Lots of Newbie bond questions

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305pelusa
Posts: 6
Joined: Fri Nov 16, 2018 10:20 pm

Lots of Newbie bond questions

Post by 305pelusa » Fri Nov 16, 2018 10:47 pm

Hello,
I have been searching for a bit for some of these questions but could not find a thread that seemed to answer them. If I missed one, I apologize. It would be great if you could point me to it.
Anyways, my questions:
1) I am curious about how the Vanguard Total Bond Market Fund works. In particular, does it hold all of its bonds to maturity or does it sell some at different times? If it's the latter, is it possible that the action of selling could trigger a capital gain, thereby making the fund more tax inefficient than an identical fund that held them to maturity?

2) I have seen recommendations from The 4 Pillars of Investment and The Best Bond Book to stick to Treasury Notes (1-10 years) instead of bonds (10-30 years) for the interest rate risk. The Total Bond Market fund has an average maturity of 8.3 years but it does hold a fair amount of Treasury bonds. So would the fund technically abide by Bernstein's advice or does it technically go agaisnt it? I'm just trying to figure out if all that matters as far as interest rate risk goes is the average maturity of the bond portfolio or if you also should consider it from a bond-to-bond basis.

3) Since Treasuries have no state tax but corporate bonds do, does this mean that if you had to prioritize putting one or the other in a tax-deferred account, you should go with the corporate bonds first? If so, I guess this begs the question: If you were to invest in bonds in a tax deferred account, you should generally opt for high investment-grade corporate bonds instead of Treasuries or Munis? I realize the advantage of the Treasuries is the lack of credit risk but if you don't have to pay state taxes on the corporate bonds, then doesn't that tip the scales?

4) Is there any point to having a Treasuries fund as opposed to just buying the actual Treasuries at auction? It's more convenient but also has some expense ratio associated with it no? Keeping with the "keep the costs low" attitude, it seems to be better to buy the actual Treasuries since the only other advantage of the fund I can think of (diversification) is not relevant when they're government bonds no?

Sorry for the ton of questions. Any help on any of these would be great!

PFInterest
Posts: 2684
Joined: Sun Jan 08, 2017 12:25 pm

Re: Lots of Newbie bond questions

Post by PFInterest » Sat Nov 17, 2018 7:42 am

305pelusa wrote:
Fri Nov 16, 2018 10:47 pm
1) I am curious about how the Vanguard Total Bond Market Fund works. In particular, does it hold all of its bonds to maturity or does it sell some at different times? If it's the latter, is it possible that the action of selling could trigger a capital gain, thereby making the fund more tax inefficient than an identical fund that held them to maturity?
some bonds are called early. thats why you see 2 reported values: duration and maturity.
you can see the funds past distributions and get a sense of the CG and dividends.
since this fund tracks a well known index, any identical fund will do exactly the same thing.
305pelusa wrote:
Fri Nov 16, 2018 10:47 pm
2) I have seen recommendations from The 4 Pillars of Investment and The Best Bond Book to stick to Treasury Notes (1-10 years) instead of bonds (10-30 years) for the interest rate risk.
you can. it takes more work. and dont forget interest rate risk works both ways.
305pelusa wrote:
Fri Nov 16, 2018 10:47 pm
If you were to invest in bonds in a tax deferred account, you should generally opt for high investment-grade corporate bonds instead of Treasuries or Munis
taxes is only part of the equation. you have to look at tax adjusted and risk adjusted yield.
no one needs corporates in the first place, but taxable bonds are inefficient either way.
munis are for higher tax bracket investors who need more space for fixed income.
305pelusa wrote:
Fri Nov 16, 2018 10:47 pm
4) Is there any point to having a Treasuries fund as opposed to just buying the actual Treasuries at auction?
sounds like a pain to me. like i said, you can. dont forget you have to sell back at some point and depending on the interest rate you might not get back the full value.
id rather let vanguard do it for me for 3 bp (the version i have availble)

305pelusa
Posts: 6
Joined: Fri Nov 16, 2018 10:20 pm

Re: Lots of Newbie bond questions

Post by 305pelusa » Sun Nov 18, 2018 9:18 am

Thank you very much for your response!
PFInterest wrote:
Sat Nov 17, 2018 7:42 am
305pelusa wrote:
Fri Nov 16, 2018 10:47 pm
1) I am curious about how the Vanguard Total Bond Market Fund works. In particular, does it hold all of its bonds to maturity or does it sell some at different times? If it's the latter, is it possible that the action of selling could trigger a capital gain, thereby making the fund more tax inefficient than an identical fund that held them to maturity?
some bonds are called early. thats why you see 2 reported values: duration and maturity.
you can see the funds past distributions and get a sense of the CG and dividends.
since this fund tracks a well known index, any identical fund will do exactly the same thing.

Interesting. I didn't know duration had anything to do with when the bonds are generally getting called. I thought it was just some form of weighted time average as to when the payments are made for interest rate risk purposes.

