MomTo2Boys wrote:
Here's my follow up question - for someone like me who not only has bought the bonds themselves but who also owns a fairly nice chunk of EDV, do you know how the volatility of EDV compares to the different durations (30 vs. 25 vs. 20 yrs) of bonds? I'm just curious, because I'm struggling with how much EDV to own as a bond portion and why. On the bond down days, I want to yell at it like a puppy who just soiled the living room carpet, and on the bond up days (like yesterday, the day after the election when the stock market tanked) I want to pick it up and carry it around on my shoulders.
I think it helps to think of bond volatility in terms of duration, where a duration of X years means a bond's price will rise/fall by about X% if yields fall/rise by 1%. A zero-coupon bond's duration is equal to its maturity, so a regular T-bond with a duration of X years has the same volatility as a zero with X years 'till maturity.
Vanguard lists EDV's average duration as 26.4 years. To compare that with regular T-bonds, we just need to calculate the duration for 20-, 25-, and 30-year regular T-bonds at current yields (assuming coupon = yield):
20-year bond duration: 16.1 years (EDV is 64% more volatile)
25-year bond duration: 18.6 years (EDV is 42% more volatile)
30-year bond duration: 20.6 years (EDV is 28% more volatile)
And for what it's worth, iShares says the average duration of TLT is 17.2 years, so EDV is currently 53% more volatile than TLT.
Just keep in mind, though, that the durations of regular T-bonds change as yields change. When yields are high, zeroes are
much more volatile than regular T-bonds. (When HB wrote
Why the Best-Laid Investment Plans Usually Go Wrong, long-term yields were at 10%, so 30-year zeroes were 3 times more volatile than 30-year regular T-bonds!) But when yields are very low, there's less of a difference in volatility between the two. In the extreme case, if interest rates actually reach zero, regular T-bonds
are zero-coupon T-bonds by definition.
sophie wrote:
Harry Browne definitely states that the longest duration bonds possible should be used for the portfolio. These would be zero coupon 30 year bonds.
[...]
Since the bond allocation is less volatile than gold and stocks, it makes sense to maximize bond volatility. I back-tested EDV vs TLT, and noted that overall performance is improved, and not hurt significantly during short periods of rising interest rates. I'm opting to buy these going forward, although only in tax advantaged accounts.
Good point. I had forgotten that Harry Browne argued in favor of the high volatility of zeroes in
Why The Best-Laid Investment Plans Usually Go Wrong.
I looked at the daily 30-year T-bond yields since 1977 and verified that the daily standard deviation in bond price has historically been roughly proportional to the duration. (As far as I know, there's no mathematical reason why that has to be the case.) In other words, regular T-bonds have less absolute volatility when yields are high. That is likely why HB recommended zeroes back in 1987 when he wrote that book. Regular T-bonds were somewhat "weak" back then in that high-yield environment.
I'm just holding regular T-bonds for now, but you've given me food for thought regarding zeroes.
It's interesting how discussions progress sometimes. I started off thinking, "Wow, look at that 50% difference in duration between 20- and 30-year bonds when yields are near zero. I should probably sell my bonds at the 25-year mark instead of the 20!" But now my attention has been drawn to a new (but related) issue: regular T-bonds become "weak" in high-yield environments, thus possibly requiring a boost from zeroes.
MomTo2Boys wrote:
So the individual bonds pay out their dividends twice yearly? It's been confusing for me - I've owned bonds (both individual and EDV) since September. [...] It looks like TLT pays monthly just like EDV but I have yet to see a payment from my individual bonds...
T-bonds make their coupon payments twice per year: (1) On the issue date, and (2) 6 months from the issue date. For example, if the issue date is 8/15/2012, the first coupon payment will be made on 2/15/2013, the second one on 8/15/2013, and so on year after year.
In your account where the bonds are held, you can usually click on the individual bonds to see the issue date and lots of other useful info. In my Schwab brokerage window, for example, when I click on my bonds it tells me the date of the next coupon payment (among many other things).
