TLT vs buying direct

[Tyler]

Buying bonds means no annual fee plus a substantial tax advantage.  

No annual fee -- yes.  But as I pointed out before there will be an expense for selling 20 year bonds to buy new 30 year ones (an expense not found in a bond fund).  It's true that this will only occur if you have capital gains and that this will not always happen, but over the past 30-ish years the annualized expense is as high as 0.22% (possibly lower depending on your personal rebalancing events).  

What's the tax advantage of direct bonds over a bond fund?  They both have unrealized capital gains that you must pay taxes on at the same rate when you rebalance.  Bond funds are somehow able to manage the bond rolling turnover process with no capital gains, which is actually a tax advantage over direct bonds. The only advantage I see is for people paying state taxes, as the way TLT is managed you may have to pay some state taxes whereas you would avoid that with bonds.

Maybe I'm missing a detail here.  But to me the decision between bonds and a bond fund is really more about counter-party risk than tax efficiency or expenses.  They're both pretty tax efficient and inexpensive and have their own tradeoffs.  Don't get me wrong, though -- counter-party risk is still a perfectly valid reason to favor direct bonds.  But I can see how those less worried about the risk of TLT would enjoy the benefit of just owning a fund and not thinking about the machinations beyond that.

[dualstow]

The "2012" annual report (Feb 29, 2012) for iShares TLT, SHY, etc. is out. I received the link in my email this morning.

[Greg]

Regarding the unrealized capital gains that are in the ETFs, would those then potentially be passed on as a taxable event then to the "unlucky" ones that are holding the ETF at that time?

For instance, if I were to purchase $10,000 in EDV, or TLT, etc. tomorrow, am I just gambling then for whenever the issuer of the ETF decides to actually sell the unrealized capital gain bonds in their fund? If so, then I would think this could pose a significant taxable risk to people opting into the funds.

It was also stated in this thread post that by owning an ETF vs. direct bonds that you might not have to incur capital gains/losses until you actually decide to sell that portion of the ETF. Direct bonds on the other hand would be purchased as a 30 year bond and sold every 10 years when it becomes a 20 year bond for a new 30 year bond and create a taxable event. Not sure of which of these would be a less taxable situation or if there isn't one answer for this.

Also brought up, during rebalancing of selling a 20 year bond and purchasing a 30 year bond, this would not count as a wash sale we are thinking?

Another point, for someone who is in the accumulation-stage of his life (I'm 24), I would be having a lot of money flowing in each month from my paycheck to then be going into my Permanent Portfolio. How would you balance adding to the BOND portion of the portfolio during this time. I could initially purchase a 30 year bond and keep cash in a separate account and once it gets large enough, purchase another 30 year bond and rinse and repeat.

This however would cause me to have multiple 30 year bonds over time. Not sure if this is really a bad thing though.

Finally, is the proper response for bonds that would run in this order?:

1.) Purchase 30 year bond
2.) If price of bond reaches above the 35% PP mark, sell the bond (would you sell the entire bond and not part of it?)
3.) If price of bond falls below 15% PP mark (either due to capital loss or you are in the accumulation stage of life and your other portfolio parts are all growing as well), purchase another 30 year bond to offset the portfolio difference percentage
4.) if neither 2.) or 3.) happens in 10 years when the 30 year bond turns into a 20 year bond; sell the bond and purchase a new 30 year bond again.

Obviously these steps get more complicated if you have multiple 30 year bonds at all different types of maturity dates. Not sure if this is how others in this forum run their bond portion however and would appreciate some advice.

Gracias.

[craigr]

Regarding the unrealized capital gains that are in the ETFs, would those then potentially be passed on as a taxable event then to the "unlucky" ones that are holding the ETF at that time?

ETFs are managed through the market for taxes. Meaning that shares that would generate gains are swapped out to new buyers so the fund shouldn't have as much of an impact. The market helps to remove the tax effects.

It was also stated in this thread post that by owning an ETF vs. direct bonds that you might not have to incur capital gains/losses until you actually decide to sell that portion of the ETF. Direct bonds on the other hand would be purchased as a 30 year bond and sold every 10 years when it becomes a 20 year bond for a new 30 year bond and create a taxable event. Not sure of which of these would be a less taxable situation or if there isn't one answer for this.

It all depends. In a way, the direct ownership of bonds gives you more control over capital gains. They will happen when you are ready and not when the fund declares a dividend/capital gain at the end of the year (if any).

Also direct ownership of the bonds eliminates manager risk which is worth something as well. You can be sure your bonds will be owned as safely as possible for full protection.

Also brought up, during rebalancing of selling a 20 year bond and purchasing a 30 year bond, this would not count as a wash sale we are thinking?