Either way, then the only way the bond exists the total bond fund is by either getting called, or maturing correct? No purposeful selling?
PFInterest wrote:
Sat Nov 17, 2018 7:42 am
305pelusa wrote:
Fri Nov 16, 2018 10:47 pm
2) I have seen recommendations from The 4 Pillars of Investment and The Best Bond Book to stick to Treasury Notes (1-10 years) instead of bonds (10-30 years) for the interest rate risk.
you can. it takes more work. and dont forget interest rate risk works both ways.
OK but I still have the question. Is it about the average maturity of your bond portfolio being <5 years, or should every bond abide by that? Which one do people mean by "stick to short-term bonds"?
PFInterest wrote:
Sat Nov 17, 2018 7:42 am
305pelusa wrote:
Fri Nov 16, 2018 10:47 pm
4) Is there any point to having a Treasuries fund as opposed to just buying the actual Treasuries at auction?
sounds like a pain to me. like i said, you can. dont forget you have to sell back at some point and depending on the interest rate you might not get back the full value.
id rather let vanguard do it for me for 3 bp (the version i have availble)
Why do I have to sell them back at some point? I guess I was planning on holding to maturity. Isn't this the Boglehead way?

Thank you very much!!

305pelusa
Posts: 6
Joined: Fri Nov 16, 2018 10:20 pm

Re: Lots of Newbie bond questions

Post by 305pelusa » Mon Nov 19, 2018 6:31 pm

Umh one last bump?

Sinsji
Posts: 25
Joined: Sat Oct 06, 2018 6:23 am

Re: Lots of Newbie bond questions

Post by Sinsji » Tue Nov 20, 2018 7:15 am

I had a question similar as your second question. I observed that even the experts on fixed-income ETFs and funds have different opinions at this forum.
What kept returning was intermediate bonds, TIPS and maturity = investment horizon.
The total bond from iShares has an average maturity of 8.5 years aproximately. It seemed cheaper to me to put the majority of fixed-income into this total bund fund.

The only thing I observed that the total bond fund seemed relatively 'flat' compared to intermediate bond funds. This was a very superficial observation, so please correct/explain if I'm wrong.

I try to keep transactions to a minimum here as well. Not specifically buying corporate bunds for example. Only total bond etf, intermediate bond etf and TIPS (diversifiction because of lower transaction cost at my broker).

longinvest
Posts: 3109
Joined: Sat Aug 11, 2012 8:44 am

Re: Lots of Newbie bond questions

Post by longinvest » Tue Nov 20, 2018 7:20 am

305pelusa wrote:
Mon Nov 19, 2018 6:31 pm
Umh one last bump?
Here's the opinion of our mentor, Jack Bogle:

http://www.aaii.com/journal/article/ach ... unds.touch
I don’t look at bond funds as a unity. You can hold a short-term bond fund if you’re willing to sacrifice income in favor or principal stability. You can hold a long-term bond fund if you want a higher interest rate and therefore a higher long-term return, but you have to be willing to tolerate the higher volatility.

I tend to favor, mostly for behavioral reasons, an intermediate-term maturity, which will only have roughly half the volatility of the stock market.
Bogleheads investment philosophy | Lifelong Portfolio: 25% each of (domestic / international) stocks / domestic (nominal / inflation-indexed) long-term bonds | VCN/VXC/VLB/ZRR

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jeffyscott
Posts: 7370
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Location: Wisconsin

