What's the deal with long term gov bonds?

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fortfun
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What's the deal with long term gov bonds?

Post by fortfun » Thu Apr 21, 2016 3:12 pm

I'm trying to finalize my AA with fidelity. Deciding on the bond AA. Spartan Long-Term Treasury Bond Index Fund seems too good to be true. However, it is cheap at .12. Should I know something about them? Someone on the board suggested Spartan US Bond Index Fund. It's cheaper at .07 but hasn't done as well (I know I shouldn't look at past performance). Suggestions on the bond portion of my AA in fidelity?
Thanks.

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Re: What's the deal with long term gov bonds?

Post by ogd » Thu Apr 21, 2016 3:18 pm

Do not look at past performance. Look at current SEC yield to decide if it's "to good to be true".

That past performance came because of decreasing yields, so it's bittersweet if you own the fund, just bitter if you don't.

My recommendation is use the wide bond index fund unless stock AA is above 80% and you have a stomach for bond volatility, in which case the pairing with long Treasuries can make for a more efficient portfolio.

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fortfun
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Re: What's the deal with long term gov bonds?

Post by fortfun » Thu Apr 21, 2016 3:21 pm

ogd wrote:Do not look at past performance. Look at current SEC yield to decide if it's "to good to be true".

That past performance came because of decreasing yields, so it's bittersweet if you own the fund, just bitter if you don't.

My recommendation is use the wide bond index fund unless stock AA is above 80% and you have a stomach for bond volatility, in which case the pairing with long Treasuries can make for a more efficient portfolio.
Ogd, would "wide" be us bond index fund? Sorry for my ignorance.

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Re: What's the deal with long term gov bonds?

Post by ogd » Thu Apr 21, 2016 3:27 pm

fortfun wrote:Ogd, would "wide" be us bond index fund? Sorry for my ignorance.
Yes, that's what I meant. The long term treasury fund is much narrower.

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Re: What's the deal with long term gov bonds?

Post by azanon » Thu Apr 21, 2016 3:31 pm

fortfun wrote:I'm trying to finalize my AA with fidelity. Deciding on the bond AA. Spartan Long-Term Treasury Bond Index Fund seems too good to be true. However, it is cheap at .12. Should I know something about them? Someone on the board suggested Spartan US Bond Index Fund. It's cheaper at .07 but hasn't done as well (I know I shouldn't look at past performance). Suggestions on the bond portion of my AA in fidelity?
Thanks.
It can actually be even better than your impression (if you're just looking at return). Why? Because LT treasuries will tend to be considerably less correlated to just about any stocks than a Total US Bond fund. I think most use a bond fund for the same purpose; lowering overall portfolio volatility. I think where some go wrong, is they don't necessarily pick the best choice for that purpose.

If one were selecting a bond fund in pure isolation, a "total bond" fund probably has about the best risk-adjusted return out there, and LT treasuries do quite poorly when analyzed in isolation. So if you're only buying a bond fund, and absolutely nothing else (e.g. 100% bonds) get a total bond fund.

As for interest rates, we've gone a good 7 years now where many folks have been certain any bonds with long duration are a bad deal. And they've been wrong for 7 years and counting.

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Re: What's the deal with long term gov bonds?

Post by fortfun » Thu Apr 21, 2016 3:41 pm

azanon wrote:
fortfun wrote:I'm trying to finalize my AA with fidelity. Deciding on the bond AA. Spartan Long-Term Treasury Bond Index Fund seems too good to be true. However, it is cheap at .12. Should I know something about them? Someone on the board suggested Spartan US Bond Index Fund. It's cheaper at .07 but hasn't done as well (I know I shouldn't look at past performance). Suggestions on the bond portion of my AA in fidelity?
Thanks.
It can actually be even better than your impression (if you're just looking at return). Why? Because LT treasuries will tend to be considerably less correlated to just about any stocks than a Total US Bond fund. I think most use a bond fund for the same purpose; lowering overall portfolio volatility. I think where some go wrong, is they don't necessarily pick the best choice for that purpose.

If one were selecting a bond fund in pure isolation, a "total bond" fund probably has about the best risk-adjusted return out there, and LT treasuries do quite poorly when analyzed in isolation. So if you're only buying a bond fund, and absolutely nothing else (e.g. 100% bonds) get a total bond fund.

As for interest rates, we've gone a good 7 years now where many folks have been certain any bonds with long duration are a bad deal. And they've been wrong for 7 years and counting.
azanon, so I guess Long Term treasury bonds wouldn't really be a true Boglehead strategy. Seems like trying to time the market to me. I guess to be a true Bogle you should look for Total Index anything? Thanks for helping a newbie.

