First 20% of bonds in long-term Treasuries

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vineviz
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First 20% of bonds in long-term Treasuries

Post by vineviz » Wed Aug 07, 2019 7:24 pm

From my observations, many Bogleheads do a reasonably good job of constructing the equity portion of their portfolio. A simple globally diversified mix of US and non-US total stock market funds accomplishes the majority of diversification benefits available to an equity investor.

However, it seems to me that precious few of these same Bogleheads are allocating their fixed income allocations in a manner congruent with modern financial knowledge. This is especially true for young accumulators, who seem just as prone as retirees to rely on milquetoast short- and intermediate-term bond funds when they should almost certainly be favoring long-term bonds instead.

Long-term bond funds not only offer superior diversification, but they also minimize interest rate risk for investors with long-term investment horizons (including virtually all investors who are currently accumulating retirement savings).

Leaving aside any question of what the stock/bond allocation should be for an investor, I propose a simple rule of thumb that gets the bond allocation in the right ballpark. This rule is designed specifically for retirement portfolios that are in their accumulation phase (i.e. pre-retirement), and while it may not be strictly optimal in every regard it is easy to remember and to codify into an IPS:

The first 20% of a portfolio allocated to bonds should be allocated to long-term US Treasury bonds.

If your portfolio is 90% stocks, then the other 10% should be long-term Treasuries.

If your portfolio is 80% stocks, then the other 20% should be long-term Treasuries.

If your portfolio is 70% stocks, then 20% should be long-term Treasuries and 10% in intermediate bonds (e.g. total bond market or intermediate-term Treasuries).

If your portfolio is 60% stocks, then 20% should be long-term Treasuries and 20% in intermediate bonds (e.g. total bond market or intermediate-term Treasuries).

And so on.


There are a number of low-cost ETFs and mutual funds that hold long-term Treasuries, including:
• SPDR Portfolio Long Term Treasury ETF (SPTL)
• Vanguard Long-Term Treasury ETF (VGLT)
• iShares 20+ Year Treasury Bond ETF (TLT)
• Vanguard Extended Duration Treasury ETF (EDV)
• Fidelity Long-Term Treasury Bond Index (FNBGX)
• Vanguard Long-Term Treasury Index (VLGSX)
• T. Rowe Price US Treasury Long-Term Index (PRUUX)

I know that few 401k and 403b plans include a decent long-term Treasury fund, and I would encourage people in those plans to simply choose a low-cost long-term or intermediate-term bond fund instead.
"Far more money has been lost by investors preparing for corrections than has been lost in corrections themselves." ~~ Peter Lynch

MoneyMarathon
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Re: First 20% of bonds in long-term Treasuries

Post by MoneyMarathon » Wed Aug 07, 2019 7:27 pm

vineviz wrote:
Wed Aug 07, 2019 7:24 pm
Leaving aside any question of what the stock/bond allocation should be for an investor, I propose a simple rule of thumb that gets the bond allocation in the right ballpark. This rule is designed specifically for retirement portfolios that are in their accumulation phase (i.e. pre-retirement), and while it may not be strictly optimal in every regard it is easy to remember and to codify into an IPS:

The first 20% of a portfolio allocated to bonds should be allocated to long-term US Treasury bonds.

If your portfolio is 90% stocks, then the other 10% should be long-term Treasuries.

If your portfolio is 80% stocks, then the other 20% should be long-term Treasuries.

If your portfolio is 70% stocks, then 20% should be long-term Treasuries and 10% in intermediate bonds (e.g. total bond market or intermediate-term Treasuries).

If your portfolio is 60% stocks, then 20% should be long-term Treasuries and 20% in intermediate bonds (e.g. total bond market or intermediate-term Treasuries).

And so on.
I like it. Thanks. :sharebeer

averagedude
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Re: First 20% of bonds in long-term Treasuries

Post by averagedude » Wed Aug 07, 2019 7:41 pm

I do see some merits of your thoughts on long term treasuries and this could be a good rule of thumb for some investors, but I disagree that this is the optimal strategy for all investors. People hold bonds for different purposes, and the purpose for which you hold bonds, should dictate how you allocate your bond portfolio.

sambb
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Re: First 20% of bonds in long-term Treasuries

Post by sambb » Wed Aug 07, 2019 7:43 pm

One could also say that one's money above long term expenses, should be allocated at their heir's age allocation, rather than one's own.
Lots of options for bonds or stocks.

columbia
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Re: First 20% of bonds in long-term Treasuries

Post by columbia » Wed Aug 07, 2019 7:48 pm

sambb wrote:
Wed Aug 07, 2019 7:43 pm
One could also say that one's money above long term expenses, should be allocated at their heir's age allocation, rather than one's own.
Lots of options for bonds or stocks.
If that’s the goal, then fooling around with bonds wouldn’t make much sense. Just put the rest in stocks.

I’ll note that is not my goal.

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Re: First 20% of bonds in long-term Treasuries

Post by HEDGEFUNDIE » Wed Aug 07, 2019 7:56 pm

I have been living this advice for the past year, ever since I saw the LTT Light.

It has paid off handsomely, to say the least. Both in terms of absolute return and equity risk mitigation.
Last edited by HEDGEFUNDIE on Wed Aug 07, 2019 8:03 pm, edited 1 time in total.

Day9
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Re: First 20% of bonds in long-term Treasuries

Post by Day9 » Wed Aug 07, 2019 8:02 pm

You list a bunch of funds but I just buy individual treasury bonds. There is no need to diversify among issuers like with corporate bonds. The "Permanent Portfolio" guy suggested to buy 30-year bonds at auction (no bid-ask spread) and sell them after 10 years and buy new 30s, but whatever you do it is not difficult to keep your duration at the level you want. I buy 30 year bonds in my taxable account, and 30 year STRIPS in my IRA. I have a question -- How much of a headache is it to hold STRIPS in a vanguard taxable account? Does Vanguard calculate the "phantom interest" that you owe for you or is it a big headache to do this manually?