Re: Lots of Newbie bond questions

Post by jeffyscott » Tue Nov 20, 2018 8:03 am

305pelusa wrote:
Fri Nov 16, 2018 10:47 pm
1) I am curious about how the Vanguard Total Bond Market Fund works. In particular, does it hold all of its bonds to maturity or does it sell some at different times? If it's the latter, is it possible that the action of selling could trigger a capital gain, thereby making the fund more tax inefficient than an identical fund that held them to maturity?
I don't think any selling makes much, if any, difference in tax efficiency? Bonds (or "fixed income investments") are not tax efficient, which is why you would want them in a tax-deferred account, if possible.
2) I have seen recommendations from The 4 Pillars of Investment and The Best Bond Book to stick to Treasury Notes (1-10 years) instead of bonds (10-30 years) for the interest rate risk. The Total Bond Market fund has an average maturity of 8.3 years but it does hold a fair amount of Treasury bonds. So would the fund technically abide by Bernstein's advice or does it technically go agaisnt it? I'm just trying to figure out if all that matters as far as interest rate risk goes is the average maturity of the bond portfolio or if you also should consider it from a bond-to-bond basis.
The fund (or you) can buy secondary "bonds" when they have less than 10 years remaining or either "notes or bonds" when they have less than 1 year remaining, so the terminology does not really matter. Of course, total bond is not limited to treasuries, nor is it limited to less than 10 year maturity at time of purchase.
3) Since Treasuries have no state tax but corporate bonds do, does this mean that if you had to prioritize putting one or the other in a tax-deferred account, you should go with the corporate bonds first? If so, I guess this begs the question: If you were to invest in bonds in a tax deferred account, you should generally opt for high investment-grade corporate bonds instead of Treasuries or Munis? I realize the advantage of the Treasuries is the lack of credit risk but if you don't have to pay state taxes on the corporate bonds, then doesn't that tip the scales?
I think opinions on this will vary, some say avoid corporates completely, that nominal treasuries work best when viewing things at the portfolio level. I think since corporates are priced based on the interest being taxable, there should be some small extra benefit to them in a tax-deferred account. This would also be the case for CDs. Of course, it also makes more sense to put stocks in taxable rather than treasuries.
4) Is there any point to having a Treasuries fund as opposed to just buying the actual Treasuries at auction? It's more convenient but also has some expense ratio associated with it no? Keeping with the "keep the costs low" attitude, it seems to be better to buy the actual Treasuries since the only other advantage of the fund I can think of (diversification) is not relevant when they're government bonds no?
If not buying at auction and holding to maturity, the fund probably gets better pricing. There is something called "roll down yield" or "rolling down the yield curve" that can mean you would do better to, say, buy 10 year and sell at 4, rather than buy and hold to maturity. If buying and holding to maturity in a tax-deferred brokerage account, you can just as easily do this with brokered CDs and get a slightly better yield.
press on, regardless - John C. Bogle

Valuethinker
Posts: 36691
Joined: Fri May 11, 2007 11:07 am

Re: Lots of Newbie bond questions

Post by Valuethinker » Tue Nov 20, 2018 8:05 am

305pelusa wrote:
Sun Nov 18, 2018 9:18 am
Thank you very much for your response!
PFInterest wrote:
Sat Nov 17, 2018 7:42 am
305pelusa wrote:
Fri Nov 16, 2018 10:47 pm
1) I am curious about how the Vanguard Total Bond Market Fund works. In particular, does it hold all of its bonds to maturity or does it sell some at different times? If it's the latter, is it possible that the action of selling could trigger a capital gain, thereby making the fund more tax inefficient than an identical fund that held them to maturity?
some bonds are called early. thats why you see 2 reported values: duration and maturity.
you can see the funds past distributions and get a sense of the CG and dividends.
since this fund tracks a well known index, any identical fund will do exactly the same thing.

Interesting. I didn't know duration had anything to do with when the bonds are generally getting called. I thought it was just some form of weighted time average as to when the payments are made for interest rate risk purposes.
Yes. But the duration of a callable bond can change. There is the maturity date but it may be called early, in which case the maturity is the call date, and thus the duration change.

Corporate bonds are often callable (I believe in general Vanguard TBM tries to avoid these issues). US Mortgage Backed Securities also have variable duration - if interest rates fall mortgage borrowers refinance earlier than expected, if they rise they defer repayment as much as they can.
Either way, then the only way the bond exists the total bond fund is by either getting called, or maturing correct? No purposeful selling?
No. The fund may sell 1). because the characteristics of the bonds in the portfolio need to change to better match the benchmark (it would be almost impossible for a large bond fund to exactly match the index - non US Treasury bonds are quite illiquid, so the fund managers exploit the fact that statistically you only need a sample, not a full replication). 2). once a bond has reached less than 1 year to maturity, it no longer fits into the mandate of the fund - AFAIK it is then sold.
PFInterest wrote:
Sat Nov 17, 2018 7:42 am
305pelusa wrote:
Fri Nov 16, 2018 10:47 pm
2) I have seen recommendations from The 4 Pillars of Investment and The Best Bond Book to stick to Treasury Notes (1-10 years) instead of bonds (10-30 years) for the interest rate risk.
you can. it takes more work. and dont forget interest rate risk works both ways.
OK but I still have the question. Is it about the average maturity of your bond portfolio being <5 years, or should every bond abide by that? Which one do people mean by "stick to short-term bonds"?
A short term bond fund will only include bonds with maturities of 1 to 5 years, typically. Thus its duration can never be more than 5 years. It would only be 5 years if entirely made up of zero coupon bonds (a bond which only pays at maturity, a zero coupon, has a duration exactly equal to its time to maturity). Most ST bond funds seem to have durations of between 2-3 years.
PFInterest wrote:
Sat Nov 17, 2018 7:42 am
305pelusa wrote:
Fri Nov 16, 2018 10:47 pm
4) Is there any point to having a Treasuries fund as opposed to just buying the actual Treasuries at auction?
sounds like a pain to me. like i said, you can. dont forget you have to sell back at some point and depending on the interest rate you might not get back the full value.
id rather let vanguard do it for me for 3 bp (the version i have availble)
Why do I have to sell them back at some point? I guess I was planning on holding to maturity. Isn't this the Boglehead way?

Thank you very much!!
[/quote]

Yes the comment does not make sense to me -- unless the US Treasury charges for a maturing bond?

