Larry Swedroe: 7 Reasons Why Advisors Should Use Bond Ladders

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Random Walker
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Larry Swedroe: 7 Reasons Why Advisors Should Use Bond Ladders

Post by Random Walker » Mon Aug 21, 2017 10:07 am

In this article from Advisor Perspectives Larry knocks down some of the arguments against bond ladders. Hopefully Larry will follow up with an article on the advantages of bond ladders for individual investors. Especially for taxable investors, I can see a few advantages of municipal bond ladder over bond fund: no expense ratio, tailor the ladder to individual's specific state tax status, possibly tax loss harvesting at individual bond level.


Dave

https://www.advisorperspectives.com/art ... nd-ladders

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nedsaid
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Re: Larry Swedroe: 7 Reasons Why Advisors Should Use Bond Ladders

Post by nedsaid » Mon Aug 21, 2017 10:47 am

My take is that ladders using US Treasuries, TIPS, and FDIC Insured Certificates of Deposit are just fine for small investors. If you want to ladder with Corporates, that takes more expertise. A ladder using Municipals might be doable for a do-it-yourself investor, but again, probably better if you work with an advisor. My concern centers on the bid/ask spread as most bonds are thinly traded, even brokered CD's purchased on the secondary market can have a pretty good bid/ask spread. Someone showed me a quote on a CD purchased from Vanguard brokerage and the spread appeared to be about 3%.

The problem I have with Corporate or Muni ladders is that this, in effect, drafts the investor into being his or her own credit analyst. If you work with an advisor, make certain that you work with a fiduciary, you don't want to buy the flawed stuff that the brokerage firm doesn't want anymore. If you have an advisor, you not only want the firm to be a fiduciary but you also want expertise in the bond market.

The thing is, bonds can be very complex instruments. Most investors are not aware of this. Things like call dates, bond covenants, order in which bonds are repaid in the case of bankruptcy add to their complexity. The other thing is that most bonds are pretty thinly traded.

Larry knows what he is talking about. I like that his firm has a list of several states that are avoided, largely because of underfunded pensions. You want to know what you are doing or want to work with people who know what they are doing when you attempt this.

Speaking for myself, early on in my investing career I bought a brokered CD and three zero coupon treasury bonds. The broker did all that for me but these were relatively simple instruments. I was offered a bond from a major regional bank, but I passed. The investment would have turned out okay, but it was a bit beyond my circle of competence so I did not invest. The broker was a friend, but I had no way of knowing whether or not the firm had these in inventory and wanted to unload.

Be careful out there.
A fool and his money are good for business.

afan
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Re: Larry Swedroe: 7 Reasons Why Advisors Should Use Bond Ladders

Post by afan » Mon Aug 21, 2017 12:06 pm

Well, for an individual investor the expense ratio is avoided only if you do it yourself or your advisor works for free.

The complexities of bonds and the lack of information about munis also work against you. These factors plus the thin trading lead the ratings agencies to rarely update the ratings. The vast majority of the time they do not have any current information on which to base a rating change. If there is a rating change in one of your bonds how sure are you that you would know about it? Check daily? Hourly? Subscribe to a service that will monitor the ratings on your portfolio? What would that cost? If the rating does change and you know of it, then you have to decide whether the bond is worth keeping.

For an individual with a few dozen bonds there is also a question of diversification. For a fund with thousands of issues, much less of a concern.

The main advantage seems to be the ability to tailor the portfolio to an individual investor's tax status. That might mean bonds outside their state but not a national fund. It would be fascinating to see a comparison between the ladder approach, after fees and transaction costs, vs

1. A simple national bond muni fund
2. A blend of a national and an in-state muni fund for a given investor.

The headwinds of cost and complexity are a lot to overcome when trying to save 12 basis points of expense ratio.
We don't know how to beat the market on a risk-adjusted basis, and we don't know anyone that does know either | --Swedroe | We assume that markets are efficient, that prices are right | --Fama

stlutz
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Re: Larry Swedroe: 7 Reasons Why Advisors Should Use Bond Ladders

Post by stlutz » Mon Aug 21, 2017 9:16 pm

The key thing to remember is that holding a collection of individual bonds is functionally equivalent to holding a mutual fund that holds a collection of individual bonds.

Two situations where they are different:

a) CDs are not available in mutual fund form. If you want CDs (either brokered or directly from the bank), you need to ladder them yourself.

b) Bond funds/ETS are more liquid than individual bonds. That advantage can be overstated, as bond prices (and hence the fund NAV) can decline during times of low liquidity. But even during times of high liquidity, it could take several weeks to unload a bunch of individual muni bonds.