I use a barbell strategy and use fixed income investments that I believe are superior than short term treasuries but are only available to small time individuals as my short end.
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dorster
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Re: First 20% of bonds in long-term Treasuries

Post by dorster » Wed Aug 07, 2019 8:31 pm

Vineviz, I realize this is a rule of thumb post. But with a 70% allocation (or 60% allocation) what is the rationale for not having all bonds match an investors (presumably) long term timeline?

Along a similar line you've mentioned elsewhere that someone in decumulation (but who still had a longish timeline) may want TIPS if they have a low equity allocation. If they wanted to use a fund, rather than individual TIPS, is LTPZ the only option? Any others worth considering?

Thanks!

MindBogler
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Re: First 20% of bonds in long-term Treasuries

Post by MindBogler » Wed Aug 07, 2019 8:40 pm

This is similar to what I do. I have about 50-50 EDV-money market split in my fixed income. It's been a great year...

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Re: First 20% of bonds in long-term Treasuries

Post by HawkeyePierce » Wed Aug 07, 2019 8:42 pm

Wouldn’t the ER on LTPZ (0.2%) be an issue given their low yield? I could see this being a case where I’d rather hold individual bonds (if I held any TIPS, that is).

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HomerJ
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Re: First 20% of bonds in long-term Treasuries

Post by HomerJ » Wed Aug 07, 2019 8:53 pm

vineviz wrote:
Wed Aug 07, 2019 7:24 pm
modern financial knowledge.
This is a oxymoron.

Of course, I could be wrong. But young people always think they know more than they actually do.

I know I certainly did.
The J stands for Jay

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HomerJ
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Re: First 20% of bonds in long-term Treasuries

Post by HomerJ » Wed Aug 07, 2019 8:55 pm

This is why markets always repeat every 30 years.

It takes about that long for the next generation to come along and forget/ignore everything that happened in the past.
The J stands for Jay

ceperry
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Re: First 20% of bonds in long-term Treasuries

Post by ceperry » Wed Aug 07, 2019 9:18 pm

vineviz, your rule of thumb is interesting, but you didn’t support your claim with much evidence. (You may have discussed this topic in depth in other threads, but I must admit I don’t read every thread.) Can you discuss the reasons for your claim, or point readers to other sources that support your suggestion to hold long-term bonds?

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Re: First 20% of bonds in long-term Treasuries

Post by willthrill81 » Wed Aug 07, 2019 9:33 pm

HomerJ wrote:
Wed Aug 07, 2019 8:55 pm
This is why markets always repeat every 30 years.

It takes about that long for the next generation to come along and forget/ignore everything that happened in the past.
Are you referring to the decimation of long-term bonds in the 1970s and early 1980s due to inflation?

I wonder whether 30 year TIPS might be preferable to LTT for this reason. Or perhaps, taking a note from David Swensen, going 50/50 with LTT and 30 year TIPS might be a good balance.
“It's a dangerous business, Frodo, going out your door. You step onto the road, and if you don't keep your feet, there's no knowing where you might be swept off to.” J.R.R. Tolkien,The Lord of the Rings

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Re: First 20% of bonds in long-term Treasuries

Post by Bluce » Wed Aug 07, 2019 10:08 pm

HomerJ wrote:
Wed Aug 07, 2019 8:53 pm
vineviz wrote:
Wed Aug 07, 2019 7:24 pm
modern financial knowledge.
This is a oxymoron.

Of course, I could be wrong. But young people always think they know more than they actually do.

I know I certainly did.
LOL, yes.

I find that the older I get, the less I know. (I'll be 69 in two weeks, so getting pretty clueless)

I read somewhere, years ago, where someone had figured out at what point in human history would one person be capable of knowing all of mankind's accumulated knowledge. It was something like 500-1,000 years ago, but that doesn't seem right -- seems it would have to be farther back than that.

Dude2
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Re: First 20% of bonds in long-term Treasuries

Post by Dude2 » Wed Aug 07, 2019 10:28 pm

No dog in this fight. Do what you want with your money. Yes, I do understand the concept of take the entire portfolio into consideration, i.e. this zigs when that zags.

But, I favor the "take the risk on the equity side" argument because there is such a huge possibility for a tremendous outcome. On the other hand, even long term bonds or junk bonds, whatever the highest yielding animal is, have only a certain level of upside potential. Plus, they are not without risks -- interest rate risk, inflation risk.

Take short term TIPS for instance. That's a pretty low risk animal. It's short enough that interest rate risk isn't significant, and it tracks inflation and unexpected inflation to a very high degree. It is relatively risk-less and also relatively reward-less. I'm not looking for reward on the bond side, that's what the stock side is for. The bond side is to reduce my risk, i.e. the risk of losing everything or the risk of needing money when the money isn't there.

I use bonds to reduce overall portfolio risk, so I start with the most risk-less item and go from there. I do not mix something with certain risks with another thing with certain other risks because I believe the risks are mutually exclusive. Also I am not trying to necessarily reduce overall portfolio volatility, I am looking to reduce overall portfolio risks.

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Re: First 20% of bonds in long-term Treasuries

Post by willthrill81 » Wed Aug 07, 2019 11:17 pm

Bluce wrote:
Wed Aug 07, 2019 10:08 pm
HomerJ wrote:
Wed Aug 07, 2019 8:53 pm
vineviz wrote:
Wed Aug 07, 2019 7:24 pm
modern financial knowledge.
This is a oxymoron.

Of course, I could be wrong. But young people always think they know more than they actually do.

I know I certainly did.
LOL, yes.

