Simple Bond Ladder

[doodle]

I have taken the advice of the residents here and will set up a traditional PP for my parents instead of the modified 5 year ladder version.

I will be buying the bonds through schwab which has a free treasury window to save on the expense ratio and transaction costs of the ETF but I have a few questions.

#1) Is there an easier way to set up a ladder for the PP than dividing the total amount to be invested in bonds by ten and then buying equal amounts of ten bonds with maturities ranging from 21 - 30 years?

#2) How does one rebalance a ladder if bond prices rise or fall dramatically. Which bond maturity do I sell?

#3) Does one reinvest the interest payouts immediately back into bonds or into cash?


Thanks!

[MediumTex]

For the LT bond piece, just buy the longest dated bond that is available.  This will be a bond that has 29 or more years until maturity.  The interest will be paid twice a year and should go into cash.  When the bond gets to 20 years, sell it and buy another recently issued 30 year bond.

TLT also works fine for the LT bond piece.

For the ST bond piece, I would consider using one of the treasury ETFs (e.g., SHY or SHV) and just have the dividends reinvested.

[doodle]

Thanks to all for the help with this. It is a weight of of my shoulders to know that my parents have a strategy that will hopefully protect them during their retirement.

A few last question regarding the bonds.

Wouldn't waiting 10 years to sell the 30 year bond reduce its volatility? Why wait ten years vs. 1 year or 5 years before rolling it into another 30 year bond?

Also, why do all of the long bond mutual funds create a ladder rather than just buy the longest bond out there? Is there some advantage to doing this?

Thanks again!

[Tortoise]

Most PP investors buying LT Treasuries directly will naturally create a ladder over time, whether they intend to or not. When rebalancing, buying at ~30 years (if you need to buy) or selling some of the shortest maturities (if you need to sell) will gradually build up a ladder of sorts.

As for volatility, I think the PP ideal would be to have nothing but 30-year LT Treasuries since they are the most volatile. But the reason Harry Browne didn't advocate frequently buying and selling LTs to keep the average maturity as close to 30 years as possible is most likely because:

• It makes the PP more complicated than it needs to be, and the PP is supposed to be all about simplicity
• For some investors, it will result in higher transaction costs
• The more frequently an investor has to buy or sell, the more the temptation to time the market may creep in

The difference between an average time to maturity of, say, 25 years instead of 30 years for one's LT Treasury allocation isn't likely to change the PP's long-term CAGR drastically. I suspect more than one person on this forum has done the comparison before and might be willing to tell us the CAGR difference.

[MediumTex]

The difference between an average time to maturity of, say, 25 years instead of 30 years for one's LT Treasury allocation isn't likely to change the PP's long-term CAGR drastically. I suspect more than one person on this forum has done the comparison before and might be willing to tell us the CAGR difference.

Since a lot of people backtest the PP using VUSTX, it seems clear that shortening the duration a lot hasn't translated into significantly different returns, so I wouldn't worry about 25 vs. 30 years to maturity.

Ayone setting up a new PP would do themselves a big favor by setting up a smart money or similar portfolio tracking tool for when they must peek in on the portfolio.  This forces you to look at the portfolio as a package rather than at the individual assets.

After spending a few months actually invested in the PP, the world normally looks a lot different.

[MediumTex]

Thanks to all for the help with this. It is a weight of of my shoulders to know that my parents have a strategy that will hopefully protect them during their retirement.

I think now is a good time to start since none of the PP assets are really surging currently.

[Gumby]

From Harry Browne's Fail Safe Investing, p.110:

Bonds

For the bond portion, you don't want to have to monitor credit risk, so buy only U.S. Treasury bonds. So long as the U.S. government has the ability to tax people or print money to pay its bills, there is virtually no credit risk (although the bonds can fall in price or lose purchasing power to inflation).

The Treasury has issued a series of bonds that mature (will be paid off) at various dates over the next 30 years. The longer the time to maturity, the greater effect changes in interest rates have on the bond's price.

Since there will be times when the bond category will have to carry the entire Permanent Portfolio, you want a bond with the potential for big price movements. So put the 25% in the Treasury bond issue that currently has the longest time until it matures. That will be close to 30 years. Ten years later, the bond will have only 20 years to maturity, at that time replace it with a new 30-year bond.