Valuethinker
Posts: 36691
Joined: Fri May 11, 2007 11:07 am

Re: Lots of Newbie bond questions

Post by Valuethinker » Tue Nov 20, 2018 9:00 am

305pelusa wrote:
Fri Nov 16, 2018 10:47 pm
Hello,
I have been searching for a bit for some of these questions but could not find a thread that seemed to answer them. If I missed one, I apologize. It would be great if you could point me to it.
Anyways, my questions:
1) I am curious about how the Vanguard Total Bond Market Fund works. In particular, does it hold all of its bonds to maturity or does it sell some at different times? If it's the latter, is it possible that the action of selling could trigger a capital gain, thereby making the fund more tax inefficient than an identical fund that held them to maturity?

2) I have seen recommendations from The 4 Pillars of Investment and The Best Bond Book to stick to Treasury Notes (1-10 years) instead of bonds (10-30 years) for the interest rate risk. The Total Bond Market fund has an average maturity of 8.3 years but it does hold a fair amount of Treasury bonds. So would the fund technically abide by Bernstein's advice or does it technically go agaisnt it? I'm just trying to figure out if all that matters as far as interest rate risk goes is the average maturity of the bond portfolio or if you also should consider it from a bond-to-bond basis.

3) Since Treasuries have no state tax but corporate bonds do, does this mean that if you had to prioritize putting one or the other in a tax-deferred account, you should go with the corporate bonds first? If so, I guess this begs the question: If you were to invest in bonds in a tax deferred account, you should generally opt for high investment-grade corporate bonds instead of Treasuries or Munis? I realize the advantage of the Treasuries is the lack of credit risk but if you don't have to pay state taxes on the corporate bonds, then doesn't that tip the scales?

4) Is there any point to having a Treasuries fund as opposed to just buying the actual Treasuries at auction? It's more convenient but also has some expense ratio associated with it no? Keeping with the "keep the costs low" attitude, it seems to be better to buy the actual Treasuries since the only other advantage of the fund I can think of (diversification) is not relevant when they're government bonds no?

Sorry for the ton of questions. Any help on any of these would be great!
Be warned. Nisiprius among others has shown in many posts that the only real determinant of portfolio risk-return is the bond-equity split. Nothing else much matters. You can waste a lot of time "fine tuning" your bond funds, or "chasing yield" (a worse mistake, generally) without making much difference (but you could have significant harm: run the graphs of a HY bond fund or a preferred stock fund 2008-09 -- you will see equity like risk).

(Exception: high yield bonds, which behave much more like equities)

So within bonds:

- if you hold TBM, for all kinds of reasons it's less preferred, but the hurt is very small and sometimes it will help. KISS really does apply here

- Bernstein, Swedroe et al the optimal is probably the intermediate term US Treasury bond fund. You are gaining significantly in yield over a ST bond fund, because the yield curve is normally fairly steep upward sloping out to at least 5 years.

You have more interest rate risk than with a ST bond fund. But that works both ways - if we enter an extended period of low long term interest rates like the last 10 years, you at least benefit to an extent.

As long as your need for cash realizations is longer than the duration of the fund, on balance you should be alright - income from the bonds is reinvested in more units of the fund so if prices fall/ yields rise you are buying into cheaper units

- there is the "barbell" portfolio recommended by Swensen. To diversify against a Japan-like scenario of deflation, holding long term US Treasury bonds (10 years plus, but ideally 30 year) is a good hedge - those bonds will do very well if the US is the next Japan. This works well in a bond-equity portfolio

- TIPS are a whole separate issue. There's a case for holding up to half your bonds in a TIPS fund. However unless it is a ST TIPS fund it will be significantly more volatile than an IT US Treasury bond (straight bonds) fund

- in Treasury bonds, the term "note" refers to a bond that had a maturity of up to 10 years at time of issue. Otherwise it is a bond. Thus we could have both a 5 year note (that was issued with a 6 year maturity 1 year ago) and a 5 year bond (that was issued 25 years ago with 30 years to maturity).

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Sandtrap
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Location: Hawaii😀 Northern AZ.😳 Retired.

Re: Lots of Newbie bond questions

Post by Sandtrap » Tue Nov 20, 2018 9:07 am


305pelusa
Posts: 6
Joined: Fri Nov 16, 2018 10:20 pm

Re: Lots of Newbie bond questions

Post by 305pelusa » Tue Nov 20, 2018 5:26 pm

Sinsji wrote:
Tue Nov 20, 2018 7:15 am
I had a question similar as your second question. I observed that even the experts on fixed-income ETFs and funds have different opinions at this forum.
What kept returning was intermediate bonds, TIPS and maturity = investment horizon.
The total bond from iShares has an average maturity of 8.5 years aproximately. It seemed cheaper to me to put the majority of fixed-income into this total bund fund.

The only thing I observed that the total bond fund seemed relatively 'flat' compared to intermediate bond funds. This was a very superficial observation, so please correct/explain if I'm wrong.

