Maximum Bond Upside

Discussion of the Bond portion of the Permanent Portfolio

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Lang
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Re: Maximum Bond Upside

Post by Lang » Sat Jul 02, 2016 8:24 am

The fall in Treasury yields also impacted the mortgage market. The average interest rate for a 30 year fixed interest mortgage is 3.48%, pretty close to its all-time low in 2013.

https://fred.stlouisfed.org/series/MORTGAGE30US
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Re: Maximum Bond Upside

Post by iwealth » Sat Jul 02, 2016 9:30 am

MachineGhost wrote:EDV has phantom income taxation issues also.

Thinking ahead, we should just assume rates are going to go to 0%. In that case, I don't think we should be buying past 20-year T-Bonds right now. I don't know how bond funds will be reflected, but it seems like it would favor VUSTX at 16.9 duration vs TLT or TLO at 18 duration. I'm willing to pay an extra .05% to .10% just to have autoinvest capability.

This bond crap is so stressful!
I'm confused. If one assumes rates are going to 0%, doesn't it make sense to buy the longest duration bond possible for the ride down before switching out to a shorter duration variety?
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buddtholomew
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Re: Maximum Bond Upside

Post by buddtholomew » Sat Jul 02, 2016 2:52 pm

iwealth wrote:
MachineGhost wrote:EDV has phantom income taxation issues also.

Thinking ahead, we should just assume rates are going to go to 0%. In that case, I don't think we should be buying past 20-year T-Bonds right now. I don't know how bond funds will be reflected, but it seems like it would favor VUSTX at 16.9 duration vs TLT or TLO at 18 duration. I'm willing to pay an extra .05% to .10% just to have autoinvest capability.

This bond crap is so stressful!
I'm confused. If one assumes rates are going to 0%, doesn't it make sense to buy the longest duration bond possible for the ride down before switching out to a shorter duration variety?
Since that is what I am proposing, interested as well.
Sell TLT and replace with EDV/Cash. Keep duration the same but buy the longest available treasury.
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Re: Maximum Bond Upside

Post by Lang » Sat Jul 02, 2016 3:06 pm

ZROZ is even "heavier" than EDV. Use with caution. ;)
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buddtholomew
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Re: Maximum Bond Upside

Post by buddtholomew » Sat Jul 02, 2016 3:45 pm

Lang wrote:ZROZ is even "heavier" than EDV. Use with caution. ;)
Point well taken.
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Re: Maximum Bond Upside

Post by curlew » Sat Jul 02, 2016 4:02 pm

When I bought into the PP philosophy about 7 years ago I went all in and converted 25% of my portfolio to the longest duration bonds I could find.

Since then, I haven't had to do anything except that one year I think I had to sell some to re-balance.

With rates going down the way they are, I have a hard time wrapping my head around why anyone would have to think about buying unless they were just starting out. As long as 15% of my portfolio is LT bonds then I have at least the minimum deflation protection that the PP calls for so why would I want to buy more with rates falling? And, for that matter, why would I even have to, according to the re-balancing bands? If rates are falling, then the value of my bonds would be going up.

So if it's more complicated and stressful than what I am thinking, I must be missing something.
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Re: Maximum Bond Upside

Post by buddtholomew » Sat Jul 02, 2016 5:27 pm

For me its a way of harvesting gains in LTT's.
Trying to determine if it makes sense.

Tax deferred account - switch a portion of LTT's for EDV and the balance cash. Enough EDV/cash to approximate TLT duration (18 years).
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MachineGhost
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Re: Maximum Bond Upside

Post by MachineGhost » Sat Jul 02, 2016 7:29 pm

I don't know about ZROZ, but EDV is a fixed duration bond fund; maturity is dynamic.

I'm currently trying to generate some zero coupon time series for backtesting purposes, but it's not going well.

