Buying the 30yr Bond

Discussion of the Bond portion of the Permanent Portfolio

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Jan Van
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Buying the 30yr Bond

Post by Jan Van » Tue Aug 03, 2010 8:08 am

On TreasuryDirect I see a possible auction is mentioned for 30 year bonds on 8/4. What would be the better choice then, get in on those, or buy some of the May 30 year bonds?

This is what I see at the Vanguard bond desk now (8/3 9am):

Coupon     Maturity         Price                            Yield
4.375       05/15/2040     105.542969/105.613281   4.057
4.625       02/15/2040     109.734375/109.890625   4.058

Should I pay more for the 2/15 with higher coupon? Am I correct in thinking the small difference between these two won't matter much over the long run, and I should just go for the 5/15?


Edit: This from Vanguard:
"The announcement date for the upcoming Treasury Auction for 30 year bonds is indeed tomorrow, August 4, around noon Eastern time. Approximately one hour after that, we'll be able to take orders online, or you may call us if you prefer and we'll take your order over the phone.

Orders will be taken up until 10 AM Eastern time on Thursday, August 12. The bonds have an issue date of August 16."
Last edited by Jan Van on Tue Aug 03, 2010 10:47 am, edited 1 time in total.
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Re: Buying the 30yr Bond

Post by craigr » Tue Aug 03, 2010 12:22 pm

There should not be a significant difference on secondary markets vs. treasury direct. The bid ask spreads on Treasury bonds is very small and the markets are very efficient at setting prices.

As for the Bond desk. I suspect the price difference you see is due to accrued interest on the earlier maturity bond. You should call the bond desk to verify. The Vanguard bond desk should be sorting bonds by best yield for that type and maturity though so I'd buy what Vanguard recommends. The coupon yield is different than bond yield. The coupon yield is what the bond sold for initially, but the current yield is what it pays you vs. the amount of money the bond cost to purchase right now.

I found an article that goes over some of these issues here:

http://www.militarymoney.com/investing/1131654180


But again just call the bond desk and talk to them if you have a question. They are very helpful.
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Re: Buying the 30yr Bond

Post by Pkg Man » Tue Aug 03, 2010 7:22 pm

HB suggested that you buy the one with the lower coupon.  The reason is that for taxable investors relatively less of the gain will come from income as opposed to capital gains, which is favorable since income is taxed at a higher rate.  If it is in a 401k then I don't think it makes any difference.
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Re: Buying the 30yr Bond

Post by Jan Van » Tue Aug 03, 2010 7:24 pm

Yes, this is in my IRA... Thanks guys!
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Re: Buying the 30yr Bond

Post by craigr » Tue Aug 03, 2010 7:44 pm

Pkg Man wrote: HB suggested that you buy the one with the lower coupon.  The reason is that for taxable investors relatively less of the gain will come from income as opposed to capital gains, which is favorable since income is taxed at a higher rate.  If it is in a 401k then I don't think it makes any difference.
This is an interesting point.
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Re: Buying the 30yr Bond

Post by MediumTex » Tue Aug 03, 2010 8:50 pm

craigr wrote:
Pkg Man wrote: HB suggested that you buy the one with the lower coupon.  The reason is that for taxable investors relatively less of the gain will come from income as opposed to capital gains, which is favorable since income is taxed at a higher rate.  If it is in a 401k then I don't think it makes any difference.
This is an interesting point.
IIRC, HB cited the slightly higher volatility that a bond with a lower coupon will have relative to a higher coupon bond if both are priced the same.

I don't think it had anything to do with the taxable gains over the life of the bond (especially since you are not holding the 30 year bonds until maturity anyway).

I may be wrong about this point, and please correct me if I am, but as I recall it was the higher volatility of a lower coupon rate that HB cited as the reason for preferring them.  It's possible, of course, that a lower coupon rate in a taxable account could also result in a higher proportion of total gains on the bond to be in the form of capital gains rather than ordinary income, though I wonder if such a benefit would be noticeable.

I buy the lowest coupon rate that I can because of the higher volatility that HB cited.
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Re: Buying the 30yr Bond

Post by craigr » Tue Aug 03, 2010 9:00 pm

MediumTex wrote:
craigr wrote:
Pkg Man wrote: HB suggested that you buy the one with the lower coupon.  The reason is that for taxable investors relatively less of the gain will come from income as opposed to capital gains, which is favorable since income is taxed at a higher rate.  If it is in a 401k then I don't think it makes any difference.
This is an interesting point.
IIRC, HB cited the slightly higher volatility that a bond with a lower coupon will have relative to a higher coupon bond if both are priced the same.