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Re: What's the deal with long term gov bonds?

Post by azanon » Thu Apr 21, 2016 3:52 pm

fortfun wrote:
azanon wrote:
fortfun wrote:I'm trying to finalize my AA with fidelity. Deciding on the bond AA. Spartan Long-Term Treasury Bond Index Fund seems too good to be true. However, it is cheap at .12. Should I know something about them? Someone on the board suggested Spartan US Bond Index Fund. It's cheaper at .07 but hasn't done as well (I know I shouldn't look at past performance). Suggestions on the bond portion of my AA in fidelity?
Thanks.
It can actually be even better than your impression (if you're just looking at return). Why? Because LT treasuries will tend to be considerably less correlated to just about any stocks than a Total US Bond fund. I think most use a bond fund for the same purpose; lowering overall portfolio volatility. I think where some go wrong, is they don't necessarily pick the best choice for that purpose.

If one were selecting a bond fund in pure isolation, a "total bond" fund probably has about the best risk-adjusted return out there, and LT treasuries do quite poorly when analyzed in isolation. So if you're only buying a bond fund, and absolutely nothing else (e.g. 100% bonds) get a total bond fund.

As for interest rates, we've gone a good 7 years now where many folks have been certain any bonds with long duration are a bad deal. And they've been wrong for 7 years and counting.
azanon, so I guess Long Term treasury bonds wouldn't really be a true Boglehead strategy. Seems like trying to time the market to me. I guess to be a true Bogle you should look for Total Index anything? Thanks for helping a newbie.
Oh no I wouldn't say that. Actually, I would argue avoiding LT bonds because one thinks they know which direction interest rates are going is trying to time the market, and thus anti-boglehead.

The proper way to estimate a bond's return is its yield, so if you're interested in accurate estimates of return, even today, LT treasuries yield higher than a typical total bond fund. The only thing you might add in there for a true estimate is chance of default and, of course, total bond will score lower there too (treasuries being essentially 0%, and total bond maybe 1-2% defaults from the corporates, ... if that?)

I actually think a lot of bogleheads are conflicted on this matter. In practice, a lot of them select total bond. But I think a boglehead argument, with a dash of modern portfolio theory, could easily support LT treasuries in lieu of total bond, for at least a portion of the bond position.

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Re: What's the deal with long term gov bonds?

Post by FillorKill » Thu Apr 21, 2016 3:56 pm

Anyone backtesting with portfolio visualizer to arrive at their proposed bond allocation should be required to run their proposed bond allocation 1972-1981 to see what things can look like in a different rate environment. Short term treasuries - too good to be true? :wink:

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Re: What's the deal with long term gov bonds?

Post by azanon » Thu Apr 21, 2016 3:59 pm

FillorKill wrote:Anyone backtesting with portfolio visualizer to arrive at their proposed bond allocation should be required to run their proposed bond allocation 1972-1981 to see what things can look like in a different rate environment. Short term treasuries - too good to be true? :wink:
If you're buying bonds with a duration of 15 years or more, for just 9 years, you might want to let someone else manage your portfolio. :?

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Re: What's the deal with long term gov bonds?

Post by FillorKill » Thu Apr 21, 2016 4:03 pm

azanon wrote:
FillorKill wrote:Anyone backtesting with portfolio visualizer to arrive at their proposed bond allocation should be required to run their proposed bond allocation 1972-1981 to see what things can look like in a different rate environment. Short term treasuries - too good to be true? :wink:
If you're buying bonds with a duration of 15 years or more, for just 9 years, you might want to let someone else manage your portfolio. :?
They were horrible from 1940-1981 and the results would be the same. The limitation is with visualizer not my point.

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Re: What's the deal with long term gov bonds?

Post by dbr » Thu Apr 21, 2016 4:09 pm

fortfun wrote:
azanon, so I guess Long Term treasury bonds wouldn't really be a true Boglehead strategy. Seems like trying to time the market to me. I guess to be a true Bogle you should look for Total Index anything? Thanks for helping a newbie.
I don't think Boglehead strategy has a position on what duration one might select in bonds. Ogd has described some of the considerations involved. Investing at low cost and not chasing after recent performance are Boglehead ideas that do apply. A person might still decide that a low cost long bond fund is appropriate to their situation but not because long bonds have a recent history of good returns. A lot of people feel that the high interest rate sensitivity and inflation risk are downsides to a long bond position, but I would not raise that to the level of strategy.