I find that the older I get, the less I know. (I'll be 69 in two weeks, so getting pretty clueless)

I read somewhere, years ago, where someone had figured out at what point in human history would one person be capable of knowing all of mankind's accumulated knowledge. It was something like 500-1,000 years ago, but that doesn't seem right -- seems it would have to be farther back than that.
You'd have to go much further back than that. The library of Alexandria contained an estimated 40,000 to 400,000 scrolls at 250 B.C. But of course it depends on what precisely is meant by "mankind's accumulated knowledge." Many of those scrolls were first-hand and second-hand historical accounts, much of it stories and poems, etc. They certainly didn't have 40,000 scrolls on the sciences or mathematics. But the knowledge of the ancients was clearly far greater than we once thought. Heck, we still don't really know how they built many of the ancient wonders of the world.
“It's a dangerous business, Frodo, going out your door. You step onto the road, and if you don't keep your feet, there's no knowing where you might be swept off to.” J.R.R. Tolkien,The Lord of the Rings

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Re: First 20% of bonds in long-term Treasuries

Post by ThrustVectoring » Wed Aug 07, 2019 11:47 pm

If anything, I'd personally use TIPS instead of nominal bonds here for long-term bonds. 30 years is a long time, and any bout of unexpected inflation will do nasty things to long-term treasuries. TIPS, on the other hand, will get inflation adjustments, and at expected inflation levels will do as well as nominal bonds.
Current portfolio: 60% VTI / 40% VXUS

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Re: First 20% of bonds in long-term Treasuries

Post by rascott » Wed Aug 07, 2019 11:48 pm

Dude2 wrote:
Wed Aug 07, 2019 10:28 pm
No dog in this fight. Do what you want with your money. Yes, I do understand the concept of take the entire portfolio into consideration, i.e. this zigs when that zags.

But, I favor the "take the risk on the equity side" argument because there is such a huge possibility for a tremendous outcome. On the other hand, even long term bonds or junk bonds, whatever the highest yielding animal is, have only a certain level of upside potential. Plus, they are not without risks -- interest rate risk, inflation risk.

Take short term TIPS for instance. That's a pretty low risk animal. It's short enough that interest rate risk isn't significant, and it tracks inflation and unexpected inflation to a very high degree. It is relatively risk-less and also relatively reward-less. I'm not looking for reward on the bond side, that's what the stock side is for. The bond side is to reduce my risk, i.e. the risk of losing everything or the risk of needing money when the money isn't there.

I use bonds to reduce overall portfolio risk, so I start with the most risk-less item and go from there. I do not mix something with certain risks with another thing with certain other risks because I believe the risks are mutually exclusive. Also I am not trying to necessarily reduce overall portfolio volatility, I am looking to reduce overall portfolio risks.

You seem to have missed the point about risk that he specifically underlined.

Dude2
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Re: First 20% of bonds in long-term Treasuries

Post by Dude2 » Thu Aug 08, 2019 12:35 am

rascott wrote:
Wed Aug 07, 2019 11:48 pm
Dude2 wrote:
Wed Aug 07, 2019 10:28 pm
No dog in this fight. Do what you want with your money. Yes, I do understand the concept of take the entire portfolio into consideration, i.e. this zigs when that zags.

But, I favor the "take the risk on the equity side" argument because there is such a huge possibility for a tremendous outcome. On the other hand, even long term bonds or junk bonds, whatever the highest yielding animal is, have only a certain level of upside potential. Plus, they are not without risks -- interest rate risk, inflation risk.

Take short term TIPS for instance. That's a pretty low risk animal. It's short enough that interest rate risk isn't significant, and it tracks inflation and unexpected inflation to a very high degree. It is relatively risk-less and also relatively reward-less. I'm not looking for reward on the bond side, that's what the stock side is for. The bond side is to reduce my risk, i.e. the risk of losing everything or the risk of needing money when the money isn't there.

I use bonds to reduce overall portfolio risk, so I start with the most risk-less item and go from there. I do not mix something with certain risks with another thing with certain other risks because I believe the risks are mutually exclusive. Also I am not trying to necessarily reduce overall portfolio volatility, I am looking to reduce overall portfolio risks.

You seem to have missed the point about risk that he specifically underlined.
Even if I accept the premise that long term bonds minimize interest rate risk given the qualification that this applies to people that are going to wait it out for the entire duration of the investment, that's still only one of the risks that is allegedly removed from the equation via a mixture of LTNB and stocks. Just read a prospectus to gather a list of risk factors. Various risk factors show up at various times. In the aggregate, you may draw all sorts of conclusions that this risk factor cancelled out this other one. You really just have to guess. When risks show up they do damage. LTNBs have more risk than short term TIPS. Hopefully they have more reward. I hesitate to draw conclusions that the marriage of LTNB and stocks creates an animal in which internal risk factors are minimized. There is a scenario in which both LTNB and stocks can have a really bad outcome because you get a perfect storm of risk factors all showing up at the same time. On the other hand, you take the risk, maybe you get a better reward. Good job.

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Re: First 20% of bonds in long-term Treasuries

Post by Atticus » Thu Aug 08, 2019 12:50 am

vineviz wrote:
Wed Aug 07, 2019 7:24 pm

Long-term bond funds not only offer superior diversification, but they also minimize interest rate risk for investors with long-term investment horizons (including virtually all investors who are currently accumulating retirement savings).
Vineviz, could you explain your statement regarding interest rate risk? In my (admittedly elementary) understanding of bonds, increasing duration is equivalent to increasing term/interest rate risk. Does this risk differ depending on whether one owns a bond directly and holds to maturity, versus holding a bond ETF/mutual fund where a long-term bond might be held for only 10 years or so before being replaced in the portfolio?

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Re: First 20% of bonds in long-term Treasuries

Post by TaxingAccount » Thu Aug 08, 2019 3:30 am

.....
Last edited by TaxingAccount on Tue Aug 13, 2019 3:25 pm, edited 3 times in total.

grok87
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Re: First 20% of bonds in long-term Treasuries

Post by grok87 » Thu Aug 08, 2019 4:39 am

ThrustVectoring wrote:
Wed Aug 07, 2019 11:47 pm
If anything, I'd personally use TIPS instead of nominal bonds here for long-term bonds. 30 years is a long time, and any bout of unexpected inflation will do nasty things to long-term treasuries. TIPS, on the other hand, will get inflation adjustments, and at expected inflation levels will do as well as nominal bonds.
agree.

the only role i would see for long term nominal treasuries is liability matching. i.e. if one somehow had long term nominal liabilities (a fixed rate mortgage?) or spending needs (hard to think of what that might be?)

i understand the idea that long term nominal treasuries provide superior diversification to an equity portfolio. I think David Swensen argued that in his first book.

But i personally don't agree with it. And I think Swensen backed off the idea in his second book. There he uses 50/50 treasuries/tips and when pressed said to use the market weight duration. Long term treasuries were a terrible equity diversifier in the late 70s-early 80s.

cheers,
grok
RIP Mr. Bogle.

