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Adjust Asset Allocation for Inflationary Environment?
Old 11-14-2016, 10:53 AM   #1
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Adjust Asset Allocation for Inflationary Environment?

I have followed a 50/50 AA since ER back at the end of 2002. This has served me well since bond returns have been very good over that period and in fact my liquid NW has doubled since ER even after draws for living expenses over the last 14 years.

It would seem that there is a fairly strong possibility that the low inflation environment is going to change going forward. Does it make sense to change AA to lower bond exposure? and if so, what would make sense for particular areas of equity investment?
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Old 11-14-2016, 11:46 AM   #2
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I agree than bonds are not going to do as well for you as they have over the last 14 years. However, finding an alternative is difficult in this environment, if not always. Any alternative is likely to have higher risk or lower return. If you want to increase equity, I would just go with an index ETF.
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Old 11-14-2016, 12:20 PM   #3
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If it ain't broke don't fix it. You can monitor and respond as necessary rather than making a move based on conjecture.
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Old 11-14-2016, 12:26 PM   #4
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Is a 2% move in the bond market conjecture or reality?
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Old 11-14-2016, 12:34 PM   #5
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If it ain't broke don't fix it. You can monitor and respond as necessary rather than making a move based on conjecture.
I generally agree with your view and have acted accordingly. In the past, I just simply adjusted my AA based on a wide 10% band i.e. do nothing as long as the AA was within that range and then buy/sell to bring AA back to 50/50 if limits exceeded.

With the events in the last few days my AA is starting to get closer to the point I would adjust - i.e. sell equities and buy bonds. BUT and I know it's silly to say so at this forum this time it feels different...
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Old 11-14-2016, 12:43 PM   #6
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Does it make sense to change AA to lower bond exposure? and if so, what would make sense for particular areas of equity investment?
If you think inflation is going to take off, getting a 30 year fixed mortgage today could be a way to protect against that, esp given the dearth of other great options. Pay it off over the next 30 years with dollars that are worth less and less. A 4% mortgage (approx 3% after taxes) will seem brilliant when inflation is 6%. Enjoy the tax write-off (worth even more if your other investments take off), and if you want to be safe invest the money from the mortgage in a CD ladder or I-bonds (terrible rates now, but should keep pace with inflation and maybe even provide a little return, If nothing else, it is a cash cushion if there's a sudden need for a slug of cash)
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Old 11-14-2016, 12:54 PM   #7
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If you think inflation is going to take off, getting a 30 year fixed mortgage today could be a way to protect against that, esp given the dearth of other great options. Pay it off over the next 30 years with dollars that are worth less and less. A 4% mortgage (approx 3% after taxes) will seem brilliant when inflation is 6%. Enjoy the tax write-off (worth even more if your other investments take off), and if you want to be safe invest the money from the mortgage in a CD ladder or I-bonds (terrible rates now, but should keep pace with inflation and maybe even provide a little return, If nothing else, it is a cash cushion if there's a sudden need for a slug of cash)
Thank you. I hadn't thought of that. I haven't had a mortgage for many years. I'll have to check and see how hard it would be to get one since I don't have any wage income.
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Old 11-14-2016, 04:07 PM   #8
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Since you have a paid-off house, your asset allocation isn't half stock half bonds...you have a residential real estate component that isn't reflected in the 50/50 statement. The reason I bring that up is because my first thought was for you to consider an REIT. The best asset allocations have investment classes that are less correlated with each other. Also consider emerging markets.
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Old 11-14-2016, 04:09 PM   #9
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It would seem that there is a fairly strong possibility that the low inflation environment is going to change going forward. Does it make sense to change AA to lower bond exposure? and if so, what would make sense for particular areas of equity investment?
I do not believe we are going to have inflation. My base case is stagnation and worse case is outright deflation. I have felt this way for many years and the election changes nothing. Here is why:

* Starting in 2016 the Baby Boomer cohort starts turning 70. This will go on for roughly three decades or more. Baby Boomers have been the engine of growth but this is going to change soon (nobody to pick up the slack either with tiny gen-x, broke and in-debt millennials, and low wage immigrants).

* At some point, probably after or around 2020, we will have another housing crash due to Baby Boomers needing to downsize due to health issues and no buyers available. My guess is we are going to see a lot of Baby Boomers forced to walk away from houses.

* Extremely disruptive technology is on its way. Self-driving vehicles will start to really take off in 2020+. This will destroy millions of jobs and it will get worse as AI/robotics starts to impact other areas.

* For the past few decades most of the world (all but Africa) have had a large birth rate decline. We are going to have population decline in the rich countries as well as most poorer countries (FYI, Mexico and South America have had below replacement level birth rate for decades as well, immigration issues will go away regardless of politics).