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Re: What's the deal with long term gov bonds?

Post by fortfun » Thu Apr 21, 2016 4:10 pm

azanon wrote:
I actually think a lot of bogleheads are conflicted on this matter. In practice, a lot of them select total bond. But I think a boglehead argument, with a dash of modern portfolio theory, could easily support LT treasuries in lieu of total bond, for at least a portion of the bond position.
Is modern portfolio theory replacing Boglehead? In 20 years, will I have been an idiot for going Boglehead? It was supposed to be so simple: "pick cheap index funds" and wait. Now, I have to decide on LT index bonds vs U.S. Bond Index (both cheap). So confused???

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Re: What's the deal with long term gov bonds?

Post by mhc » Thu Apr 21, 2016 4:28 pm

One of the main purposes of bonds is to reduce the risk of your portfolio. LT bonds introduce some of their own risks. Most people around here would recommend a total bond index. Look at the Target Retirement Funds. That is what they tend to use.

Don't over think your portfolio. Read about the 3 fund portfolio on the wiki. It is hard to beat it.

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Re: What's the deal with long term gov bonds?

Post by oldcomputerguy » Thu Apr 21, 2016 4:29 pm

fortfun wrote:I'm trying to finalize my AA with fidelity. Deciding on the bond AA. Spartan Long-Term Treasury Bond Index Fund seems too good to be true. However, it is cheap at .12. Should I know something about them? Someone on the board suggested Spartan US Bond Index Fund. It's cheaper at .07 but hasn't done as well (I know I shouldn't look at past performance). Suggestions on the bond portion of my AA in fidelity?
Thanks.
Spartan US Bond Indx Fund has a more diversified makeup (corporate and agency bonds in addition to Treasuries). You should also look at duration of both funds to make sure it matches your investment horizon at least fairly closely. Long Term Treasury Indx has a duration of right at 18 years, while US Bond is just over 5 years.
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Re: What's the deal with long term gov bonds?

Post by nisiprius » Thu Apr 21, 2016 5:00 pm

The big problem with any kind of long-term bonds is that they are more sensitive to interest rate changes. When you buy a $1,000 bond, you are locked into the coupon interest rate for the term of the bond. If you buy a bond when the interest rate is 2% and it pays 2%, and interest rates rise to 4%, people won't want to pay you a full $1,000 for your bond when they can buy a newly-issued bond for the $1,000 that will pay double the interest. If your too-low interest rate is locked in for thirty years, that's a lot more serious than if it is locked in for five years, so the bond's market value will be depressed more.

The result is that long-term bonds have more interest-rate sensitivity, more risk.

You can see this plainly with the naked eye in a growth chart. Blue, Vanguard short-term bond index fund. Orange, Vanguard long-term bond index fund.

Incidentally, Morningstar shows the short-term fund as having a 15-year Sharpe ratio of 0.97, versus 0.64 for the long-term fund, meaning that over this time period, and taking standard deviation as a measure of "risk," even though the long-term fund had a higher return, the return wasn't commensurate with the extra risk.

Source
Image

They also expose you to much more inflation risk. Of course, investors take expected inflation into account when bidding on a bond, but there is a lot more chance of running into serious unexpected inflation over thirty years than over five.

Personally, I wouldn't want any substantial holding in long-term nominal bonds. To my mind, nominal bonds are not appropriate for an ordinary investor like me. I see them as having two uses:

a) Individual bonds, for purchase by insurance companies and pension funds, to match known future liabilities.

b) People who are consciously investing in long-term bonds because they want the volatility, because they hope it will work synergistically with stocks to smooth things out slightly due to low correlation. That is, people who are intentionally buying an asset class that's not too good by itself because, based on modern portfolio theory, they think it will work synergistically to improve the portfolio as a whole.
Last edited by nisiprius on Thu Apr 21, 2016 9:18 pm, edited 1 time in total.
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Re: What's the deal with long term gov bonds?

Post by ogd » Thu Apr 21, 2016 5:43 pm

fortfun wrote: Is modern portfolio theory replacing Boglehead? In 20 years, will I have been an idiot for going Boglehead? It was supposed to be so simple: "pick cheap index funds" and wait. Now, I have to decide on LT index bonds vs U.S. Bond Index (both cheap). So confused???
You don't need to. You wanted to, it seems.

Think of the possibility of LT treasuries as the same kind of thing as portfolio tilting towards small or value stocks. If you are a statistics nerd (and to some degree, believer), you'll do a 10 fund portfolio and hope it continues to do better than the 3 fund. But the three fund portfolio will continue to be the yardstick.