It's that simple.

[cabronjames]

I will be buying the bonds through schwab which has a free treasury window to save on the expense ratio and transaction costs of the ETF but I have a few questions.

Thanks for noting the Schwab has free treasury window.  I didn't know that, & have an old Schwab taxable account that remains open though with a trivial amount of money.

In my PP experience, my custodian is Vanguard VBS in an IRA account, & for the BOND allocation I use EDV & VUSTX.  I've never directly bought treasury bonds, so forgive me if these are dumb questions:

1 How big is the bid ask spread for a treasury bond maturing in 30 yrs?  Is this historical avg bid ask spread info posted on the web?  I like that for Vanguard ETFs, Vanguard posts the avg bid ask spread info https://advisors.vanguard.com/VGApp/iip ... daskspread, & for non-Vanguard ETFs seekingalpha.com .

Although the US Treasury Bond market is very liquid, I wonder if the bid ask spreads are higher than say for Vanguard ETFs.  While there is only exactly 1 ETF tracking a particular index (such as EDV), there are multiple different Treasury bonds per year.  For example, EDV as of 2011-Mar-31, EDV has prinicpals from 4 different dates in calendar 2040 alone.  So isn't there say a 2040-Feb-15 30 yr T-bond market, a 2040-May-15 30 yr T-bond market, etc?  And doesn't this big amount of markets lead to a higher bid ask spread, which might mitigate the savings on the low expense ratio one has in an ETF (example EDV 0.13% exp ratio, VUSTX 0.22% TLT 0.15%)?

2 For future rebalancing purposes, doesn't one need to buy multiple treasury bonds?  If Joe Smith was starting an HBPP today with $40K available, & hence $10K needed for BOND allocation, wouldn't it be better for Joe to buy 5 $2K T-bonds maturing on 2041-Feb-15, as opposed to 1 $10K T-bond maturing on 2041-Feb-15?  This way say if in 2012-Jan-01, the BOND portion has outperformed the other asset classes, & is now 35% of the total portfolio, Joe could sell 1 of the $2K T-bonds to rebalance & buy the worse performing asset.

Am I thinking about this correctly?  Perhaps walk me through an example to illustrate how this works with direct T-bond ownership.

3 Is there any possibility of auto dividend reinvest for T-Bonds?  For tax-sheltered/IRA type accounts, auto div reinvest is a nice feature at Vanguard VBS.  I would imagine this is not possible for T-bonds at Schwab, because the integer nature of T-bonds does not allow for fractional purchases of additional T-Bonds.  OTOH Vanguard allows fractional div reinvest of its ETFs.

4 How does one look up T-Bond prices to monitor their account & determine if rebalancing is required?  For example this Bloomberg link http://www.bloomberg.com/markets/rates- ... -bonds/us/ lists only the 30-yr T-Bond maturing 2041-May-15.  If Joe's sister Mary set up an exactly same portfolio for herself, but exactly 2 years ago & assuming no subsequent contributions or rebalances, how would Mary lookup the current price of her 2039-May-15 T-Bond?

Thx in advance!

[doodle]

#1 - Spreads on Treasuries are very tight. Like you might be looking at yield differences like 4.179 vs. 4.178

#2 - You buy and sell the bonds in increments of $100. So for example if I wanted to buy 25,000 dollars worth of bonds I would buy 250 bonds. However depending on the coupon that they were issued with and where interest rates are at when you buy them they might trade above or below the 100 dollar face value.

#3 I'm not sure about an answer to this one.

#4 The prices is schwab are shown just like a regular bond fund.

THe only issue is that I believe you must buy like 10,000 dollars minimum to get the trade free. You might want to call them at schwab and clarify the commisions, but for buying at least it was free for me.

[cabronjames]

Thx for your reply doodle.

Does anyone from experience have a ballpark recommendation, assuming BOND is in a tax-sheltered/IRA type account, on the size of the BOND allocation of 1's total Perm port where it becomes effective to buy Treasuries directly say at Schwab custodian, vs indirectly via fund (EDV/TLT/VUSTX) say at Vanguard custodian?