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Re: First 20% of bonds in long-term Treasuries

Post by Tdubs » Thu Aug 08, 2019 4:41 am

Besides % of portfolio allocated to bonds, would age till retirement require additional adjustment?

bck63
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Re: First 20% of bonds in long-term Treasuries

Post by bck63 » Thu Aug 08, 2019 4:50 am

How about keeping it simple and just using the total US bond market? Good enough?

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Re: First 20% of bonds in long-term Treasuries

Post by schismal » Thu Aug 08, 2019 5:08 am

bck63 wrote:
Thu Aug 08, 2019 4:50 am
How about keeping it simple and just using the total US bond market? Good enough?
Simple, yes. Optimal, probably not.

Half the reason I set up BrokerageLink in my 403b was to access FNBGX. I have one bond fund. That's also simple.

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Re: First 20% of bonds in long-term Treasuries

Post by bck63 » Thu Aug 08, 2019 5:19 am

schismal wrote:
Thu Aug 08, 2019 5:08 am
bck63 wrote:
Thu Aug 08, 2019 4:50 am
How about keeping it simple and just using the total US bond market? Good enough?
Simple, yes. Optimal, probably not.

Half the reason I set up BrokerageLink in my 403b was to access FNBGX. I have one bond fund. That's also simple.
I'm 10 years from retirement. FNBGX has a duration of 17.92 years. Would adding long-term treasuries still make sense for me? If yes, at what proportion might someone do this?

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Re: First 20% of bonds in long-term Treasuries

Post by schismal » Thu Aug 08, 2019 5:26 am

bck63 wrote:
Thu Aug 08, 2019 5:19 am
schismal wrote:
Thu Aug 08, 2019 5:08 am
bck63 wrote:
Thu Aug 08, 2019 4:50 am
How about keeping it simple and just using the total US bond market? Good enough?
Simple, yes. Optimal, probably not.

Half the reason I set up BrokerageLink in my 403b was to access FNBGX. I have one bond fund. That's also simple.
I'm 10 years from retirement. FNBGX has a duration of 17.92 years. Would adding long-term treasuries still make sense for me? If yes, at what proportion might someone do this?
I was taking the OP as directed toward younger investors who encounter the traditional Boglehead advice of TBM. Vineviz has been asked about an age-adjusted rule, and I'm curious how they respond.

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Re: First 20% of bonds in long-term Treasuries

Post by samsdad » Thu Aug 08, 2019 5:46 am

Vineviz,

In your opinion, are long-term treasuries essentially limited in how much they can return in the future—as described in this exchange below?
Kevin M wrote:
Wed Aug 07, 2019 7:31 pm
HEDGEFUNDIE wrote:
Wed Aug 07, 2019 3:58 pm
Lee_WSP wrote:
Wed Aug 07, 2019 3:53 pm
MotoTrojan wrote:
Wed Aug 07, 2019 3:16 pm
Lee_WSP wrote:
Wed Aug 07, 2019 3:07 pm

We make out like bandits.
It is good to keep perspective. Stealing this from Kevin M
A drop from about 3% to about 2% on 20-30 year Treasuries gives you your 20% YTD return on long-term Treasuries. A drop from 2% to 1% gives you another 20%, and a drop from 1% to 0% gives you another 20%. That pretty much limits you to about 73% capital return (=1.2^3-1), to which you add the income return.

The Simba backtest spreadsheet shows long-term Treasury cumulative total return from 1982-2018 at about 2,400%. So yeah, it seems more than just borderline fundamentally impossible, but just impossible to earn 2,400% on long-term Treasuries over the next 37 years. This is especially true if you expect yields to remain low, since 2% compounded over 37 years only gives you a 108% income return.
I'm confused as to the response. If rates go negative, the bond fund will continue to increase in value as investors are now paying the government to hold onto the bond. Unless you are implying that the leveraged fund would not mirror the underlying asset, I am confused as to why TMF would not increase in value by a lot.

Also, are you sure Kevin is correct that a drop from 1% to 0% will only increase the fund value by 20%?
Kevin is not correct, he is not accounting for convexity.
Once again (for the third time I think), this is not a matter of convexity, but a matter of duration being related to both yield and coupon rate, but that's just a technical point. The more fundamental point is that I was just using a rough duration rule of thumb, but that doesn't change the main point. To amplify on this ...

Assuming a 25-year par bond (coupon rate = yield) is rolled annually starting at 3%, with rates dropping one percentage point per year, here are the annual capital returns:

3% -> 2%: 19.5%
2% -> 1%: 22.0%
1% -> 0%: 25.0%

(Although the increasing capital returns as both coupon rate and yield drop looks similar to convexity, that's not how convexity typically is defined).

Adding in the coupon returns of 3%, 2% and 1% for each year, we get total annual returns of 22.5%, 24.0% and 26.0%. This generates a 3-year compound return of 91%, so yeah, higher than the off-the-cuff estimate of 73%, but still far shy of the 2,400% return generated from 1982-2018.

Missing the forest (73% compared to 2,400%) for the trees (91% compared to 73%)?

To answer the question about returns if you really believe that the 25-year yield could drop significantly below 0%, a drop from 0% to -1% with a 0% coupon 25-year bond results in a capital return (and total return) of 28.6% = -PV(-1%,25,0%,1)-1. Adding that annual return to the previous three to get to 0% gives a compound return of 146%, so you'll have to go way negative to get to 2,400%, and I don't think anyone wants to live in that world.

Kevin

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vineviz
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Re: First 20% of bonds in long-term Treasuries

Post by vineviz » Thu Aug 08, 2019 6:50 am

dorster wrote:
Wed Aug 07, 2019 8:31 pm
Vineviz, I realize this is a rule of thumb post. But with a 70% allocation (or 60% allocation) what is the rationale for not having all bonds match an investors (presumably) long term timeline?
Good question. I was trying to imagine a rule of thumb that was flexible and universal enough to be useful across many investors, so there is certainly some room for folks to employ different strategies. So, what comes "after" that first 20% could be more long-term nominal bonds or long-term TIPs if the investor was comfortable keeping duration very long because of their investment horizon.

