more risk for money you won’t need for a year or so then you could do ST Treasury bonds.

Also if you find rates go up and you are down slightly in your ST bond fund, you can simply hold onto it for the average duration and the price will eventually recover. This is why I say you should have enough in your Treasury MMF to ride out long enough in case you need to wait for the ST bonds to recover.

In the 1970s it was the case that the ST bond fund did better than a Treasury MMF even though interest rates were rapidly rising (ST Bonds 9.4% CAGR vs. 7.7% CAGR from 1972-1982). So there is no guarantee that ST bonds won’t outperform even in rising interest rates either. The markets are just not predictable!

I use a mix of Treasury MMF and ST Treasuries like iShares SHY. For the portfolio there is only a slight difference between the two. Harry Browne recommended only using the Treasury MMF. However if you have enough cash for near-term needs and can go a year without needing to touch it then you may want to consider using a mix of ST bonds along with it as it doesn’t affect over portfolio risk that much but you get a higher return.

The returns used are total returns which include interest, dividends and price appreciation of all the assets. My spreadsheet shows about 1.97% total return for T-Bills in 2008 and 6.68% total return for ST Treasuries.

Keep in mind that 2008 was a very unusual year for treasury bonds. They were able to go up greatly in price as people bid them up. Bond price movements are reflected in the duration of the bond. A ST bond for instance may have a duration of 1.5 years. That means for every 1% drop in yield they go up in price by 1.5%. For every 1% rise in yield they go down 1.5%. In 2008 I don’t recall where they started, but if the yield dropped from say 3% to below 1% that would be enough to bring the price up 3-4% alone plus the interest payments. So it’s quite possible to see that a return of 6.68% for ST bonds.

Here’s the short version of my Cash FAQ. It’s quite simple:

1) Only own Treasury Bills in a T-Bill Money Market fund. Don’t own lesser quality bonds even if the yield is higher. The ETFS such as SHV or BIL can work, but mind your transaction costs. It may be more economical to own the Vanguard Treasury Money Market Fund (even though it’s not pure Treasuries, it may be close enough for this purpose and not kill you in commissions).

2) OPTIONAL: If you have a nice savings for emergency living expenses in your Treasury MMF, then you may consider adding some ST Treasury Notes to your holdings. A fund in the 1-3 Year maturity range that ONLY holds Treasuries is a good option. Something like iShares SHY would work.

3) Don’t take risks with your cash portion. Again you should only be buying US Treasury securities for your cash.

Working in spurts. Been busying with non-investing stuff lately. I need to look at the data again, but the reason you see a return that high for the year is a combination of yield plus capital appreciation for holders of existing bonds. There was a flight to quality bonds which drove down yield but boosted prices for existing bonds. This means you could achieve returns higher than stated yield if you used this opportunity to rebalance.

I had considered this as well. The original portfolio tried to use stock funds that had higher “Beta” (more volatility) over the overall stock market. So Browne early on advocated “aggressive” stock funds.

The problem is aggressive may mean you under perform the stock market just as likely as you are to outperform it. It all depends on the manager. But this also applies to index funds that focus on one particular sector of the market. When they’re hot, they’re hot. When they’re not, well…

With Value tilts many people don’t realize that there have been significant stretches of time where they lagged the overall market. From 1980-1999 for instance a large cap blend fund significantly beat value funds. That’s almost 20 years of underperformance.

Ultimately, it’s a better bet to just use the blend funds. You can benefit from when growth stocks do well or value stocks do well.

Some people split stocks assets to achieve diversification benefits. Well, I don’t think you can get adequate diversification from owning stocks alone. 2008 showed that when market risks show up it tends to hit all stock asset classes. I think your best bang for the buck on diversification is to focus on the stock/bond/cash/gold split personally.

Good column and timely. What I hear now is the nascent Treasury bubble which will soon turn into a rout. It may, but it may not. Who knows?

It’s interesting reading on Bogleheads about having a “value” tilt on equity investments to generate a better return. The more I read about this, the more I believe Harry Browne may actually have agreed with it simply because the higher volatility would exasperate an up move in the portfolio when it needed it most. I don’t follow this strategy myself (I invest 50% VTI and 50% VEU), but it seems like it would fit into HB’s portfolio as long as one stayed with this strategy and didn’t move to large caps, growth, international, etc. as they saw fit.

Ray