I would not invest in anything through and advisor that I'm not comfortable managing myself. Bonds are complex with terms like "yield-to-maturity", "yield-to-worst", "coupon", "maturity", "duration", "convexity" etc. A few people on this board (e.g. me, Doc, grok) geek out on this stuff; most do not. For those who do not, an advisor putting you into a bunch of individual bonds is a way for them to lock you into using their services for no clear significant benefit.

In terms of value that an advisor can provide, I think they can provide more value by making appropriate market timing calls. For example when TIPS prices collapsed in 2008 making them a screaming bargain vs. nominal treasuries. At the beginning of 2017, many AAA-rated muni bonds had higher yields than Treasuries even before considering the tax advantages. There is also a strategy that backtests fairly well to vary average maturities based on the shape of the yield curve. All of these opportunities (which were discussed on Bogleheads BTW), could have been easily exploited with funds or ETFs. If your advisor missed these opportunities but was stressing the importance of having a slight overweight to Georgia municipal bonds, well I'd suggest a different advisor.

Vanguard has a wide variety of fund options with costs <.1%. That's pretty darned hard to beat. It's also pretty hard to find exposures that you can't accomplish with the combination of a couple of funds (again, excepting CDs).

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Artsdoctor
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Re: Larry Swedroe: 7 Reasons Why Advisors Should Use Bond Ladders

Post by Artsdoctor » Tue Aug 22, 2017 1:49 pm

There may be some confusion when talking about bond ladders. Primarily, you're going to have to differentiate rolling ladders from non-rolling ladders. If you're going to need the money at a specific time, that's going to be a very different situation that just rolling through several decades of investing. During accumulation years, you're almost always going to do better with a fund. It's later on when there are very specific spending needs that the argument becomes more compelling.

As the article points out, there's also a very big difference between having your advisors buy the bonds for you on the secondary market and doing it yourself. If you do it yourself, you're going to pay for it. And God forbid you're going to want to unload the bond before maturity--you're almost never going to get a good price for it (although your advisor may if trading volume is extremely large like in Larry's case).

The information is all in Larry's article but you are going to have to read it carefully to get the full value of its contents.

skeptical
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Re: Larry Swedroe: 7 Reasons Why Advisors Should Use Bond Ladders

Post by skeptical » Tue Aug 22, 2017 4:09 pm

stlutz wrote:
Mon Aug 21, 2017 9:16 pm
The key thing to remember is that holding a collection of individual bonds is functionally equivalent to holding a mutual fund that holds a collection of individual bonds.

Two situations where they are different:

a) CDs are not available in mutual fund form. If you want CDs (either brokered or directly from the bank), you need to ladder them yourself.

b) Bond funds/ETS are more liquid than individual bonds. That advantage can be overstated, as bond prices (and hence the fund NAV) can decline during times of low liquidity. But even during times of high liquidity, it could take several weeks to unload a bunch of individual muni bonds.
For me, the significant difference between holding individual bonds and a mutual fund is the liquidity risk for a mutual fund. If there is a run on the fund, the fund manager will be forced to sell bonds at distressed prices, potentially causing long lasting harm. If you hold individual bonds and you can hold tight until they mature, you can recoup the par value, barring defaults, which could, of course rise in this type of situation.

I have a lot invested in Vanguards intermediate muni funds (national/VWIUX and MA state/VMATX), and I have had several large and well known institutions put together proposals for bond ladders using these two funds as benchmarks. None of them were able to beat these two funds when you looked at YTW, YTM, current yield, credit risk, GO vs Revenue vs pre-refunded, etc., and all of them acknowledged that what I would get from their bond ladders was more control over my bond portfolio, not better risk adjusted returns.

Adding in the advantages of day to day liquidity, ability to add incremental amounts to the bond side, and not getting stuck with complications, going the fund approach is better for my situation.

Theoretical
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Re: Larry Swedroe: 7 Reasons Why Advisors Should Use Bond Ladders

Post by Theoretical » Tue Aug 22, 2017 11:28 pm

I think the Guggenheim BulletShares and iShares IBonds target maturity funds can play an interesting role if you want to DIY a ladder of corporates or munis.

grok87
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Re: Larry Swedroe: 7 Reasons Why Advisors Should Use Bond Ladders

Post by grok87 » Wed Aug 23, 2017 9:33 am

Interesting article.

Re the credit risk point, ie the argument that there have been basically zero losses from AA/AAA GO bonds in the last x number of years...

1) it is worth thinking about the Near misses etc. orange county was AA when it defaulted in 1994.
The train wreck that is the state of Illinois was AA as recently as 2010.

2) also woth pointing out that AA isn't what it used to be. moodys etc recalibrated their scales in 2010.
A bunch of single A credits moved to AA. This was not for improving credit quality reasons. So the historical analysis is not necessarily valid. Worth reading this article.

http://muninetguide.com/americas-cities ... -part-one/

Cheers,
Grok
"...people always live for ever when there is any annuity to be paid them"- Jane Austen

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