For one thing, keep in mind that a portfolio containing 20% EDV and 20% BND still has an average duration of nearly 15 years
dorster wrote:
Wed Aug 07, 2019 8:31 pm
Along a similar line you've mentioned elsewhere that someone in decumulation (but who still had a longish timeline) may want TIPS if they have a low equity allocation. If they wanted to use a fund, rather than individual TIPS, is LTPZ the only option? Any others worth considering?
Not a lot of good choices in long-term TIPs funds. Besides LTPZ, the only other decent choice that I know of is DFA LTIP Portfolio (DRXIX) but few investors will have access to that fund.

Otherwise, a combination of long-term nominal bonds (e.g. VGLT or TLT) and intermediate-term TIPS might work. Something like SPDR Blmbg Barclays TIPS ETF (IPE), Schwab US TIPS ETF (SCHP), or Vanguard Inflation-Protected Secs Adm (VAIPX).
"Far more money has been lost by investors preparing for corrections than has been lost in corrections themselves." ~~ Peter Lynch

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vineviz
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Re: First 20% of bonds in long-term Treasuries

Post by vineviz » Thu Aug 08, 2019 6:53 am

HawkeyePierce wrote:
Wed Aug 07, 2019 8:42 pm
Wouldn’t the ER on LTPZ (0.2%) be an issue given their low yield? I could see this being a case where I’d rather hold individual bonds (if I held any TIPS, that is).
I normally wouldn't suggest TIPs for early-stage accumulators, but at some point in the later stages (say, 10-15 years before retirement) building a ladder of individual TIPs wold be a great strategy IMHO.
"Far more money has been lost by investors preparing for corrections than has been lost in corrections themselves." ~~ Peter Lynch

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Re: First 20% of bonds in long-term Treasuries

Post by vineviz » Thu Aug 08, 2019 7:16 am

Atticus wrote:
Thu Aug 08, 2019 12:50 am
vineviz wrote:
Wed Aug 07, 2019 7:24 pm

Long-term bond funds not only offer superior diversification, but they also minimize interest rate risk for investors with long-term investment horizons (including virtually all investors who are currently accumulating retirement savings).
Vineviz, could you explain your statement regarding interest rate risk? In my (admittedly elementary) understanding of bonds, increasing duration is equivalent to increasing term/interest rate risk. Does this risk differ depending on whether one owns a bond directly and holds to maturity, versus holding a bond ETF/mutual fund where a long-term bond might be held for only 10 years or so before being replaced in the portfolio?
Sure. I'll try to keep this short, so let me know if it's still not helpful.

The basic idea is that what we often refer to as "interest rate risk" or "duration risk" or "term risk" actually has two components.

1) Price risk reflects that fact the price of a bond changes in response to a change in interest rates;
2) Reinvestment risk reflects the fact that maturing bonds and/or coupon payments from those bonds must be reinvested at higher or lower rates in the future in response to a change in interest rates;

These two risks tend to move in opposite directions for the investor, and either one or the other can be larger at any given time.

For an investor with a short-term investment goal (e.g. buying a car in October) the price risk of a long-term bond is by far the dominant risk: if interest rates rise between now and October, the bond price will fall and there isn't enough time for reinvestment at the higher rates to kick in.

Similarly, for an investor with a long-term investment goal (e.g. retirement spending in 20 years) the reinvestment risk is dominant: if interest rates fall between now and October, the bond price will rise but the cumulative impact of reinvesting at lower rates for 19 more years will impact return.

One useful trait of bond duration is that it reflects the moment in time where price risk and reinvestment risk are balanced. When the investor can match the duration of the bond or bond fund to their investment horizon, they minimize interest rate risk because price risk and reinvestment risk zero each other out.

The investor may have OTHER risks (e.g. inflation risk, shortfall risk, etc.), but matching bond duration to investment horizon is an important part of making sure you aren't taking on more risk than you need to and that you are compensated for the risks you DO take.
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Re: First 20% of bonds in long-term Treasuries

Post by vineviz » Thu Aug 08, 2019 7:33 am

schismal wrote:
Thu Aug 08, 2019 5:26 am
bck63 wrote:
Thu Aug 08, 2019 5:19 am
schismal wrote:
Thu Aug 08, 2019 5:08 am
bck63 wrote:
Thu Aug 08, 2019 4:50 am
How about keeping it simple and just using the total US bond market? Good enough?
Simple, yes. Optimal, probably not.

Half the reason I set up BrokerageLink in my 403b was to access FNBGX. I have one bond fund. That's also simple.
I'm 10 years from retirement. FNBGX has a duration of 17.92 years. Would adding long-term treasuries still make sense for me? If yes, at what proportion might someone do this?
I was taking the OP as directed toward younger investors who encounter the traditional Boglehead advice of TBM. Vineviz has been asked about an age-adjusted rule, and I'm curious how they respond.
I'd say that long-term bonds still make sense for most investors who are still 10 years from retirement, although by this stage of the game you can possibly start thinking of a more targeted implementation than a rule of thumb.

But generally speaking, let's imagine we're talking about some one who is 57 years hold who intends to retire at age 67. Their FIRST retirement spending will be in 10 years and could very easily extend for 25 or 30 years beyond that. Calculating roughly, that equates to an investment horizon of 23 years or more so a fund like FNBGX seems like an entirely reasonable choice.

That said, I'd also be thinking about inflation risk at that point. Fidelity has a great TIPS fund in Fidelity Inflation-Protected Bond Index Fund (FIPDX), so I'd consider that in conjunction with FNBGX. Or PIMCO 15+ Year U.S. TIPS Index Exchange-Traded Fund (LTPZ) mentioned earlier, but it is not NTF at Fidelity.
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Re: First 20% of bonds in long-term Treasuries

Post by Blueskies123 » Thu Aug 08, 2019 7:44 am

I can only assume you were not an adult during the '70s and early 80's. I remember them well. Inflation-adjusted losses in long term bonds were around 70%.