I try to keep transactions to a minimum here as well. Not specifically buying corporate bunds for example. Only total bond etf, intermediate bond etf and TIPS (diversifiction because of lower transaction cost at my broker).
Thank you for your response! Could you explain a bit more about the maturities and the horizons? Meaning younger people should go for longer bonds?

What do you mean by "flat" by the way?
longinvest wrote:
Tue Nov 20, 2018 7:20 am
305pelusa wrote:
Mon Nov 19, 2018 6:31 pm
Umh one last bump?
Here's the opinion of our mentor, Jack Bogle:

http://www.aaii.com/journal/article/ach ... unds.touch
I don’t look at bond funds as a unity. You can hold a short-term bond fund if you’re willing to sacrifice income in favor or principal stability. You can hold a long-term bond fund if you want a higher interest rate and therefore a higher long-term return, but you have to be willing to tolerate the higher volatility.

I tend to favor, mostly for behavioral reasons, an intermediate-term maturity, which will only have roughly half the volatility of the stock market.
Thank you for the quote. It is very interesting because others like Bernstein and Thau seem to recommend short terms for the most part and potentially dipping into intermediate term. But Jack seems to say the intermediate term should be the go-to?
jeffyscott wrote:
Tue Nov 20, 2018 8:03 am

The fund (or you) can buy secondary "bonds" when they have less than 10 years remaining or either "notes or bonds" when they have less than 1 year remaining, so the terminology does not really matter. Of course, total bond is not limited to treasuries, nor is it limited to less than 10 year maturity at time of purchase.
Ok fair enough. My wording was all over the place. Let me try once more:
2) I have seen recommendations to stick to bonds that will mature in less than 10 years. The Total Bond Market fund has an average maturity of 8.3 years but it holds many bonds with maturities above 10 years (or so I assume). So would the fund technically abide by Bernstein's advice or does it technically go against it? I'm just trying to figure out if all that matters as far as interest rate risk goes is the average maturity of the bond portfolio or if you also should consider it from a bond-to-bond basis.

I hope this is a little clearer :happy
jeffyscott wrote:
Tue Nov 20, 2018 8:03 am
I think opinions on this will vary, some say avoid corporates completely, that nominal treasuries work best when viewing things at the portfolio level. I think since corporates are priced based on the interest being taxable, there should be some small extra benefit to them in a tax-deferred account. This would also be the case for CDs. Of course, it also makes more sense to put stocks in taxable rather than treasuries.
To me this makes sense. I just wanted to make sure others thought similarly and that I wasn't missing anything obvious. Thanks!
jeffyscott wrote:
Tue Nov 20, 2018 8:03 am

If not buying at auction and holding to maturity, the fund probably gets better pricing. There is something called "roll down yield" or "rolling down the yield curve" that can mean you would do better to, say, buy 10 year and sell at 4, rather than buy and hold to maturity. If buying and holding to maturity in a tax-deferred brokerage account, you can just as easily do this with brokered CDs and get a slightly better yield.
Sorry, your wording is a bit confusing to me. Let me get this right. If I am not buying at auction and holding them to maturity, I'm best off with a fund. But if I do buy them at auction and hold them to maturity, then that would be better than the fund? What's confusing is that the rest of your response seems to hint that even if I planned to buy at auction and hold to maturity, the fund might still be better because they know when to sell at opportune times that I would miss and that this extra money would more than cover the extra expense.

305pelusa
Posts: 6
Joined: Fri Nov 16, 2018 10:20 pm

Re: Lots of Newbie bond questions

Post by 305pelusa » Tue Nov 20, 2018 5:45 pm

Valuethinker wrote:
Tue Nov 20, 2018 8:05 am
305pelusa wrote:
Sun Nov 18, 2018 9:18 am
Thank you very much for your response!
PFInterest wrote:
Sat Nov 17, 2018 7:42 am
305pelusa wrote:
Fri Nov 16, 2018 10:47 pm
1) I am curious about how the Vanguard Total Bond Market Fund works. In particular, does it hold all of its bonds to maturity or does it sell some at different times? If it's the latter, is it possible that the action of selling could trigger a capital gain, thereby making the fund more tax inefficient than an identical fund that held them to maturity?
some bonds are called early. thats why you see 2 reported values: duration and maturity.
you can see the funds past distributions and get a sense of the CG and dividends.
since this fund tracks a well known index, any identical fund will do exactly the same thing.

Interesting. I didn't know duration had anything to do with when the bonds are generally getting called. I thought it was just some form of weighted time average as to when the payments are made for interest rate risk purposes.
Yes. But the duration of a callable bond can change. There is the maturity date but it may be called early, in which case the maturity is the call date, and thus the duration change.

