TheFinanceBuff article on bonds [Invest in Long-Term Now?]

[xram]

http://thefinancebuff.com/invest-in-lon ... s-now.html

Title of article

Invest in long term bonds now?

[larryswedroe]

It seems to this article makes one of the most grevious of errors, confusing strategy with outcome. Either a strategy is right or it’s wrong BEFORE we know the outcome. Only fools judge strategies by outcomes without considering what alternative universes might have shown up. What if in fact instead of a deflationary recession like we had we experienced an inflationary one like we had in the 1970s, when stocks and long bonds both did poorly. Would you have come to the same conclusion?
Having said that Kevin Grogan and I wrote a paper which demonstrated that whether one should own long or short to intermediate bonds depended on (among other things) your equity allocation. Those with high equity allocation should consider longer bonds and vice versa. This article appeared in the Journal of Investing
Other issues should include your ability to take the risks of unexpected inflation
Best wishes
Larry

[xram]

Here is the article Mr. Swedroe mentions above

http://www.iijournals.com/doi/abs/10.39 ... 9.18.4.107

I would pay to read it but I probably wouldn't understand it anyway.....

Here is another page discussing the article...

https://www.pwlcapital.com/en/Advisor/T ... term-bonds

xram

[tfb]

It seems to this article makes one of the most grevious of errors, confusing strategy with outcome.

No it does not. After pointing out that the strategy of limiting oneself to short- and intermediate-term *appears* to be wrong, it goes on to say that the good outcome from investing in long-term bonds could only be attributed to being lucky and that counting on luck isn’t a viable strategy.

[Dale_G]

It seems to this article makes one of the most grevious of errors, confusing strategy with outcome. Either a strategy is right or it’s wrong BEFORE we know the outcome. Only fools judge strategies by outcomes without considering what alternative universes might have shown up. What if in fact instead of a deflationary recession like we had we experienced an inflationary one like we had in the 1970s, when stocks and long bonds both did poorly. Would you have come to the same conclusion?
Best wishes
Larry

Let's face it Larry, your strategy to stay short turned out to be wrong, and a strategy to to longer duration turned out to be correct.

But it is your "this article makes one of the most grevious of errors, confusing strategy with outcome" statement that bothers me. This is a cop-out.

Things might have turned out differently. If the stay short strategy had worked and the go longer strategy had failed, the go long guy could have looked you straight in the eye and said, "You are a fool to judge strategies by outcomes".

So the cop-out of "judging strategies by outcomes" can be used by anyone who selected a strategy that didn't work out. That makes the phrase meaningless to me.

Dale

[Riprap]

Larry,

On page 207 of Only Guide to a Winning Bond Strategy You'll Ever Need, you say,

"Extend the maturity only if by extendng one year you gain at least an incremental yield of fifteen basis points for tax-exempt instruments"

Using Vanguard's own data for their intermediate and long term tax exempt funds, it looks like one can gain about 50 basis points per year or 3 times the minimum you recommend in your book.

What am I missing?

[Levett]

This strategy/outcome mantra has always struck me as somewhat limited.

Maybe it's because I played competitive sports and watched my coaches game plan after we broke down film and, by golly, more often than not my coach's strategy led to a positive outcome. It's called picking apart an opponent's tendencies.

More to the point (I guess), I've found that a firm commitment to an investment plan (is this not a "strategy?") has, to date, led to a successful retirement (is this not an "outcome"--at least to date?).

Anyway, what's an adviser selling if not a "strategy" that's supposedly meant to lead to an "outcome?"

If an adviser's "strategy" isn't meant to lead to an "outcome," why bother with paying an adviser or,
for that matter, listening to or reading an adviser who can't deliver the goods?

Oy, my skepticism is showing.

Lev

[stlutz]

Just wanted to say that regardless of the specific issue under discussion here, one of the great things about tfb's blog is that the fact that he will try things and then report back how it actually worked out, for better or for worse.