Yields may not go to 0%; you have to consider if you're wrong. So you don't want to have too high of a duration exposure. "Too high" is completely subjective at this point.
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Re: Maximum Bond Upside

Post by ochotona » Sun Jul 03, 2016 10:07 am

I know this is more germane to a VP discussion, but I put my TLO and SCHR into an automated watchlist, and I get an email if the price falls below the 200 day moving average.

I hold "synthetic" IEF, which is a 7-10 year US Treasury ETF. The synthesis is of TLO (30%) and SCHR (~5 year US Treasury ETF, 70%), so an asymmetric barbell. If TLO starts going bearish, I'll go all SCHR. If SCHR goes bearish, I'll go all SCHO (1-2 year US Treasury) or CASH.
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MachineGhost
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Re: Maximum Bond Upside

Post by MachineGhost » Sun Jul 03, 2016 10:26 pm

Turns out both EDV and ZROZ make distributions each quarter when they rebalance and is exactly for the amount of the phantom income you didn't receive but will be taxed upon.

So can someone make a convincing argument why it would be better to use these instead of buying a 30-year Treasury? Aside from the constant duration and non-management hassles, of course. I'm trying to visualize why I would want to have 9.25% of my bond allocation in ZROZ for a net duration of 10 years instead of 15% into a 30-yr Treasury.

Also, I'm surprised TreasuryDirect has a lowly $100 buying minimum even for Treasury bonds. Why aren't more people using that option instead of paying management fees to funds? Sure there's more management hassles and there's no online banking support, but not paying .10% to .20% seems like a free lunch. That's $25-$50 per $25K saved per year.
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sophie
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Re: Maximum Bond Upside

Post by sophie » Tue Jul 05, 2016 6:49 pm

I use TLT as an accumulator. When it reaches my chosen bond-buying aliquot, I sell it and buy new 30 year treasuries.

It also makes it psychologically easier to add to your bond allocation. Somehow, buying an individual bond is more anxiety-producing than buying into a fund that pays you nice dividends every month.
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Re: Maximum Bond Upside

Post by drumminj » Tue Jul 05, 2016 9:13 pm

I like that approach! The downside, of course, is that the sale of TLT may be taxable, depending on how the market moves and how long you hold.
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Re: Maximum Bond Upside

Post by MachineGhost » Wed Jul 06, 2016 12:05 am

sophie wrote:I use TLT as an accumulator. When it reaches my chosen bond-buying aliquot, I sell it and buy new 30 year treasuries.

It also makes it psychologically easier to add to your bond allocation. Somehow, buying an individual bond is more anxiety-producing than buying into a fund that pays you nice dividends every month.
I like that idea! Just out of curioisity, I wanted to see if using zero coupons funds would provide more or less yield than regular when normalizing to a 10-year effective duration. I threw in the other long term Treasury funds as well:

Image

Note that yields are based on 30-day yields not YTM because not all funds had YTM available.

I was leaning towards PLW, but it's not commission-free nor is there autoinvest for ETF's yet. Even with a reduced .05% fee, it still wouldn't crack the top 3. Blarney! I guess it's not that much trouble to roll my own ladder. I like the idea of an equal weight ladder in keeping with the PP "no forecasting" methodology. There's no rhyme nor reason to the way other bond funds choose their Treasury holdings. Drives me nuts.

VUSTX still seems like a winner for accumulation via autoinvest. And it would prevent the hassle of having individual Treasury bonds all over the place if you only buy the formal bond once a year. I don't relish the thought of having to update all individual bonds by hand in Quicken, though. It's a pain. However, if you buy them at Fidelity instead of TreasuryDirect, Quicken will able to keep them updated based on previous experience.