Harry Markowitz developed the Modern Portfolio Theory (MPT) in the 1950’s. Simply put his theory argues that portfolio risk can be reduced by holding combinations of different securities and asset classes that are not positively correlated. We agree with the theory that there are benefits to diversification but we do not subscribe to MPT. Diversification makes sense when you buy uncorrelated assets that are undervalued. Buying assets for the sake of diversification without regard for valuation is fraught with risk regardless of how many different securities and asset classes one may hold
https://www.seeitmarket.com/understandi ... isk-16048/

So are long term bonds undervalued?
Last edited by Blueskies123 on Thu Aug 08, 2019 8:08 am, edited 1 time in total.

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Re: First 20% of bonds in long-term Treasuries

Post by TBillT » Thu Aug 08, 2019 7:55 am

A couple weeks ago I started a small TLT position and I am up 10%.

Problem is, where do we go from here? TBond king A. Gary Shilling has for 40 years said 2% on the Long Bond, and well here we are at 2.1%

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Re: First 20% of bonds in long-term Treasuries

Post by HomerJ » Thu Aug 08, 2019 9:50 am

The investor may have OTHER risks (e.g. inflation risk, shortfall risk, etc.), but matching bond duration to investment horizon is an important part of making sure you aren't taking on more risk than you need to and that you are compensated for the risks you DO take.
The other risks are important.

For instance, one can't guarantee it's going to be 20 years before they touch their bond money, even if one is only 35.

A huge stock market crash, loss of a job. The bond money might be needed to feed your kids.
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Re: First 20% of bonds in long-term Treasuries

Post by HomerJ » Thu Aug 08, 2019 10:03 am

vineviz wrote:
Thu Aug 08, 2019 7:33 am
I'd say that long-term bonds still make sense for most investors who are still 10 years from retirement, although by this stage of the game you can possibly start thinking of a more targeted implementation than a rule of thumb.

But generally speaking, let's imagine we're talking about some one who is 57 years hold who intends to retire at age 67. Their FIRST retirement spending will be in 10 years and could very easily extend for 25 or 30 years beyond that. Calculating roughly, that equates to an investment horizon of 23 years or more so a fund like FNBGX seems like an entirely reasonable choice.
Ah, yes, one always get to retire when they INTEND to.

I still don't understand why it's an optimal strategy to lock in 2.18% yields for the next 20 years.

Why not lock in 1.69% for the next 5-6 years, and get all new rates in 5-6 years, as all the bonds are replaced, and again 5-6 years after that.

Sure, it's possible that you might make less over the 20 years if rates go down, but I would think the odds are on your side. It's not that much of a difference, and rates are historically low.

Sure, they can still go lower, but over the next 20 years, it seems somewhat likely they might go higher someday...

Especially if inflation shows up, and the Fed has to raise interest rates to fight inflation. That is a risk you are ignoring. You seem to believe inflation will never again occur.

That's a bet I'm not willing to make.
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Re: First 20% of bonds in long-term Treasuries

Post by Atticus » Thu Aug 08, 2019 11:45 am

vineviz wrote:
Thu Aug 08, 2019 7:16 am
Atticus wrote:
Thu Aug 08, 2019 12:50 am
vineviz wrote:
Wed Aug 07, 2019 7:24 pm

Long-term bond funds not only offer superior diversification, but they also minimize interest rate risk for investors with long-term investment horizons (including virtually all investors who are currently accumulating retirement savings).
Vineviz, could you explain your statement regarding interest rate risk? In my (admittedly elementary) understanding of bonds, increasing duration is equivalent to increasing term/interest rate risk. Does this risk differ depending on whether one owns a bond directly and holds to maturity, versus holding a bond ETF/mutual fund where a long-term bond might be held for only 10 years or so before being replaced in the portfolio?
Sure. I'll try to keep this short, so let me know if it's still not helpful.

The basic idea is that what we often refer to as "interest rate risk" or "duration risk" or "term risk" actually has two components.

1) Price risk reflects that fact the price of a bond changes in response to a change in interest rates;
2) Reinvestment risk reflects the fact that maturing bonds and/or coupon payments from those bonds must be reinvested at higher or lower rates in the future in response to a change in interest rates;

These two risks tend to move in opposite directions for the investor, and either one or the other can be larger at any given time.

For an investor with a short-term investment goal (e.g. buying a car in October) the price risk of a long-term bond is by far the dominant risk: if interest rates rise between now and October, the bond price will fall and there isn't enough time for reinvestment at the higher rates to kick in.

Similarly, for an investor with a long-term investment goal (e.g. retirement spending in 20 years) the reinvestment risk is dominant: if interest rates fall between now and October, the bond price will rise but the cumulative impact of reinvesting at lower rates for 19 more years will impact return.

One useful trait of bond duration is that it reflects the moment in time where price risk and reinvestment risk are balanced. When the investor can match the duration of the bond or bond fund to their investment horizon, they minimize interest rate risk because price risk and reinvestment risk zero each other out.

The investor may have OTHER risks (e.g. inflation risk, shortfall risk, etc.), but matching bond duration to investment horizon is an important part of making sure you aren't taking on more risk than you need to and that you are compensated for the risks you DO take.
Yes, that makes sense. I think I had mentally included inflation risk with the term risk, but you're correct that it should be considered separately.

Inflation risk is still something to weigh for the portfolio. However, for the hypothetical 80/20 portfolio discussed, I suspect the high equity allocation helps to mitigate that risk.

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Re: First 20% of bonds in long-term Treasuries

Post by vineviz » Thu Aug 08, 2019 1:41 pm

Atticus wrote:
Thu Aug 08, 2019 11:45 am
Inflation risk is still something to weigh for the portfolio. However, for the hypothetical 80/20 portfolio discussed, I suspect the high equity allocation helps to mitigate that risk.
Yep.

Also, I’d wager that most investors with an 80/20 portfolio are still in their prime working years such that their human capital is significant (wages tend to track inflation over the medium to long run).