I don't think it had anything to do with the taxable gains over the life of the bond (especially since you are not holding the 30 year bonds until maturity anyway).

I may be wrong about this point, and please correct me if I am, but as I recall it was the higher volatility of a lower coupon rate that HB cited as the reason for preferring them.  It's possible, of course, that a lower coupon rate in a taxable account could also result in a higher proportion of total gains on the bond to be in the form of capital gains rather than ordinary income, though I wonder if such a benefit would be noticeable.

I buy the lowest coupon rate that I can because of the higher volatility that HB cited.
I need to sit down and go through these scenarios a bit. When I setup my portfolio I just wanted to get it done and I use the bond income for living expenses so I didn't think about it in all of these levels. I'm not sure in the end how much it really matters, but I need to find some time to do the numbers and look at things.

Based on how well the bonds performed in 2008, my gut instinct is anything in the 25-30 year range regardless of coupon rate is probably fine.
Last edited by craigr on Tue Aug 03, 2010 9:02 pm, edited 1 time in total.
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Re: Buying the 30yr Bond

Post by Pkg Man » Tue Aug 03, 2010 10:32 pm

I think HB mentioned both issues.  I found the quote in "Why the Best Laid Plans" on page 466, or if you don't have my edition, under Getting Started, Choosing the Bonds"

"A bond with a lower coupon rate will be a bit more volatile. And a little larger part of its return will come in the form of its rising value, rather than from coupon interest payments.  This means that there will be slightly less taxable interest generated each year, while you overall return will be as great".

This is likely counting angles on the head of a pin though, as the interest payment differential for 10K invested in the two different 2040 maturing bonds is only $25.  Assuming the return on the two bonds is the same, the savings would be the differential between the marginal income tax rate and the capital gains tax rate.  For example, (.28 - .15) * 25 = 3.25.  If the coupon differential, and the dollar amount invested, were larger, then it could add up to a bit over several years. 

I think I would just buy the ones that allowed me to get closest to my 25% initial target allocation and be done with it.
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Re: Buying the 30yr Bond

Post by MediumTex » Wed Aug 04, 2010 8:40 am

Thanks for that follow-up Pkg Man.
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Re: Buying the 30yr Bond

Post by Jan Van » Fri Aug 06, 2010 2:07 pm

One advantage of buying the auction is the commission. At Vanguard you pay zilch, zippo, nada. Guess at other brokerages too. So that makes it interesting (however insignificant in the long term). I'm buying me some from this August auction, see how that works out!
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Re: Buying the 30yr Bond -- Vanguard

Post by Jan Van » Sat Aug 14, 2010 10:28 am

For those who wonder like I used to, how it works at Vanguard...
Last week I put in an order at the bond desk for the August auction of the 30 year bond. I ordered 15 bonds, each $1000. This part was easy, the thing that jolted me for a moment was that when I checked the order status it showed a quantity of 15,000! Huh? So I called the bond desk and they confirmed that I did indeed only order 15, and that it shows up a bit confusing on the status screen.
Yesterday I received the confirmation. Yield 3.954%, Net Amount $14,794,45. Interesting, the price shows as $98.61912900! So I paid less than $15K for $15k in bonds. That surprised me a little bit.
In my "Accounts & Activity" screen it now shows up as "U S TREASURY BOND CPN 3.87500 % MTD 2040-08-15 DTD 2010-08-15", Quantity stil 15,000 and current price is $100.078. Value: 15,011.70. Making out like a bandit here! :-)
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Re: Buying the 30yr Bond

Post by SmallPotatoes » Sun Aug 15, 2010 1:21 am

Thank you Jmourik for sharing you VBD experience.  I think everyone would agree that buying the 30-year at auction makes the best sense. Now that you've de-mystified the purchase process I'm confident this is how I will hold the LT Treasury portion of my PP.

Just need 2011 to roll around, so I'll have the tax-advantaged space to do it.
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Re: Buying the 30yr Bond

Post by Jan Van » Wed Aug 25, 2010 2:32 pm

Just an FYI, in case you're wondering. As per last night the bond showed:
U S TREASURY BOND CPN 3.87500 % MTD 2040-08-15 DTD 2010-08-15  value: $15,862.50

So Vanguard keeps updating the value of the bonds in your brokerage account...
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Re: Buying the 30yr Bond

Post by MediumTex » Wed Aug 25, 2010 2:54 pm

jmourik wrote: So Vanguard keeps updating the value of the bonds in your brokerage account...
The value is updated daily, but not intra-day (unless you are buying or selling).