Wash sale is only a problem if trying to do tax loss harvesting. In that case, I would simply sell the losers and wait 31 days then buy back in to be safe. But this is more rare than people may think. Also, bonds should go into tax-deferred first to shield the income from taxes. So wash sale rules might not even apply.

Another point, for someone who is in the accumulation-stage of his life (I'm 24), I would be having a lot of money flowing in each month from my paycheck to then be going into my Permanent Portfolio. How would you balance adding to the BOND portion of the portfolio during this time. I could initially purchase a 30 year bond and keep cash in a separate account and once it gets large enough, purchase another 30 year bond and rinse and repeat.

Yes that is what I'd do.

This however would cause me to have multiple 30 year bonds over time. Not sure if this is really a bad thing though.

Actually you'd start to have a ladder of bonds as those you bought earlier go to 29, 28, 27 years, etc. This is all fine. The secondary market doesn't care when you sell them. The yields are set by the market constantly and sold just as easily regardless of years they have left.

1.) Purchase 30 year bond
2.) If price of bond reaches above the 35% PP mark, sell the bond (would you sell the entire bond and not part of it?)
3.) If price of bond falls below 15% PP mark (either due to capital loss or you are in the accumulation stage of life and your other portfolio parts are all growing as well), purchase another 30 year bond to offset the portfolio difference percentage
4.) if neither 2.) or 3.) happens in 10 years when the 30 year bond turns into a 20 year bond; sell the bond and purchase a new 30 year bond again.

Yes pretty much that is it. If you are owning the bonds directly you can't do partial sales though. You'd have to sell the whole bond. But once you save enough this is not an issue. It's more of a rounding error when rebalancing. Recognize this isn't a science and approximately 25% is good enough to get the job done even if it is slightly above or below depending on your bond sale.

Obviously these steps get more complicated if you have multiple 30 year bonds at all different types of maturity dates. Not sure if this is how others in this forum run their bond portion however and would appreciate some advice.

It's not a big deal. I have bonds of multiple maturities and I just sell of bits and pieces when needed to get the appropriate bond level. You can also pick and choose the sales to manage capital gains taxes as well.

[Greg]

craigr, Thank you for the advice.

Regarding taxable events though, let's go with the example for you having a 30-year bond ladder of 30, 29, 28, 27, etc. years left to maturity. In this scenario, wouldn't you sell off then a 20 year bond every year regardless of how your Bond's portion of your portfolio is doing? Even though you would have "control" then over when you want to sell a bond, you'd still be incurring a taxable event every year versus an ETF where you would potentially only have taxable events on interest payments and when you sell due to Bond portion of portfolio growing larger than the 35% band.

This might be a moot point however if the ETF (such as TLT) sells their 20 year treasury bonds each year and then distributes the capital gains to the ETF holders where they would then pay taxes on it just as you would if you held the bonds directly.

I'm just trying to see the benefit then of holding the bonds directly versus the TLT as stated earlier in this thread.

If the only real benefits are counter-party risk for having a ETF, I would think that the ETF would just need to justify this added risk by being less tax cumbersome than owning bonds directly. Everything else being equal though, having an ETF might be easier and you could track the price easier through a tool such as Google Finance, etc.

I've been reading through about TLT and that they have a .15% expense ratio and a weight maturity of 27.73 years currently. Wouldn't it be difficult through bond ladders to be able to have a higher maturity than this though? You'd have to either be over-weight in your 30 year bonds or selling your old bonds around the 25 year mark to be able to hit this maturity or higher and you'd probably have a lot of taxable events to be able to do this. We're looking for as long of maturities as possible I believe so would this be an advantage towards TLT versus direct?

According to Tyler, if held in a taxable account where you wouldn't be selling your 20 year bonds and you could just ride the bond wave for TLT until you need to rebalance with the 27.73 year weighted maturity. This could potentially be less taxes to be paid.

However, if in a Roth IRA or the like, the direct bonds I would think would have less taxes because the gains wouldn't be taxed and you wouldn't have the expense ratio that TLT has.

So I would think in a taxable account, potentially TLT is slightly more tax friendly minus if you have high state taxes and in a Roth IRA account, direct bonds would be preferable. Does this make sense or does TLT have some sort of features that still would make it more beneficial than owning Direct in a Roth IRA or a taxable account?

Finally, when actually selling the bonds for balancing once you hit the 35% band, do you sell the shortest term (closer to 20 years) first or the ones with the lowest amount of taxable gain first? Is there a priority order to selling as there somewhat is with stocks (selling tax lots that are the least amount of taxable gain as an example).