[Occupier]

Right now interest rates are at historic lows. The most likely direction is up at some unknown point in the future. When that happens the value of the bonds, or bond fund will decline by their duration. Typical durations for funds, Short term 2 - 3 years, Intermediate term 5-7 years, long term 15-20 years. Most of my lifetime interest rates have been around 5-6% instead of the present 2-3%. If they return to 5% Short term bond funds will decline by 4-9% Intermediate term bond funds will decline by 10 to 21% and long term bond funds will decline by 30% to 60%. So just how intelligent is it to hold long term bonds now earning around 3%? If your name is Dale G, you might think the answer is very intelligent now, but you also might think different in the future. Dave

[larryswedroe]

TFB
If I missed that my apologies

Dale
Sorry but that is just wrong, not the strategy. And my colleague and I wrote a paper showing when it might be appropriate to buy longer bonds for a portfolio- when you have high equity allocation. Your error is judging the outcome instead of by what also might have happened. And I would note that some people can buy longer bonds because they can take more risk of unexpected inflation.


Riprap

One should consider that, going longer if the yield curve is that steep, because the evidence says term risk has been best rewarded when it is steep. But today for taxables at 20bp you get that up to about 10 years but not after. Example 10 year at 2.04 and 20 year at 283, so about 8 bp between them.

For munis 10 year is about 186 for AAA and 297 for 20 year (and there almost always have call risk which I would not take) So there about 10 per year plus the call risk.
I have been buying 10 year munis for a while with the curve this steep

A quick look at Vanguard's funds on M* shows only about 1 year difference in the maturity/duration of the intermediate and longer term fund. That's strange. Certainly would not call a 6.5 year fund long term. So I don't get that. But if you got paid more than 15bp and the ytm is correct and you can take the risk of unexpected inflation I would extend.

Larry

[Riprap]

Vanguard data

VWITX (Intermediate Term Tax-Exempt)
Duration 5.1 years
Ave Maturity 5.5 years
Yield to Maturity 1.7%
Distribution Yield 2.92%

VWLTX (Long Term Tax-Exempt)
Duration 6.1 years
Ave Maturity 6.4 years
Yield to Maturity 2.2%
Distribution Yield 3.67%

[Riprap]

A quick look at Vanguard's funds on M* shows only about 1 year difference in the maturity/duration of the intermediate and longer term fund. That's strange. Certainly would not call a 6.5 year fund long term. So I don't get that.

I guess in my mind one of the main points of TFB's article is that the Vanguard muni fund is long in name only.

[larryswedroe]

riprap
On that we would agree, never noticed that before
Larry

[Dale_G]

Right now interest rates are at historic lows. The most likely direction is up at some unknown point in the future. When that happens the value of the bonds, or bond fund will decline by their duration. Typical durations for funds, Short term 2 - 3 years, Intermediate term 5-7 years, long term 15-20 years. Most of my lifetime interest rates have been around 5-6% instead of the present 2-3%. If they return to 5% Short term bond funds will decline by 4-9% Intermediate term bond funds will decline by 10 to 21% and long term bond funds will decline by 30% to 60%. So just how intelligent is it to hold long term bonds now earning around 3%? If your name is Dale G, you might think the answer is very intelligent now, but you also might think different in the future. Dave

I an 75 and my wife is 77. We have long held Intermediate term muni's in her account, but lately I have added to the Long Term Muni account - not really long, but longer than the Intermediate. In any case, the duration is less than our expected joint lifetimes and far less than the expected lifetimes of our heirs. We've been through this before.

If I am wrong, Uncle Sam will share our misery via tax losses. If I am right I will enjoy positive returns compared to a shorter duration investment.

And maybe I am wrong - at the very least I will be able to say, "Don't confuse strategy with outcomes", apparently an accepted phrase for having selected the wrong strategy.

I am reminded that four and five years ago Bogleheads were abandoning the Short Term Investment Grade fund because Prime MM was yielding more. Those who have stuck with it haven't done that well.

I don't know what interest rates will do in the future, and I am very concerned about inflation eroding the value of my investments, but nearly 50 years of investing have taught me not to blow with the wind of forecasts of any kind.

Dale

.

.

[larryswedroe]

Dale
First there is very little difference, to my surprise between the two funds, only a year. I was shocked to see that. To me long term is at least 10 years. That is misleading by Vanguard IMO.
My own portfolio has average maturity of about 4 years. I wish it was longer (with TIPS). When I owned TIPS it was much longer because the TIPS were as long as 20 years. But you don't have inflation risk with TIPS.
Best wishes
Larry

[Phineas J. Whoopee]

This strategy/outcome mantra has always struck me as somewhat limited.
...

Hi Lev,

The issue is you cannot wait until later to see the outcome in order to decide on a strategy today.