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Re: What's the deal with long term gov bonds?

Post by fortfun » Thu Apr 21, 2016 6:00 pm

Thanks everyone. Sounds like I'll stick with the Broad U.S. short term bond to meet my AA goals. Much appreciated.

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Re: What's the deal with long term gov bonds?

Post by mhc » Fri Apr 22, 2016 11:37 am

Most go with an intermediate bond index. That is what is in target retirement funds.

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Re: What's the deal with long term gov bonds?

Post by fortfun » Fri Apr 22, 2016 11:41 am

nisiprius wrote:The big problem with any kind of long-term bonds is that they are more sensitive to interest rate changes. When you buy a $1,000 bond, you are locked into the coupon interest rate for the term of the bond. If you buy a bond when the interest rate is 2% and it pays 2%, and interest rates rise to 4%, people won't want to pay you a full $1,000 for your bond when they can buy a newly-issued bond for the $1,000 that will pay double the interest. If your too-low interest rate is locked in for thirty years, that's a lot more serious than if it is locked in for five years, so the bond's market value will be depressed more.

The result is that long-term bonds have more interest-rate sensitivity, more risk.

You can see this plainly with the naked eye in a growth chart. Blue, Vanguard short-term bond index fund. Orange, Vanguard long-term bond index fund.

Incidentally, Morningstar shows the short-term fund as having a 15-year Sharpe ratio of 0.97, versus 0.64 for the long-term fund, meaning that over this time period, and taking standard deviation as a measure of "risk," even though the long-term fund had a higher return, the return wasn't commensurate with the extra risk.

Source
Image

They also expose you to much more inflation risk. Of course, investors take expected inflation into account when bidding on a bond, but there is a lot more chance of running into serious unexpected inflation over thirty years than over five.

Personally, I wouldn't want any substantial holding in long-term nominal bonds. To my mind, nominal bonds are not appropriate for an ordinary investor like me. I see them as having two uses:

a) Individual bonds, for purchase by insurance companies and pension funds, to match known future liabilities.

b) People who are consciously investing in long-term bonds because they want the volatility, because they hope it will work synergistically with stocks to smooth things out slightly due to low correlation. That is, people who are intentionally buying an asset class that's not too good by itself because, based on modern portfolio theory, they think it will work synergistically to improve the portfolio as a whole.
Thanks for the thorough explanation nisiprius! Very helpful.

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Re: What's the deal with long term gov bonds?

Post by fortfun » Fri Apr 22, 2016 11:44 am

mhc wrote:Most go with an intermediate bond index. That is what is in target retirement funds.
So this would be the most commonly used among bogleheads:
Spartan® Intermediate Treasury Bond Index Fund - Fidelity Advantage Class (FIBAX)

List of all choices.
https://docs.google.com/spreadsheets/d/ ... edit#gid=0

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Re: What's the deal with long term gov bonds?

Post by mhc » Fri Apr 22, 2016 11:55 am

I can't use google.docs right now because I am at work. The intermediate Fidelity bond fund that most would recommend is Spartan US Bond Index which tracks the Barclay's US Aggregate Bond Index. It holds a mix of government and corporate bonds. The one you are referencing is government only.

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Re: What's the deal with long term gov bonds?

Post by dbr » Fri Apr 22, 2016 2:55 pm

fortfun wrote:
mhc wrote:Most go with an intermediate bond index. That is what is in target retirement funds.
So this would be the most commonly used among bogleheads:
Spartan® Intermediate Treasury Bond Index Fund - Fidelity Advantage Class (FIBAX)

List of all choices.
https://docs.google.com/spreadsheets/d/ ... edit#gid=0
In my opinion an intermediate term index is a perfectly reasonable choice. If you want to know what "Bogleheads" as a group tend to hold, that would be all over the map and off the map on every side.

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Re: What's the deal with long term gov bonds?

Post by Call_Me_Op » Fri Apr 22, 2016 4:22 pm

fortfun wrote:I'm trying to finalize my AA with fidelity. Deciding on the bond AA. Spartan Long-Term Treasury Bond Index Fund seems too good to be true.
Surely you must be joking.
Best regards, -Op | | "In the middle of difficulty lies opportunity." Einstein

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Re: What's the deal with long term gov bonds?