Corporate bonds are often callable (I believe in general Vanguard TBM tries to avoid these issues). US Mortgage Backed Securities also have variable duration - if interest rates fall mortgage borrowers refinance earlier than expected, if they rise they defer repayment as much as they can.
Ok wait, let me get this straight. There is a maturity and a duration (which is always shorter due to coupons, except in zeros as there are no coupons). If a bond is called, the maturity becomes the call date and the duration would then be something shorter than the call date. This is what I understand and it seems to be what you say.

What I don't follow is the statement "some bonds are called early. thats why you see 2 reported values: duration and maturity. " What I understand from that statement is that maturity refers to when the bond was planned to expire, while duration was when it ended up getting called. I did not know that was the case.

Even if bonds were not callable... they would still report both values. So I'm not following the logic that it is because bonds get called that two values are reported. :confused
Valuethinker wrote:
Tue Nov 20, 2018 8:05 am
305pelusa wrote:
Fri Nov 16, 2018 10:47 pm
PFInterest wrote:
Sat Nov 17, 2018 7:42 am
305pelusa wrote:
Fri Nov 16, 2018 10:47 pm
2) I have seen recommendations from The 4 Pillars of Investment and The Best Bond Book to stick to Treasury Notes (1-10 years) instead of bonds (10-30 years) for the interest rate risk.
you can. it takes more work. and dont forget interest rate risk works both ways.
OK but I still have the question. Is it about the average maturity of your bond portfolio being <5 years, or should every bond abide by that? Which one do people mean by "stick to short-term bonds"?
A short term bond fund will only include bonds with maturities of 1 to 5 years, typically. Thus its duration can never be more than 5 years. It would only be 5 years if entirely made up of zero coupon bonds (a bond which only pays at maturity, a zero coupon, has a duration exactly equal to its time to maturity). Most ST bond funds seem to have durations of between 2-3 years.
Ok fair enough. This does not seem to be an issue with ST bond funds. I will ask the question again for intermediates vs long (coincidentally, that was my original question).
If bond fund A has 6 bonds with 2 year maturities and 1 bond with 30 year maturity, the fund would have an average maturity of 6 years (intermediate) yet not have a single "intermediate" bond at the moment. So would this be technically against the Bernstein recommendation? Again, I'm just trying to understand if all that matters is the average maturity of the fund, or whether the fund holds mostly bonds of that specific maturity. Does this make sense?

Essentially, if someone told you "stick to intermediate bonds", would you go out there and buy a ton of short term bonds and a couple of long term bonds and that would be essentially the same thing since the average maturity of your portfolio if intermediate?
Sandtrap wrote:
Tue Nov 20, 2018 9:07 am
"The Bond Book" by Thau
https://www.amazon.com/Bond-Book-Third- ... 007166470X
Yes I just finished this book and surprisingly, I couldn't find the answers to these questions. If you refer me to the page number, I surely will! It did answer many other questions I had.

305pelusa
Posts: 6
Joined: Fri Nov 16, 2018 10:20 pm

Re: Lots of Newbie bond questions

Post by 305pelusa » Tue Nov 20, 2018 5:58 pm

Valuethinker wrote:
Tue Nov 20, 2018 9:00 am
305pelusa wrote:
Fri Nov 16, 2018 10:47 pm
Hello,
I have been searching for a bit for some of these questions but could not find a thread that seemed to answer them. If I missed one, I apologize. It would be great if you could point me to it.
Anyways, my questions:
1) I am curious about how the Vanguard Total Bond Market Fund works. In particular, does it hold all of its bonds to maturity or does it sell some at different times? If it's the latter, is it possible that the action of selling could trigger a capital gain, thereby making the fund more tax inefficient than an identical fund that held them to maturity?

2) I have seen recommendations from The 4 Pillars of Investment and The Best Bond Book to stick to Treasury Notes (1-10 years) instead of bonds (10-30 years) for the interest rate risk. The Total Bond Market fund has an average maturity of 8.3 years but it does hold a fair amount of Treasury bonds. So would the fund technically abide by Bernstein's advice or does it technically go agaisnt it? I'm just trying to figure out if all that matters as far as interest rate risk goes is the average maturity of the bond portfolio or if you also should consider it from a bond-to-bond basis.

3) Since Treasuries have no state tax but corporate bonds do, does this mean that if you had to prioritize putting one or the other in a tax-deferred account, you should go with the corporate bonds first? If so, I guess this begs the question: If you were to invest in bonds in a tax deferred account, you should generally opt for high investment-grade corporate bonds instead of Treasuries or Munis? I realize the advantage of the Treasuries is the lack of credit risk but if you don't have to pay state taxes on the corporate bonds, then doesn't that tip the scales?

4) Is there any point to having a Treasuries fund as opposed to just buying the actual Treasuries at auction? It's more convenient but also has some expense ratio associated with it no? Keeping with the "keep the costs low" attitude, it seems to be better to buy the actual Treasuries since the only other advantage of the fund I can think of (diversification) is not relevant when they're government bonds no?