I view this recent activity (bonds down, stocks up) as an opportunity to reduce equities and buy more fixed income. I think that fixed income CEFs (closed end funds) are the way to go. I think leverage will be needed to make good returns and that the environment will be good for leverage (i.e. I view Japan-like stagnation as the most likely outcome for the US).
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Old 11-14-2016, 06:24 PM   #10
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Since you have a paid-off house, your asset allocation isn't half stock half bonds...you have a residential real estate component that isn't reflected in the 50/50 statement.
True, whether it is significant or not depends on the person/situation. I've got to live somewhere, and if I sell my house to "harvest" the appreciation (even if it's only nominal appreciation, not real), I'd have to find some other dwelling in which to live. If I can (and want to) downsize or go to a cheaper area, then it will work out. But if my other realistic replacement options are the same price, my home's appreciation hasn't improved my overall situation.

I don't count my home as part of my liquid portfolio (to meet living expenses, etc). I'd count it as part of my total net worth, but that's not an especially important metric to me.
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Old 11-14-2016, 07:31 PM   #11
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Since you have a paid-off house, your asset allocation isn't half stock half bonds...you have a residential real estate component that isn't reflected in the 50/50 statement. The reason I bring that up is because my first thought was for you to consider an REIT. The best asset allocations have investment classes that are less correlated with each other. Also consider emerging markets.
In the past I've only considered liquid investments in my AA. The only time (financially) that I consider my house is when I look at Net Worth. In fact when I calculate NW I ignore all other potential items ( cars, hobby collections, furniture etc etc that are probably only at the noise level for me, unfortunately no Picasso's hanging on the walls @ ejman manse).

Having said all that how would I consider my house as part of the AA?
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Old 11-14-2016, 07:38 PM   #12
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I do not believe we are going to have inflation. My base case is stagnation and worse case is outright deflation. I have felt this way for many years and the election changes nothing. Here is why:

* Starting in 2016 the Baby Boomer cohort starts turning 70. This will go on for roughly three decades or more. Baby Boomers have been the engine of growth but this is going to change soon (nobody to pick up the slack either with tiny gen-x, broke and in-debt millennials, and low wage immigrants).

* At some point, probably after or around 2020, we will have another housing crash due to Baby Boomers needing to downsize due to health issues and no buyers available. My guess is we are going to see a lot of Baby Boomers forced to walk away from houses.

* Extremely disruptive technology is on its way. Self-driving vehicles will start to really take off in 2020+. This will destroy millions of jobs and it will get worse as AI/robotics starts to impact other areas.

* For the past few decades most of the world (all but Africa) have had a large birth rate decline. We are going to have population decline in the rich countries as well as most poorer countries (FYI, Mexico and South America have had below replacement level birth rate for decades as well, immigration issues will go away regardless of politics).


I view this recent activity (bonds down, stocks up) as an opportunity to reduce equities and buy more fixed income. I think that fixed income CEFs (closed end funds) are the way to go. I think leverage will be needed to make good returns and that the environment will be good for leverage (i.e. I view Japan-like stagnation as the most likely outcome for the US).
Interesting perspective and I have to admit that until very recently (ha!) I thought along the same lines. What's changed in my thinking is that it seems that a very large slug of unconstrained deficit spending (for infrastructure, military and so forth) is on the way and as that works its way in an economy that is fairly close to full employment the probable effect is a large inflationary impact.
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Old 11-14-2016, 10:13 PM   #13
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One possibility if want you bonds but are concerned about inflation is to maintain the asset allocation but shorten the bond durations. Another option is TIPs.
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Old 11-14-2016, 10:32 PM   #14
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We always have a fixed 30 year mortgage of some amount on the house and every time mortgage rates drop just get a zero fee, zero point loan at the newest rate and if they go up we just keep what we have. Our pensions are mostly non-COLA so the fixed rate mortgage helps offset that income (pensions won't go up but then neither will mortgage if interest rates shoot up). We also have TIPS ladders and some I-bonds.

I think it pays to prepare for the possibility of high inflation but my best guess is interest rates and inflation are not going up significantly long term in the U.S. any time soon because globally the trend in interest rates has been downward for several decades now.

There is a good chart in the link below that shows the long term global trend:

The Decline in Long Term Interest Rates
https://www.whitehouse.gov/blog/2015...interest-rates

"Long-term interest rates in the United States have been falling since the early 1980s and have reached historically low levels. But does this experience indicate that the level of long-term interest rates has shifted to a lower long-run equilibrium? A new report by the Council of Economic Advisers surveys the latest thinking on the many drivers of interest rates, both in recent decades and into the future. While there is no definitive answer to the question, most explanations for currently low long-term interest rates suggest that in the long run, they will remain lower relative to those that prevailed before the financial crisis."
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Old 11-15-2016, 09:20 AM   #15
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Interesting perspective and I have to admit that until very recently (ha!) I thought along the same lines. What's changed in my thinking is that it seems that a very large slug of unconstrained deficit spending (for infrastructure, military and so forth) is on the way and as that works its way in an economy that is fairly close to full employment the probable effect is a large inflationary impact.

I think Japan is a good model for what the US will experience. Japan has thrown money at massive infrastructure projects for years and years to little affect. They have not been able to overcome their deflationary demographics despite the fact that they were going through this when other parts of asia (China) were going gang busters.

The US is going into this with a stagnant world economy and facing radical technological change. There are around 8.7 million people employed in driving trucks around, 3.5 million as truck drivers (which pay a good wage for non-college educated). For taxi drivers it is around 233,900. All of those jobs can be impacted to one degree or another.

