The Permanent Portfolio, Investing, Finance and Random Thoughts.
Posts tagged cash
Fed Bank Failure Stress Test
2 months ago
by Craig Rowland
in Investing
Normally I don’t pay much attention to these things, but this story on bank failure stress testing caught my eye:
Fed Unveils Doomsday Scenario for Banks
The Fed will look at how the nation’s 19 largest banks would survive a world with a 13 percent jobless rate, a 50-percent drop in stocks, a 21-percent decline in housing prices and a significant contraction of other major world economies.
The Fed conducts the tests on banks every year, but this is the first time since 2009 that it will release its results to the public. In 2009 the Fed found billions in insufficient funds on bank balance sheets.
(emphasis added)
It’s stories like this which is why the Permanent Portfolio chooses to hold only the safest of cash and bond assets issued by the government. The fractional reserve banking system is inherently unstable during a crisis. You don’t want to hold a bunch of bank paper if you can hold the safer t-bills and bonds from the US Treasury. Unlike a bank, the US government can always pay back its debt with more taxes or (worst case) printing money.
I’d hate to think how FDIC would handle the situation if there was a very large banking crisis in the country. I’m not a big doom and gloomer, but I suspect delayed payments or maybe even pennies on the dollar back for depositors in the worst case. This is not out of the realm of possibility if a crisis were really bad.
When the report is released it will be interesting to see how the banks rank. It may be worth looking to see how your own bank fares. If they look weak, it might not be a bad idea to take your business elsewhere until they get their act together.
Risk and the Future
2 months ago
Let’s talk about risk and the future.
Sometimes I get a question about event X or event Y or event Z. These can sometimes be extreme events that someone is worried over. They often want to know how the Permanent Portfolio will deal with one or all of them.
My answer is that nobody knows what every possible hypothetical event will lead to in terms of unintended consequences. Even a portfolio you think will do best under event X may in fact do quite poorly if you guess incorrectly how the markets will react. Many investors in fact have been burned in just this very way. In other words, you can be right about a bad event happening, but totally wrong on how to invest to protect yourself from it. I never assume I know how the markets will react to a piece of news myself. I’ve been surprised often enough to know it just isn’t very profitable.
However what I most appreciate about the Permanent Portfolio is the fact that it is a way to diversify against a wide variety of serious or not-so-serious economic risks without having to guess about anything. As an entrepreneur, I like having options at all times to deal with the uncertain and the Permanent Portfolio does that. I don’t however spend a lot of time considering every possible scenario that could play out because it likely won’t happen that way. At least that’s what I’ve found in the business world and life in general. I think the best strategy continues to be one in which it makes no assumptions about any particular future, but at the same time gives an investor access to assets to accommodate even extreme situations if they show up.
For instance, let’s say the stock market dives by 50% tomorrow. If your portfolio was very heavy into stocks this would be a disaster. But if your portfolio is more Permanent Portfolio style the damage is limited. The 25% division of the four major assets of stocks, bonds, cash and gold limit your downside overall. Further, you would also have access to options to deal with the disaster (such as rebalancing into stocks with your cash, bonds and gold which is very likely the best option).
The Permanent Portfolio gives you options to deal with various contingencies if they should happen.
Or let’s say that happy days are here again and gold drops by 50%. That will be bad news for gold, but probably pretty good news for stocks. Take those profits and buy the yellow metal that everyone now hates because eventually they’ll want it again. Portfolio damage is limited because the downside of the gold can be absorbed by the upside in the stocks.
On the opposite end, if Treasury bonds tank and yields rise to 10% tomorrow the gold allocation will be there to deal with the very high inflation. This will allow a rebalancing into what is likely going to be lucrative high yields on your bonds once inflation comes back down. The gold gives you that option that a concentrated portfolio alone might not.
Finally, if you find out in 10 years that the US has gone to pot and a very dangerous government is rising to power you can make a decision to keep the gold separate and not rebalance. Instead you can hold the asset for the perceived emergency. There is nothing set in stone that says you must rebalance out of gold if you thought there was a extremely serious danger and you thought you’d need it. The future is unpredictable and because you hold the gold at least you have an option that other investors may not.
Each situation needs to be addressed when it comes about. However, the Permanent Portfolio gives you options to deal with various contingencies if they should happen.