If not, using long-term TIPs in place of nominal bonds would be a reasonable accommodation.
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Re: First 20% of bonds in long-term Treasuries

Post by garlandwhizzer » Thu Aug 08, 2019 2:30 pm

Blueskies123 wrote regarding Vineviz's strong preferences for LT Treasuries:

I can only assume you were not an adult during the '70s and early 80's. I remember them well. Inflation-adjusted losses in long term bonds were around 70%.
I remember those days quite well. We have not had substantial and ever increasing inflation in this country for 37 years. Due to a long multi-decade period of decreasing inflation backtesting results on LT Treasuries look great relative to other bond options--greater diversification to equity, greater long term risk adjusted yields. Hence a lot of current academic literature which is based on backtesting models supports the LTT approach as the dominant and sometimes only bond holding. Ever decreasing inflation and low long term inflation rates juice returns and lowers risk of LTT, there is no doubt about that. The thrust of this opinion comes from the fact that inflation has basically gone only one way, down, for longer than most investors and many young academics have any memory of.

The current yield on 30 year Treasuries is 2.25%. If we go into a multi-decade period of rising inflation which we did from the 1960s to the early 1980s, and your bond holdings are exclusively in LTT, you are toast, pure and simple. The long term average inflation rate in the US from 1913 through 2013 was 3.22%/yr. about a full percentage point higher than than the current 30 year T yield. If you buy that LTT bond now you're locking in for 3 decades the lowest yield that the 30 yr. Treasury has had in its 39 year history. The average yield of 30 year Treasuries during that 39 years is well over 6%, almost 3 times higher than the current yield. As long as inflation remains incredibly muted and rates keep going down for decades which will actually require a long period of persistent deflation as in Japan 1989 to the present, a high or total allocation to LTT will work. But to put it mildly predicting anything over 3 decades has huge margins of potential error and complete uncertainty. If you believe the last 3.8 decades will be replayed exactly for the next 3 decades it seems reasonable to load up on LTT. Certainly no one expects inflation to crank up again anytime in the foreseeable future. On the other hand no one expected the Great Recession or the Great Depression which is why they piled into stocks right up until stocks collapsed just like investors are now piling into LTT. No one in 1967 expected that inflation would reach 15%/yr. in 15 years. It seemed preposterous at the time and yet it happened. Personally I recommend having LT and IT/ST bonds, something like TBM or a barbell approach plus possibly TIPS depending on circumstances. Diversification balances risk rather than putting all eggs in the low inflation basket of LTT but that is a my personal decision and I don't think it applies to everyone.

I have in other bond posts argued against taking on excessive duration risk in fixed income especially when rates are historically low. You don't know if for when you will need money unexpectedly in the future. If you have to sell 30 year Treasuries that yield 2.25% during an episode when inflation is 3.5% which has happened frequently in the long term past, good luck. Furthermore some very knowledgeable, brilliant and experienced investors, Buffett and Bernstein to name a couple, strongly suggest exposure to short term Treasuries. They have been around long enough to have witnessed both sides of the inflation coin and also have observed over and over that whatever the herd is currently rushing after in the market, like LTT now, may turn out to be a rubber carrot in the end. Grok 87 also makes the valid point that TIPS now offer protection from unexpected inflation free of charge relative to LTT yields. In sum I do not believe that there is one approach such as LTT that all bond holders must follow regardless of their circumstances.

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Re: First 20% of bonds in long-term Treasuries

Post by vineviz » Thu Aug 08, 2019 3:28 pm

garlandwhizzer wrote:
Thu Aug 08, 2019 2:30 pm
I remember those days quite well. We have not had substantial and ever increasing inflation in this country for 37 years. Due to a long multi-decade period of decreasing inflation backtesting results on LT Treasuries look great relative to other bond options--greater diversification to equity, greater long term risk adjusted yields. Hence a lot of current academic literature which is based on backtesting models supports the LTT approach as the dominant and sometimes only bond holding. Ever decreasing inflation and low long term inflation rates juice returns and lowers risk of LTT, there is no doubt about that. The thrust of this opinion comes from the fact that inflation has basically gone only one way, down, for longer than most investors and many young academics have any memory of.
There are enough differences between the 1960s/1970s and today that any comparison is fraught with hypotheticals: there were no 401ks, no IRAs, no index funds of any kind, no TIPS, no long-term Treasury bond funds, very few intermediate-term Treasury funds, and way more pensions.

Leaving all that aside, it's readily apparent that many investors think they remember aspects of that era that upon closer examination turn out not to be true.

Take the case of two hypothetical investors born in 1939: they've taken jobs, started families, and in 1963 decide that saving for retirement is a good idea. Starting in January 1963 both investors save $125/month - raising that amount to keep up with inflation - in an account that is 70% US stocks and 30% treasury bonds. After a solid 30 year career, each retires at the end of December 1992.

The only difference is Investor A put all their bond money in intermediate-term bonds and Investor B followed by "first 20% in long-term treasury" rule

Investor B is " toast, pure and simple" right? How much smaller do you think Investor B's portfolio was, having been so unlucky as to have invested his bond allocation entirely in long-term Treasuries during a career that completely bracketed "a multi-decade period of rising inflation"?

I'll tell you: $2,128. Investor B retired with a mere $575,665 compared to Investor A's $577,793.


Toast, indeed. I suppose the only thing I can say is that time plays tricks on the memory. A conventional wisdom has been built up around the "wild disaster" of long-term bonds in the 1960s and 1970s that seemingly ignores the actual truth of what those decades were like.

Flip the cards and imagine that A and B were retirees in 1966 instead, starting with $100k in a 60/40 portfolio and withdrawing $330/month adjusted for inflation. Same bonds as before: A is all intermediate Treasuries while B is 20% in long Treasuries and 20% in intermediate Treasuries.

Despite living very near the limits of their SWRs, both investors enjoy their inflation-adjusted income for a full 30 years of retirement. Investor A dies with $194K and Investor B dies with $92k. Investor B came out behind, for sure, but that is despite putting half his bonds in long-term Treasuries during the WORST period in history when one could have done so. If B lived until the age of 102 then his portfolio would have been depleted in September 2002. Again, 1966 is the unluckiest year in history for B to have retired: starting retirement just four years later, in 1970, Investor B's portfolio would be over $1,200,000 by now.
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Re: First 20% of bonds in long-term Treasuries

Post by Dottie57 » Thu Aug 08, 2019 4:13 pm

schismal wrote:
Thu Aug 08, 2019 5:08 am
bck63 wrote:
Thu Aug 08, 2019 4:50 am
How about keeping it simple and just using the total US bond market? Good enough?
Simple, yes. Optimal, probably not.