Sorry for the ton of questions. Any help on any of these would be great!
Be warned. Nisiprius among others has shown in many posts that the only real determinant of portfolio risk-return is the bond-equity split. Nothing else much matters. You can waste a lot of time "fine tuning" your bond funds, or "chasing yield" (a worse mistake, generally) without making much difference (but you could have significant harm: run the graphs of a HY bond fund or a preferred stock fund 2008-09 -- you will see equity like risk).

(Exception: high yield bonds, which behave much more like equities)

So within bonds:

- if you hold TBM, for all kinds of reasons it's less preferred, but the hurt is very small and sometimes it will help. KISS really does apply here

- Bernstein, Swedroe et al the optimal is probably the intermediate term US Treasury bond fund. You are gaining significantly in yield over a ST bond fund, because the yield curve is normally fairly steep upward sloping out to at least 5 years.

You have more interest rate risk than with a ST bond fund. But that works both ways - if we enter an extended period of low long term interest rates like the last 10 years, you at least benefit to an extent.

As long as your need for cash realizations is longer than the duration of the fund, on balance you should be alright - income from the bonds is reinvested in more units of the fund so if prices fall/ yields rise you are buying into cheaper units

- there is the "barbell" portfolio recommended by Swensen. To diversify against a Japan-like scenario of deflation, holding long term US Treasury bonds (10 years plus, but ideally 30 year) is a good hedge - those bonds will do very well if the US is the next Japan. This works well in a bond-equity portfolio

- TIPS are a whole separate issue. There's a case for holding up to half your bonds in a TIPS fund. However unless it is a ST TIPS fund it will be significantly more volatile than an IT US Treasury bond (straight bonds) fund

- in Treasury bonds, the term "note" refers to a bond that had a maturity of up to 10 years at time of issue. Otherwise it is a bond. Thus we could have both a 5 year note (that was issued with a 6 year maturity 1 year ago) and a 5 year bond (that was issued 25 years ago with 30 years to maturity).
- I am not finding the TBM as appealing, hence some of my questions. It seems the duration is a bit longer than what I've read is recommended (except for Jack Bogle on this thread of course). And if it's mostly treasuries, I could just buy those at auction and save the expense ratio. At least it seems like the selling of the bonds would not generate much capital gains, so that part wouldn't be a concern any more thanks to this thread.

- Umh I don't have Swedroe's book but what I gathered from Berstein was ST Treasuries or 1-5 year Treasury ladders (2.5 average maturity). The intermediate term US Treasury bond fund has a shorter maturity than the TBM so I feel a bit better about it nonetheless. Maybe some equal parts ST and IT US Treasury bond funds?

- Yes I recall the barbell portfolio from the Thau book. I'll read up on that again. I forget the conclusion (recommended or not).

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jeffyscott
Posts: 7370
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Location: Wisconsin

Re: Lots of Newbie bond questions

Post by jeffyscott » Tue Nov 20, 2018 11:02 pm

305pelusa wrote:
Tue Nov 20, 2018 5:26 pm
jeffyscott wrote:
Tue Nov 20, 2018 8:03 am
The fund (or you) can buy secondary "bonds" when they have less than 10 years remaining or either "notes or bonds" when they have less than 1 year remaining, so the terminology does not really matter. Of course, total bond is not limited to treasuries, nor is it limited to less than 10 year maturity at time of purchase.
Ok fair enough. My wording was all over the place. Let me try once more:
2) I have seen recommendations to stick to bonds that will mature in less than 10 years. The Total Bond Market fund has an average maturity of 8.3 years but it holds many bonds with maturities above 10 years (or so I assume). So would the fund technically abide by Bernstein's advice or does it technically go against it? I'm just trying to figure out if all that matters as far as interest rate risk goes is the average maturity of the bond portfolio or if you also should consider it from a bond-to-bond basis.

I hope this is a little clearer :happy
jeffyscott wrote:
Tue Nov 20, 2018 8:03 am

If not buying at auction and holding to maturity, the fund probably gets better pricing. There is something called "roll down yield" or "rolling down the yield curve" that can mean you would do better to, say, buy 10 year and sell at 4, rather than buy and hold to maturity. If buying and holding to maturity in a tax-deferred brokerage account, you can just as easily do this with brokered CDs and get a slightly better yield.
Sorry, your wording is a bit confusing to me. Let me get this right. If I am not buying at auction and holding them to maturity, I'm best off with a fund. But if I do buy them at auction and hold them to maturity, then that would be better than the fund? What's confusing is that the rest of your response seems to hint that even if I planned to buy at auction and hold to maturity, the fund might still be better because they know when to sell at opportune times that I would miss and that this extra money would more than cover the extra expense.
Re 2) It's been a while since I read Bill b, so don't really know what he specifically recommends. For myself, I would just go by the average duration in deciding how sensitive to interest rates a fund is likely to be.

On treasuries, my comments were not meant to suggest what would be better to do, just pointing out some considerations one might look into. When you buy at auction you get exactly the same price as everyone else. If you buy or sell secondaries the prices vary depending on how much you are buying or selling.