Post by fortfun » Sat Apr 23, 2016 9:26 pm

Call_Me_Op wrote:
fortfun wrote:I'm trying to finalize my AA with fidelity. Deciding on the bond AA. Spartan Long-Term Treasury Bond Index Fund seems too good to be true.
Surely you must be joking.
Op, these are the returns:
ytd7.68% 1yr2.69% 3yr5.95% 5yr9.58% 10yr7.85%

Sadly, I don't know much about investing but they sure look good to me. However, smart people in this group told me otherwise. Take it easy on a newbie. At least I'm trying.

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Re: What's the deal with long term gov bonds?

Post by dltnfs » Sun Apr 24, 2016 1:36 am

fortfun wrote:Op, these are the returns:
ytd7.68% 1yr2.69% 3yr5.95% 5yr9.58% 10yr7.85%

Sadly, I don't know much about investing but they sure look good to me. However, smart people in this group told me otherwise. Take it easy on a newbie. At least I'm trying.
To put more explicitly what's implied above: The reason why this fund went up is that long-term interest rates went down over the last ten years, to historically low levels. They can't keep going down forever, so the cause of that fund's good performance is fundamentally unsustainable. Nobody knows how low rates will go, beyond that they can't go too far below zero without putting the financial system into uncharted territory (e.g., requiring the government to forbid or limit storage of cash).

To a first order, a bond fund with duration x will perform sort of like a combination of half cash, and half bond fund with duration 2x. (Depending on the shape of the yield curve, they'll pay interest at slightly different rates, and bond traders seem to care about higher-order effects sometimes.) So shortening duration is sort of like moving some of your bond allocation to cash, and you'll see the merits of long plus short vs. just intermediate ("barbell" vs. "bullet") debated in the archives.

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Re: What's the deal with long term gov bonds?

Post by Call_Me_Op » Sun Apr 24, 2016 6:44 am

fortfun wrote:
Call_Me_Op wrote:
fortfun wrote:I'm trying to finalize my AA with fidelity. Deciding on the bond AA. Spartan Long-Term Treasury Bond Index Fund seems too good to be true.
Surely you must be joking.
Op, these are the returns:
ytd7.68% 1yr2.69% 3yr5.95% 5yr9.58% 10yr7.85%

Sadly, I don't know much about investing but they sure look good to me. However, smart people in this group told me otherwise. Take it easy on a newbie. At least I'm trying.
I was simply borrowing from the title of a famous book (at least among geeks like me), "Surely You Must be Joking, Mr Feynman." Sorry if it came across as abrupt. You are doing the right thing by "looking before you leap."

The returns you quote are from the recent past. The expected return right now is about equal to the yield, which is very small. Plus, they come with enormous (unexpected) inflation risk (and interest-rate risk, which is more of an opportunity cost). Especially with bonds, do not use the past 30-40 years as a guide. I am afraid that you, like all of us, must accept that the returns on bonds in the coming years will be relatively paltry. Think of bonds not in terms of how much return you can get but rather "this is the money I want to be there if all hell breaks loose." This is why some here recommend only the safest bonds (short-term treasuries, CD's, and perhaps top-rate muni's.)
Best regards, -Op | | "In the middle of difficulty lies opportunity." Einstein

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Re: What's the deal with long term gov bonds?

Post by fortfun » Sun Apr 24, 2016 9:14 am

Call_Me_Op wrote:
fortfun wrote:
Call_Me_Op wrote:
fortfun wrote:I'm trying to finalize my AA with fidelity. Deciding on the bond AA. Spartan Long-Term Treasury Bond Index Fund seems too good to be true.
Surely you must be joking.
Op, these are the returns:
ytd7.68% 1yr2.69% 3yr5.95% 5yr9.58% 10yr7.85%

Sadly, I don't know much about investing but they sure look good to me. However, smart people in this group told me otherwise. Take it easy on a newbie. At least I'm trying.
I was simply borrowing from the title of a famous book (at least among geeks like me), "Surely You Must be Joking, Mr Feynman." Sorry if it came across as abrupt. You are doing the right thing by "looking before you leap."

The returns you quote are from the recent past. The expected return right now is about equal to the yield, which is very small. Plus, they come with enormous (unexpected) inflation risk (and interest-rate risk, which is more of an opportunity cost). Especially with bonds, do not use the past 30-40 years as a guide. I am afraid that you, like all of us, must accept that the returns on bonds in the coming years will be relatively paltry. Think of bonds not in terms of how much return you can get but rather "this is the money I want to be there if all hell breaks loose." This is why some here recommend only the safest bonds (short-term treasuries, CD's, and perhaps top-rate muni's.)
Thanks Op. That's helpful. Sorry I didn't get that reference.

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