So accumulate into TLO commission-free then ladder into formal commission-free Treasuries at Fidelity whenever the minimum is met. Sounds like a plan!
Last edited by MachineGhost on Wed Jul 06, 2016 12:41 am, edited 2 times in total.
"All generous minds have a horror of what are commonly called 'Facts'. They are the brute beasts of the intellectual domain." -- Thomas Hobbes

Disclaimer: I am not a broker, dealer, investment advisor, physician, theologian or prophet.  I should not be considered as legally permitted to render such advice!
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MachineGhost
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Re: Maximum Bond Upside

Post by MachineGhost » Thu Jul 07, 2016 4:31 am

As an alternative to target duration, here's a lookup table based on 30-year Treasury yields for how invested you should be in them:

Image

It's an interesting gimmick but duration definitely doesn't change linearly as yields increase or decrease. At 2.3/15.12%, net duration would be 3.3 years which is pretty wimpy for the PP.
"All generous minds have a horror of what are commonly called 'Facts'. They are the brute beasts of the intellectual domain." -- Thomas Hobbes

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MachineGhost
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Re: Maximum Bond Upside

Post by MachineGhost » Fri Jul 22, 2016 4:30 am

Is "Tight Money" coming soon???

Image
"All generous minds have a horror of what are commonly called 'Facts'. They are the brute beasts of the intellectual domain." -- Thomas Hobbes

Disclaimer: I am not a broker, dealer, investment advisor, physician, theologian or prophet.  I should not be considered as legally permitted to render such advice!
Lang
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Re: Maximum Bond Upside

Post by Lang » Fri Jul 22, 2016 6:05 am

A misleading chart. The 10 year rate is forward-looking, and they use the present core inflation to deflate.

It is more appropriate to looks at 10 year TIPS:

https://fred.stlouisfed.org/series/DFII10
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Re: Maximum Bond Upside

Post by bedraggled » Mon Aug 01, 2016 8:57 am

As I establish my first portfolio in October, I ask the following:

1) What would the capital gain be on the 10 Year Treasury if we experience zero interest rates?

2) The capital gain on the 30 Year Treasury?

3) Would the difference in capital gains potential make going out 20 years more at this time worth the risk?

I'm inclined to start with 10-Ts as Desert offers an impressive portfolio and add 30-Ts over time. Those 10-Ts will eventually be the near cash portion. The 4x25 will be the 2021 portfolio goal.

I believe a chart was posted on the 30-Ts gains at different rates but I can't find it at the moment.

Thanks.
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Re: Maximum Bond Upside

Post by ochotona » Mon Aug 01, 2016 5:09 pm

bedraggled wrote:As I establish my first portfolio in October, I ask the following:

1) What would the capital gain be on the 10 Year Treasury if we experience zero interest rates?

2) The capital gain on the 30 Year Treasury?

3) Would the difference in capital gains potential make going out 20 years more at this time worth the risk?

I'm inclined to start with 10-Ts as Desert offers an impressive portfolio and add 30-Ts over time. Those 10-Ts will eventually be the near cash portion. The 4x25 will be the 2021 portfolio goal.

I believe a chart was posted on the 30-Ts gains at different rates but I can't find it at the moment.

Thanks.
Kevin, if you bought new Treasury bonds for $1,000 each on October 1, 2015, these are the yields you got:
Ten year 2.05%
Thirty year 2.85%

Right now, you've got a 110 month and a 350 month bond, because time has passed. If both these interest rates went to zero today, the Present Value of the bonds would be:
Ten year $2,127.50
Thirty year $5,987.50

If interest rates go up, the same leverage works against you.

(HP 10bII+ Financial Calculator, present value functions)

I can't answer question 3 for you. That's a judgement call.
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Re: Maximum Bond Upside

Post by Kbg » Mon Aug 01, 2016 6:36 pm

If I might add to answering #3.

First, totally agree it is a judgment call and at best a wild a** guess as to which will be better. However, the options are pretty straight forward. The most accurate guess (amazingly so) for the return on a bond is its yield. So let's go with that as our best guess on realized returns. Thus, is +/- .8% points for 240 months worth the leverage +/- you may experience? While the exact path and results are unknown and unknowable, the potential roads to be traveled are utterly and totally predictable.