You might search for things like: "roll down yield", "rolling down the yield curve", "riding the yield curve" to learn about why a fund or individual might sell, rather than hold to maturity.

For myself, I am just using brokered CDs rather than treasuries in tax deferred and these are bought and held to maturity as transaction costs are too high to do otherwise, even if I wanted to. I have only been at it for a few months. I have averaged about 0.4% better yield than equivalent treasuries on my purchases so far.
press on, regardless - John C. Bogle

Sinsji
Posts: 25
Joined: Sat Oct 06, 2018 6:23 am

Re: Lots of Newbie bond questions

Post by Sinsji » Fri Nov 23, 2018 8:03 am

Valuethinker wrote:
Tue Nov 20, 2018 9:00 am
305pelusa wrote:
Fri Nov 16, 2018 10:47 pm
Hello,
I have been searching for a bit for some of these questions but could not find a thread that seemed to answer them. If I missed one, I apologize. It would be great if you could point me to it.
Anyways, my questions:
1) I am curious about how the Vanguard Total Bond Market Fund works. In particular, does it hold all of its bonds to maturity or does it sell some at different times? If it's the latter, is it possible that the action of selling could trigger a capital gain, thereby making the fund more tax inefficient than an identical fund that held them to maturity?

2) I have seen recommendations from The 4 Pillars of Investment and The Best Bond Book to stick to Treasury Notes (1-10 years) instead of bonds (10-30 years) for the interest rate risk. The Total Bond Market fund has an average maturity of 8.3 years but it does hold a fair amount of Treasury bonds. So would the fund technically abide by Bernstein's advice or does it technically go agaisnt it? I'm just trying to figure out if all that matters as far as interest rate risk goes is the average maturity of the bond portfolio or if you also should consider it from a bond-to-bond basis.

3) Since Treasuries have no state tax but corporate bonds do, does this mean that if you had to prioritize putting one or the other in a tax-deferred account, you should go with the corporate bonds first? If so, I guess this begs the question: If you were to invest in bonds in a tax deferred account, you should generally opt for high investment-grade corporate bonds instead of Treasuries or Munis? I realize the advantage of the Treasuries is the lack of credit risk but if you don't have to pay state taxes on the corporate bonds, then doesn't that tip the scales?

4) Is there any point to having a Treasuries fund as opposed to just buying the actual Treasuries at auction? It's more convenient but also has some expense ratio associated with it no? Keeping with the "keep the costs low" attitude, it seems to be better to buy the actual Treasuries since the only other advantage of the fund I can think of (diversification) is not relevant when they're government bonds no?

Sorry for the ton of questions. Any help on any of these would be great!
Be warned. Nisiprius among others has shown in many posts that the only real determinant of portfolio risk-return is the bond-equity split. Nothing else much matters. You can waste a lot of time "fine tuning" your bond funds, or "chasing yield" (a worse mistake, generally) without making much difference (but you could have significant harm: run the graphs of a HY bond fund or a preferred stock fund 2008-09 -- you will see equity like risk).

(Exception: high yield bonds, which behave much more like equities)

So within bonds:

- if you hold TBM, for all kinds of reasons it's less preferred, but the hurt is very small and sometimes it will help. KISS really does apply here

- Bernstein, Swedroe et al the optimal is probably the intermediate term US Treasury bond fund. You are gaining significantly in yield over a ST bond fund, because the yield curve is normally fairly steep upward sloping out to at least 5 years.

You have more interest rate risk than with a ST bond fund. But that works both ways - if we enter an extended period of low long term interest rates like the last 10 years, you at least benefit to an extent.

As long as your need for cash realizations is longer than the duration of the fund, on balance you should be alright - income from the bonds is reinvested in more units of the fund so if prices fall/ yields rise you are buying into cheaper units

- there is the "barbell" portfolio recommended by Swensen. To diversify against a Japan-like scenario of deflation, holding long term US Treasury bonds (10 years plus, but ideally 30 year) is a good hedge - those bonds will do very well if the US is the next Japan. This works well in a bond-equity portfolio

- TIPS are a whole separate issue. There's a case for holding up to half your bonds in a TIPS fund. However unless it is a ST TIPS fund it will be significantly more volatile than an IT US Treasury bond (straight bonds) fund

- in Treasury bonds, the term "note" refers to a bond that had a maturity of up to 10 years at time of issue. Otherwise it is a bond. Thus we could have both a 5 year note (that was issued with a 6 year maturity 1 year ago) and a 5 year bond (that was issued 25 years ago with 30 years to maturity).
Why is TBM less preferred compared to an intermediate bond ETF?
For me it's possible to buy intermediate bond ETFs at lower broker cost (none) from both US and EU market (France, Germany, Italy, Spain combined) through iShares. I did notice that the TBM ETF seems almost flat, whereas an intermediate bond ETF increased in value over the last 5-10 yrs(?)

Thanks!

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