TLT obviously provides a good proxy, though, for people who like to keep an eye on things.
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Re: Buying the 30yr Bond

Post by dualstow » Thu Dec 02, 2010 9:44 am

craigr wrote: I need to sit down and go through these scenarios a bit. When I setup my portfolio I just wanted to get it done and I use the bond income for living expenses so I didn't think about it in all of these levels. I'm not sure in the end how much it really matters, but I need to find some time to do the numbers and look at things.

Based on how well the bonds performed in 2008, my gut instinct is anything in the 25-30 year range regardless of coupon rate is probably fine.
I, too, "just want to get it done." While I've been trading stocks & funds online for years and years, I'm not excited about calling the bond desk and placing an order because I find individual bonds confusing. I wrote to Fidelity -- that's where my 401(k) is -- and asked if I could just call the desk and have them buy approximately $10,000 worth of 30-year treasury bonds, or if it was more complicated than that. They gave me the telephone number but no straight answer. Shrug.

Can anyone tell me what sort of questions I'll be asked during the ordering process so that I can prepare? I'd sincerely appreciate it.
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Re: Buying the 30yr Bond

Post by Storm » Thu Dec 02, 2010 12:51 pm

Dualstow, call the Fidelity 1-800 number, ask for the fixed-income department, and tell them you want to know all about buying treasuries in the primary and secondary markets.  They will completely explain everything to you.  I have my 401k with Fidelity and the guy spent about 30 minutes with me, walking me through exactly how to purchase them online - it's very easy.  He even warned me of the risks of buying bonds (inflation could cause a drop in value).  I am very impressed with Fidelity's customer service.
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Re: Buying the 30yr Bond

Post by dualstow » Thu Dec 02, 2010 1:49 pm

Will do, thank you.
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Re: Buying the 30yr Bond

Post by dualstow » Thu Dec 09, 2010 1:46 pm

Well, confession time. When I browsed the fixed income desk at Fidelity I saw that, unlike the case with Vanguard's bond desk, I could order online. So, I never did make that phone call. The offering that I saw mentioned today's date, 12/9, so even though I placed the order last week, it kicked in this afternoon. I am now the proud owner of a few bonds.

Before I clicked submit, it was made clear that each instrument was $1,000.

I did write to Fido's customer service because when I ordered 8, that was later displayed as "Quantity: 8000" in the confirmation I received. Not $8000, but Quantity of 8,000. This was slightly disconcerting, because elsewhere there was a price displayed which, when multiplied by 8,000 totaled a lot more than the value of my account.

Common sense said that everything was fine, but I wrote anyway, and the other day they confirmed that all is well, that I ordered properly. Of course, in my holdings it now says I have 8,000 shares of blah-blah-blah at a price of 96.797 each :D, but I won't give it a thought until I actually talk to the desk someday.

This sure has been a different experience from exchanging into VUSTX.
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Re: Buying the 30yr Bond

Post by Jan Van » Thu Dec 09, 2010 8:17 pm

dualstow wrote: I did write to Fido's customer service because when I ordered 8, that was later displayed as "Quantity: 8000" in the confirmation I received. Not $8000, but Quantity of 8,000. This was slightly disconcerting, because elsewhere there was a price displayed which, when multiplied by 8,000 totaled a lot more than the value of my account.
Funny to see this works the same way as at Vanguard :-)
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Re: Buying the 30yr Bond

Post by dualstow » Fri Dec 10, 2010 8:25 am

jmourik wrote:
dualstow wrote: I did write to Fido's customer service because when I ordered 8, that was later displayed as "Quantity: 8000" in the confirmation I received. Not $8000, but Quantity of 8,000. This was slightly disconcerting, because elsewhere there was a price displayed which, when multiplied by 8,000 totaled a lot more than the value of my account.
Funny to see this works the same way as at Vanguard :-)
Ha, does it? Maybe it's some kind of archaic standard. In Account Positions view in Fido, the price is 96.797. But "8000" is an active link and when I click it, it does produce a more reasonable figure: "Avg cost per share: $0.97". I'm sure this would have all been explained to me if I had just taken Storm's advice and picked up the phone, but like I said, common sense says it's fine.
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Re: Buying the 30yr Bond

Post by Storm » Sun Dec 19, 2010 11:36 pm

I saw the same thing when I bought my bonds at Fidelity.  I think the reason is that you are buying a $1000 bond, but it is denominated in single dollar increments, so quantity 8 = $8000 face value of the bond (not the value upon maturity).

I'm pretty confident that they did the right thing, however.  Fidelity couldn't stay in business for very long by giving us 1000x the bonds that we actually purchased.  ;D
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