I’ve never found that dwelling on doomsday scenarios to be very useful because the future rarely ever works out the way we think. Usually it is new and surprising outcomes that nobody expected that are the problem. Instead when you think about risk and the future, think of how useful a flexible portfolio with a wide range of assets is to deal with it. When I look at the problem that way, I’m glad I run the Permanent Portfolio and don’t concentrate my bets. I like having options and the Permanent Portfolio gives them to me.
Best Way to Hold Cash
8 months ago
With the Euro under pressure from a possible Greek default, there is a chance that we could have another repeat of 2008 with large banks going under. So what is the best way to hold cash to avoid being caught in a failed bank and have to wait (and hope) that FDIC may come to your rescue? There are only two choices for US investors:
1) A Treasury Money Market Fund
2) Short Term Treasury Bonds
For the Cash portion of the Permanent Portfolio Harry Browne always recommended using a Treasury Money Market fund that is 100% Treasury T-Bills and nothing else. This is outstanding advice for the following reasons:
1) T-Bills are the most liquid form of paper asset on the planet. They can be sold instantly when you want the cash.
2) They are backed by the full faith and credit of the US Govt. which can tax or print money in order to meet their obligations (neither is good, but at least you get your money back with some kind of value vs. nothing).
3) You do not need to worry about insurance limits like FDIC accounts will have.
4) You do not need to wait for the failed bank and FDIC to allow you access to your funds in the event of major a widespread banking panic. This could lock up your assets while things are sorted out.
5) They aren’t taxed at the state level like many CDs and other types of cash interest is.
Now I also mentioned using Short Term Treasury Bonds. This is my own modification to the Permanent Portfolio and I only recommend this if you have at least a year of living expenses in a very safe Treasury Money Market Fund first. Even then, this is optional because this fund has slightly more interest rate risk. Meaning that if interest rates go up you may take a small loss while the fund cycles out lower interest T-bills and brings in higher paying ones. This process can take a year or two with a typical Short Term Treasury fund to work out. By having at least a year of living expenses in the Treasury Money Market you can ride it out while the Short Term Treasury fund value recovers.
Some More Specifics
Treasury Money Market or Short Term Treasuries are the safest way to hold cash. Barring a failure at your brokerage, they can be traded instantly. They also have no insurance limits.
FDIC accounts are subject to problems if we were to get a large number of bank failures. While the obligations may eventually be covered, you are at the mercy of the bank and FDIC when you can remove your funds. So far it has been seamless with respect to bank closures and customers, but this doesn’t mean it will remain so if there is a large banking crisis.
So if you are interested primarily in being able to get your money out no matter what, then Treasuries are your best bet as they are top of the food chain in terms of paper assets. If you can’t sell your Treasuries to raise cash then the alternatives are in even worse condition.
If you use a Treasury Money Market there is little interest rate risk. Short Term Treasuries have only slightly more. As an alternative to Treasury Money Markets (which may be closed to new investors or not available at all fund providers) you can look into iShares Ticker SHV which is their very short Treasury ETF which is essentially the same thing a Treasury Money Market would hold. There is also the SPDR Ticker BIL which is another 1-3 month T-Bill ETF. Both of these funds hold in excess of 99.7% in Treasury Bills (the remaining less than 1% are probably funds to handle redemptions). They are therefore essentially 100% Treasuries which is exactly what you want. These ETFs will have trading costs though so you don’t want to have many small transactions as it will eat into your returns.
Yes, these and other short term Treasury funds are yielding around 0%. That’s just the reality of the markets. I encourage you to just accept what it is and not try to chase yield with your cash. This is a really bad idea (read the comments at the bottom of that article, please).
What about Vanguard’s Treasury Bond Funds?
Beware that Vanguard’s Treasury Bond fund offerings can only be 80% Treasuries and 20% “Other.” Meaning not direct Treasury issues but agencies, repurchase agreements, etc. at management discretion. This is according to their prospectus. I recommend not using any Vanguard Treasury Bond funds for this reason (they all do this). You don’t need to have Vanguard’s bond managers doing cute things behind the scenes and exposing you to risks you didn’t think you had. The iShares and and SPDR products I listed above are better options for those looking to hold the safest kind of cash.