Any strategy chosen and pursued today will have an uncertain outcome. The only thing you can do is make the best decision you can with the available information. A choice which rationally is a good strategy may lead to a bad outcome, but that doesn't mean your choice was mistaken when you decided on it over pursuing some other possible strategy you had identified and analyzed as worse.

PJW

[Geologist]

Dale
First there is very little difference, to my surprise between the two funds, only a year. I was shocked to see that. To me long term is at least 10 years. That is misleading by Vanguard IMO...

Best wishes
Larry

I have never owned the Long-Term Tax-Exempt Fund, but I have owned the Intermediate for many years and I have kept a selection of annual reports (covering all the national muni funds) over the years. The maturity/duration of the Long Term Fund is at the short end of its historical range now. For example, the maturity (duration) of the Long Term Fund in Oct 2003 was 8.4 (6.6) years. What is more striking is the change in the "broad index" (Lehman [now Barclay's] Muni Bond Index) to which the fund is benchmarked: in Oct 2003, its maturity (duration) was 13.8 (8.2) years and last October it was 6.8 (5.8) years. The number of bonds in the index hasn't changed (mid-40,000's), so that suggests to me that there has been a shift in the market composition to shorter maturities. Whether or not that is true, the Long-Term fund had an average maturity rather shorter than the broad index in 2003 and is now roughly in line.

[Phineas J. Whoopee]

riprap
On that we would agree, never noticed that before
Larry

Hi everyone, not picking on Larry or riprap in particular:

It looks to me much like the issue some people have with TBM not being Total in that it doesn't hold TIPS, high-yield, or municipal bonds. In my opinion it's incumbent on an investor to read the statutory prospectus to find out what's under the hood. What if I marketed the Phineas J. Whoopee Ultra High Safety Ultra High Income Hedges You 10x Inflation and Anyone Who Tries to Verify These Claims is a Wuss fund?

I agree there's an extent to which we as investors should be secure in believing the annual reports, 10-Q, and 10-K filings, but I don't think we should be secure in believing whoever at its inception wrote the title of the fund fully agrees with us on today's meanings of the words.

I'll leave a little bit of wiggle room for Target Retirement and Lifestrategy funds (and their non-Vanguard equivalents).

PJW

[Jebediah]

Lev, Dale: It's called probabilities. Larry's oft-repeated statement about strategy vs outcome is of course correct. Ask any poker player.

[Kevin M]

I've pointed out several times on this forum that the Vanguard LT TE funds are only slightly longer duration than the IT TE funds, as compared to the investment-grade and treasury funds for which the difference is quite large (LT IG is 13.6 years and LT T is 15.3 years). Having owned both the CA IT TE and CA LT TE for some time (and now owning the national IT and LT funds), I have paid attention to this.

Similarly, the duration of LQD, a big bond ETF, is between 7 and 8 years, yet it typically is classified as a long-term bond fund, so have not considered the interest-rate risk near as significant as VG LT investment-grade.

As with all funds, you have to look beyond the name.

Kevin

[Barry Barnitz]

Hi Larry et al:

In the wiki, we have a page devoted to historical Vanguard Municipal bond fund tracking error. In footnote 4 we have a spreadsheet devoted to the Vanguard Long Term Municipal bond fund. The "duration" tab of this sheet provides the duration of both fund and index benchmark for the years 2000- 2011 as reported in annual reports.

Vanguard Municipal Bond fund tracking error - Bogleheads

regards,

[Levett]

Hi Phineas,

'The issue is you cannot wait until later to see the outcome in order to decide on a strategy today."

Yes.

And that's precisely why in investing, unlike game planning for a football game, I said the strategy/outcome mantra is limited, if not ultimately meaningless.

Randomness rules (and that's why advisers, unlike insurance companies, won't guarantee squat, but they will collect fees nevertheless ) .

We just gotta deal with uncertainty. It's the law of the jungle.

Lev

[Kevin M]

After reading Harry's post, I also see that a key point of perhaps moving from IT TE to LT TE is that he has moved much of his fixed income investments to things like CDs and savings accounts that have minimal interest-rate risk (I consider the EWP on CDs as minimal interest-rate risk, not zero risk), thus lowering the duration of his overall fixed-income. Thus, he can afford the extra interest rate risk of extending the duration of his muni fund by a year or so.

Kevin