Half the reason I set up BrokerageLink in my 403b was to access FNBGX. I have one bond fund. That's also simple.
How old are you. Why have 30 year bonds if you need to sell for income now?

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Re: First 20% of bonds in long-term Treasuries

Post by vineviz » Thu Aug 08, 2019 5:13 pm

[quoted post removed by admin LadyGeek]

It's not as if long-term bonds are a heretical concept: I'm pretty sure that the first bond fund Jack Bogle created was Vanguard Long-Term Investment-Grade Fund (VWESX), launched in 1973 before he was fired from Wellington and before he founded Vanguard. The intermediate-term counterpart, VFICX, wasn't launched for another 20 years.

And Vanguard's first Treasury bond fund wasn't short-term or intermediate term: it was Vanguard Long-Term Treasury Fund Investor Shares (VUSTX) in 1986, a full five years before the shorter duration funds were launched.
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Re: First 20% of bonds in long-term Treasuries

Post by columbia » Thu Aug 08, 2019 5:20 pm

Presumably created to sell to institutions, pension funds, etc.

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Re: First 20% of bonds in long-term Treasuries

Post by willthrill81 » Thu Aug 08, 2019 5:21 pm

vineviz wrote:
Thu Aug 08, 2019 5:13 pm
[quoted post removed by admin LadyGeek]

It's not as if long-term bonds are a heretical concept: I'm pretty sure that the first bond fund Jack Bogle created was Vanguard Long-Term Investment-Grade Fund (VWESX), launched in 1973 before he was fired from Wellington and before he founded Vanguard. The intermediate-term counterpart, VFICX, wasn't launched for another 20 years.

And Vanguard's first Treasury bond fund wasn't short-term or intermediate term: it was Vanguard Long-Term Treasury Fund Investor Shares (VUSTX) in 1986, a full five years before the shorter duration funds were launched.
I think that inflation risk is the biggest concern that people have with long-term bonds. It's hard for many to get over the 46.5% drawdown in real dollars that LTT experienced from 1977 to 1981, especially when they've been taught for years that 'bonds are for safety'. Due to the inflation risk, I'd prefer long-term TIPS. However, as you note, there are few funds for LT TIPS and even fewer 401k and similar plans with access to those funds.
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Re: First 20% of bonds in long-term Treasuries

Post by HawkeyePierce » Thu Aug 08, 2019 5:28 pm

One thing that seems missing from a lot of discussions of inflation on this board is the precise meaning of "inflation" being discussed. Near term or long term? Expected or unexpected? A high or low spread of actual inflation compared to expected inflation? Different asset classes defends against those scenarios. Equities, nominal bonds, real bonds, even fixed rate mortgages and human capital all play a role in how an individual guards against inflation but we often discuss it in such a narrow view it's hard to make the advice truly actionable.

Of course, the advice will vary based on an investor's expected remaining working years. Lately I've been giving some thought to how unexpected inflation would affected early retirees and how it might be hedged. This is with an eye towards FIRE.

Perhaps we could chart various sources of return like so, with different charts based on an investor's remaining human capital:

Image

Is anyone aware of any good papers or books on this topic?

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Re: First 20% of bonds in long-term Treasuries

Post by HEDGEFUNDIE » Thu Aug 08, 2019 5:30 pm

columbia wrote:
Thu Aug 08, 2019 5:20 pm
Presumably created to sell to institutions, pension funds, etc.
Vanguard has three flavors of the Extended Duration Treasury fund:

VEDIX, min purchase $100M
VEDTX, min purchase $5M
EDV, no min purchase

Guess which fund class has the most assets?

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Re: First 20% of bonds in long-term Treasuries

Post by SavageAmusement » Thu Aug 08, 2019 5:32 pm

vineviz wrote:
Thu Aug 08, 2019 5:13 pm
[quoted post removed by admin LadyGeek]

It's not as if long-term bonds are a heretical concept: I'm pretty sure that the first bond fund Jack Bogle created was Vanguard Long-Term Investment-Grade Fund (VWESX), launched in 1973 before he was fired from Wellington and before he founded Vanguard. The intermediate-term counterpart, VFICX, wasn't launched for another 20 years.

And Vanguard's first Treasury bond fund wasn't short-term or intermediate term: it was Vanguard Long-Term Treasury Fund Investor Shares (VUSTX) in 1986, a full five years before the shorter duration funds were launched.
I can’t say I follow any of your logic, including this post. In contrast, Garland’s reasoning is crystal clear.

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Re: First 20% of bonds in long-term Treasuries

Post by willthrill81 » Thu Aug 08, 2019 5:35 pm

HawkeyePierce wrote:
Thu Aug 08, 2019 5:28 pm
One thing that seems missing from a lot of discussions of inflation on this board is the precise meaning of "inflation" being discussed. Near term or long term? Expected or unexpected? A high or low spread of actual inflation compared to expected inflation? Different asset classes defends against those scenarios. Equities, nominal bonds, real bonds, even fixed rate mortgages and human capital all play a role in how an individual guards against inflation but we often discuss it in such a narrow view it's hard to make the advice truly actionable.
Unexpected inflation is the real enemy. Expected inflation is theoretically already priced into nominal bonds. TIPS and I bonds are the go-to means to deal with unexpected inflation. Over the long-term, arguably the best inflation hedges are investments that are likely to significantly outpace inflation, such as stocks and good rental properties.
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Re: First 20% of bonds in long-term Treasuries

Post by 9-5 Suited » Thu Aug 08, 2019 5:35 pm

This won’t be the most intellectual thing I’ll ever post, but it’s just hard to believe that I’ll reap much meaningful financial gain from locking into a bunch of 2% nominal long term treasuries as a 33 year old.

Without using a backtest (because of the specific bond regime it will cover) what is the actual expected forward looking range of ending portfolio values for 20% ITT vs. 20% LTT? Maybe it’s a lot bigger difference than I’m giving credit?

And this isn’t a comment on the diversification of risk aspect, which I totally agree with.

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