If $10K is the min to get a free commission, the impression that I get (no Mighty Mighty Bosstones) is that I'm better off with the indirect fund approach.  My initial BOND purchase would be free commission, but rebalances might not be, & div reinvesting certainly would not be.  The small fund exp ratio might end up being cheaper than the round trip commissions over the 10 year holding period for the portion that didn't get sold early due to rebalance, or the <10 yr holding period for portion that would get sold sooner due to a rebalance.

[Tortoise]

I have a 401(k) brokerage at Schwab. All LT Treasury trades are commission-free at Schwab, and they let you trade as little as $1,000. I actually did a commission-free $1,000 trade just last week.

Regarding direct LTT ownership vs. indirect ownership via TLT: Do whatever is easiest for you and makes you feel most comfortable. They are both fine options that meet the PP's requirements.

My own preference is to buy LTTs directly. Since I can buy in increments as small as $1,000 commission-free at Schwab, there aren't many reasons for me not to buy LTTs directly. But I also understand that TLT is an extremely simple option for new PP investors; I simply bought TLT shares when I first set up my PP.

[cabronjames]

Thx Tortoise for the info.

From the Schwab "Fixed Income Pricing" page http://www.schwab.com/public/schwab/inv ... me/pricing ,

if I'm comprehending this correctly, there IS a $25 commission when you sell the T-Bond, since "sell orders must be placed thru a broker", & the "Broker-assisted fee" is $25.

I concede that given a large enough BOND allocation, over a 10 year period (assuming no rebalance) this $25 sales commission could be trivial compared to the expense ratio.

Cumulative 10 year expense ratios for the relevant funds, using [ [1 + expense ratio] ^ 10 ] - 1 .

EDV 0.13% exp ratio, 1.31% over 10 yrs
TLT 0.15% er, 1.51% over 10 yrs
VUSTX 0.22% er, 2.22% over 10 yrs

--

Thx again Doodle & Tortoise.  Since I've never bought a bond directly, your examples & info is very interesting & helpful to me understanding better how "owning T-Bonds directly works".

[Gumby]

This has been mentioned many times before, but for what it's worth, Fidelity has commission-free trades on all Treasury securities bought or sold online:

https://scs.fidelity.com/other/offers/p ... hedule.pdf

[Tortoise]

Thx Tortoise for the info.

From the Schwab "Fixed Income Pricing" page http://www.schwab.com/public/schwab/inv ... me/pricing ,

if I'm comprehending this correctly, there IS a $25 commission when you sell the T-Bond, since "sell orders must be placed thru a broker", & the "Broker-assisted fee" is $25.

Sure enough, it looks like you're right. I haven't had to sell any of my LTTs yet, which is why I wasn't aware of this mandatory $25 broker-assisted fee. All my trades have been purchases thus far.

That's kind of tricky of Schwab, because a couple of their web pages on commission schedules and pricing seem to imply free purchases and sales unless you read the fine print.

I concede that given a large enough BOND allocation, over a 10 year period (assuming no rebalance) this $25 sales commission could be trivial compared to the expense ratio.

Cumulative 10 year expense ratios for the relevant funds, using [ [1 + expense ratio] ^ 10 ] - 1 .

EDV 0.13% exp ratio, 1.31% over 10 yrs
TLT 0.15% er, 1.51% over 10 yrs
VUSTX 0.22% er, 2.22% over 10 yrs

Yes, the $25 should be trivial assuming you sell in good-sized blocks and don't sell very often.

I'm kind of irked about this mandatory broker-assisted LTT sale nonsense through Schwab, since it seemed hidden in the small-print footnotes, but in the grand scheme of things I suppose it's a relatively tiny expense.

[WildAboutHarry]

#4 The prices is schwab are shown just like a regular bond fund.

The Wall Street Journal lists quotes for all outstanding (I think) treasury notes and bonds:

http://online.wsj.com/mdc/public/page/2 ... nav_2_3020

And for TIPS, although I know no one here is interested

http://online.wsj.com/mdc/public/page/2 ... nav_2_3020