That's just the tip of the iceberg though. What we will likely see is people will stop buying cars once they can rent a car anytime they need one. Hit a few buttons on smartphone and have a self-driving car show up 5-mins later ready to take you wherever you need to go.

Think about how many cars sit dormant in drive ways and parking lots every day. This is wasted resources. People that own a car will chose to rent their vehicle out while at work, asleep, etc. to generate income. Vehicle usage will become far more efficient... and this will cause many car-related business and jobs to go bankrupt. Less cars made, less car dealerships, less car part shops, less mechanics, etc.

This will not happen in isolation. Once AI/robotics revolution really gets started we will be looking at hundreds of millions of jobs affected world-wide.
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Old 11-15-2016, 06:50 PM   #16
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In the past I've only considered liquid investments in my AA. The only time (financially) that I consider my house is when I look at Net Worth. In fact when I calculate NW I ignore all other potential items ( cars, hobby collections, furniture etc etc that are probably only at the noise level for me, unfortunately no Picasso's hanging on the walls @ ejman manse).

Having said all that how would I consider my house as part of the AA?
Add in the value of your house to your liquid investments. That becomes the denominator. House value over that denominator tells you what you have "invested" in residential real estate. And if you consider getting a HELOC, then it's not as "illiquid" as you might think. I know there's no such thing as a sure bet, but imagine having the ability to get 6% on and investment, and the ability to borrow against your house for 3%. If there were a sure thing, that would be a slam-dunk, right?

But I'm the same as you with respect to what's in my AA vs Net Worth....I don't count my house. It's in the back of my mind, but I don't calculate it.
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Old 11-15-2016, 07:10 PM   #17
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Add in the value of your house to your liquid investments. That becomes the denominator. House value over that denominator tells you what you have "invested" in residential real estate. And if you consider getting a HELOC, then it's not as "illiquid" as you might think. I know there's no such thing as a sure bet, but imagine having the ability to get 6% on and investment, and the ability to borrow against your house for 3%. If there were a sure thing, that would be a slam-dunk, right?

But I'm the same as you with respect to what's in my AA vs Net Worth....I don't count my house. It's in the back of my mind, but I don't calculate it.
I see thanks for the info. Back in the days of crazy housing price increases (2006-2007) I briefly considered a HELOC. I went to one of the local banks here (Washington Mutual at the time long bankrupt) and talked to one of their officers and picked up an application so I could study it. Never signed anything. Lo and behold a few days latter an official letter comes from my insurance company that they had added Washington mutual as the new mortgage holder on my house thank you very much and were very happy to do business with me. I hadn't signed a damn thing. I eventually got this straightened out. Left me with a slightly sour mood re HELOCs needless to say...
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Old 11-15-2016, 07:15 PM   #18
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I think Japan is a good model for what the US will experience. Japan has thrown money at massive infrastructure projects for years and years to little affect. They have not been able to overcome their deflationary demographics despite the fact that they were going through this when other parts of asia (China) were going gang busters.

The US is going into this with a stagnant world economy and facing radical technological change. There are around 8.7 million people employed in driving trucks around, 3.5 million as truck drivers (which pay a good wage for non-college educated). For taxi drivers it is around 233,900. All of those jobs can be impacted to one degree or another.

That's just the tip of the iceberg though. What we will likely see is people will stop buying cars once they can rent a car anytime they need one. Hit a few buttons on smartphone and have a self-driving car show up 5-mins later ready to take you wherever you need to go.

Think about how many cars sit dormant in drive ways and parking lots every day. This is wasted resources. People that own a car will chose to rent their vehicle out while at work, asleep, etc. to generate income. Vehicle usage will become far more efficient... and this will cause many car-related business and jobs to go bankrupt. Less cars made, less car dealerships, less car part shops, less mechanics, etc.

This will not happen in isolation. Once AI/robotics revolution really gets started we will be looking at hundreds of millions of jobs affected world-wide.
Yes, this looks like a likely scenario if it is allowed to develop as outlined. I'm not sure that will happen.
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Old 04-06-2017, 08:47 AM   #19
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I just read this Fido article on high-inflation AAs, and thought I'd bump this thread with it. The punchline seems to be: consider investing 10%+/- of assets in noncorrelated assets (energy stocks, commodity stocks, REITs, etc.) to combat high inflation periods.

https://www.fidelity.com/viewpoints/...e=email_weekly

I'd like to hear others' opinions/experience in this regard. Particularly, what funds? would you choose to achieve such an AA? Or, would you do nothing at all?
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Old 04-06-2017, 10:43 AM   #20
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For the market's expectations on coming inflation I'd look at:
https://fred.stlouisfed.org/series/T10YIE

This shows a current value of 2% inflation over the next 10 years.

TIPS could be used for unexpected inflation protection i.e. inflation beyond that Fed chart number. But I don't currently own any of them as the real yields are well below historical norms.

The Fidelity article mentioned short term bonds. For other reasons I have a fair helping of short term investment grade, VFSUX. Beyond that, I don't personally like the other asset classes mentioned in the article.
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