Do you prefer paved roads or off road 4x4ing?
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ochotona
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Re: Maximum Bond Upside

Post by ochotona » Mon Aug 01, 2016 6:44 pm

Kbg wrote:Do you prefer paved roads or off road 4x4ing?
And no cushioned seat... your a$$ is on the floorboards.
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Re: Maximum Bond Upside

Post by Pet Hog » Tue Aug 02, 2016 11:31 am

ochotona wrote:
bedraggled wrote:As I establish my first portfolio in October, I ask the following:

1) What would the capital gain be on the 10 Year Treasury if we experience zero interest rates?

2) The capital gain on the 30 Year Treasury?
Kevin, if you bought new Treasury bonds for $1,000 each on October 1, 2015, these are the yields you got:
Ten year 2.05%
Thirty year 2.85%

Right now, you've got a 110 month and a 350 month bond, because time has passed. If both these interest rates went to zero today, the Present Value of the bonds would be:
Ten year $2,127.50
Thirty year $5,987.50

(HP 10bII+ Financial Calculator, present value functions)
I think there is something wrong with that calculator, ochotona. If the bond yields drop to zero, then a buyer would, at most, pay the par value plus all the coupons over 10 or 30 years. Using the yields provided above:

For a 10-year bond: $1000 + ($20.50 * 10) = $1205
For a 30-year bond: $1000 + ($28.50 * 30) = $1855

So the 30-year cannot even double in value (unless yields turn negative), limiting the PP's potential for nominal growth going forward. In fact, that 85.5% growth would trigger only one rebalance with 35/15 bands, and then we'd be stuck with 0% 30-year treasuries.

The potential for growth is even more dire using yesterday's yield on the 30-year (2.24%). Maximum bond value (at zero yield) would be $1672. That would barely trigger a 35/15 rebalance. In my opinion, for the PP to maintain 4-6% real returns going forward we will have to experience significant deflation, or rely on oversized gains in gold and equities, or get used to negative yields on LTTs.
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Re: Maximum Bond Upside

Post by ochotona » Tue Aug 02, 2016 8:17 pm

Sheesh, I will fix it. Hand calculator operator error.
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Re: Maximum Bond Upside

Post by barrett » Tue Aug 02, 2016 8:51 pm

Before you guys burn up your calculators, take note that bedraggled is talking about buying bonds in October of 2016, not bonds that were already purchased in 2015.
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ochotona
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Re: Maximum Bond Upside

Post by ochotona » Wed Aug 03, 2016 9:35 am

ochotona wrote:
bedraggled wrote:As I establish my first portfolio in October, I ask the following:

1) What would the capital gain be on the 10 Year Treasury if we experience zero interest rates?

2) The capital gain on the 30 Year Treasury?

3) Would the difference in capital gains potential make going out 20 years more at this time worth the risk?

I'm inclined to start with 10-Ts as Desert offers an impressive portfolio and add 30-Ts over time. Those 10-Ts will eventually be the near cash portion. The 4x25 will be the 2021 portfolio goal.

I believe a chart was posted on the 30-Ts gains at different rates but I can't find it at the moment.

Thanks.
Kevin, if you bought new Treasury bonds for $1,000 each on October 1, 2015, these are the yields you got:
Ten year 2.05%
Thirty year 2.85%

Let's revalue the bonds a year later, October 1, 2016, if both these interest rates went to zero today, the Present Value of the bonds would be:

Ten year (with 9 years left) $1184.50
Thirty (with 29 years left) $1826.50


(HP 10bII+ Financial Calculator, present value functions)

I can't answer question 3 for you. That's a judgement call.
Sorry for the previous error. The problem with hand calculators is the hands part.
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Re: Maximum Bond Upside

Post by MachineGhost » Tue Aug 23, 2016 1:29 pm

Hmm...

Image
"All generous minds have a horror of what are commonly called 'Facts'. They are the brute beasts of the intellectual domain." -- Thomas Hobbes

Disclaimer: I am not a broker, dealer, investment advisor, physician, theologian or prophet.  I should not be considered as legally permitted to render such advice!
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