Gyroscopic Investing

hi guys,

i am new to PP.  i usually buy bonds funds like TLT vs buying bonds directly.

I use fidelity.

is it better to buy T bonds directly? how complicated is this.?  is there a minimum investment?



thanks

There is a bond buying tutorial at the top of this section of the forum.  It should answer all of your questions.

As MT mentions, see the tutorial at http://gyroscopicinvesting.com/forum/ht ... ic.php?t=0.  I think most of us believe it's better to buy bonds directly if you can, see Craig's comments about this on the bond FAQ.

sk55 wrote: hi guys,

i am new to PP.  i usually buy bonds funds like TLT vs buying bonds directly.

I use fidelity.

is it better to buy T bonds directly? how complicated is this.?  is there a minimum investment?



thanks

I guess I will be the heretic here.  I like TLT.  That said buying bonds directly is safer and you are likely to get a slightly better return.  But I am lazy and TLT means less moving parts and less hassle for me to deal with.  The risk level is so low I am not losing sleep over it.  For me the negligible added risk and minimal fees are more than justified by the convenience.  The only asset I strongly encourage holding at least some directly is gold, which is my concession to disaster planning.

[Edit] All of which said do whatever will make you sleep better at night.

Agreed.  I've bought direct treasuries recently, but have gone back and forth on those vs TLT a few times ("best PP method" vs "most convenient").  Both are good options.  Just do what you're most comfortable with.

I switched from TLT to buying direct through Fidelity last year and it couldn't have been easier, so I don't know what people mean when they talk about it being more convenient. Not only does it save you the yearly expense fee but with Fidelity there is no charge for the trade. The expense ratio of .15% may seem small but if you hold the investment for a long time it could amount to thousands of dollars, needlessly spent, in my opinion.

I've been curious as to the tax implications of purchasing TLT versus direct bonds.

My assumption is that TLT can be treated as capital gains, while at least the coupon portion of the bonds must be treated as interest income.

Assuming that everything is held in a taxable account is there a preference of TLT versus bonds?

Mark Leavy wrote:I've been curious as to the tax implications of purchasing TLT versus direct bonds.

Much of TLT's income (recently as much as half) is from non-treasury sources (securities lending, etc.).  If you hold TLT in taxable and live in a state with state income tax, that non-treasury income is likely to be subject to state income tax.

Not so with income from the real bonds.

Thank you, Wild.
That difference would be notable for me.

jackh wrote: I switched from TLT to buying direct through Fidelity last year and it couldn't have been easier, so I don't know what people mean when they talk about it being more convenient. Not only does it save you the yearly expense fee but with Fidelity there is no charge for the trade. The expense ratio of .15% may seem small but if you hold the investment for a long time it could amount to thousands of dollars, needlessly spent, in my opinion.

The savings on expense makes sense and now Vanguard also has no charge, the problem I have with switching is as a mostly taxable investor the taxable capital gains tax I would have to pay would cancel out the expense savings. Also having to buy bonds in increments of thousands seems to make a close to exact rebalance harder. The bond ETFs also have the intraday trading and real time price quotes that I have come to enjoy. Holding directly does make sense just not sure if it is right for me at the present time. Just another note at the time when I started investing Vanguard did charge for bond trading and at the time TLT was easy and simple. I can tax loss harvest or rebalance in a matter of minutes and so far I have no regrets. I have read so many investment books. I even went sailing  and won a blue ribbon in a sail boat race with Taylor an author of the Bogleheads Guide to Investing. I learned a lot but the age in bonds and my emotional risk tolerance wasn’t the right fit for me, but when I read Harry Browne’s Fail Safe Investing I knew that was for me. Also living in a state with no income tax doesn’t hurt.

i have switched over from TLT to direct just recently as well, the small increase in safety and lower cost seemed to make it a better deal, and vanguard opening a bond option made it simple enough to do..  they are all in tax advantaged and i kept a small chunk of TLT for re-balancing... 

I'm not a PP guru like some here, but here's my 2-cents from what I've learned so far.

The financial argument for direct bonds in a taxable account is the state tax benefit as described above, and the elimination of annual expense fees.

The financial argument for TLT in a taxable account is that it never throws of capital gains unless you rebalance, while if you buy and sell your own bonds you would see capital gains when you rollover 20-year bonds back into 30-year bonds if they appreciated in that time (maybe they will in the next ten years, maybe they won't -- who knows).  You could manage that somewhat with timing of the sales, tax loss harvesting, etc., but that takes a little extra effort and if you're just not into that TLT is a perfectly reasonable alternative.

Assuming the money difference in those two options isn't huge, then the tiebreaker comes down to your feelings about counter-party risk, your comfort with managing your bond ladder, and perhaps your portfolio size (as direct treasuries through a broker like Fidelity have a $1000 increment).  

IMHO, just do what you're more comfortable with and don't stress about it.  The PP with either is most likely way safer than however you're investing outside of the PP now.

jackh wrote: I switched from TLT to buying direct through Fidelity last year and it couldn't have been easier, so I don't know what people mean when they talk about it being more convenient. Not only does it save you the yearly expense fee but with Fidelity there is no charge for the trade. The expense ratio of .15% may seem small but if you hold the investment for a long time it could amount to thousands of dollars, needlessly spent, in my opinion.

Although I am pro-direct and although I plan to eventually rid myself of the TLT in my Vanguard account, there is one thing about TLT that's more convenient. I buy treasuries at auction, usually, and in auctions Vanguard requires a minimum of 10K to be spent. (Not so at Fidelity, nor at Vanguard's secondary market access). So, it's been nice to purchase pieces of TLT here and there when dividends from my vP holdings come in.

But, again, I regret not starting with a pure play from the beginning. I'm going to hold the TLT for now, but if I ever get to rebalance they'll be the first bonds to go even though I have plenty of 30-YR bonds in tax-deferred.

Tyler wrote: Assuming the money difference in those two options isn't huge...

After running some numbers, I want to make sure I'm not missing something.  

Let's say someone buys $10,000 in direct LTTs in a taxable account.  When their treasuries reach 20-year duration, they plan to sell them to buy 30-year treasuries per the PP plan.

According to Craig's data, the CAGR for LTTs from 1972-2008 was 9.0%.  So over ten years, the original 10k investment grew on average to $23,674 with $13,674 in capital gains (not counting reinvested interest).  Taxed at 15%, that's $2050 or 8.7% of the total treasury value.  So averaged over ten years, the capital gains taxes from required treasury turnover alone amount to 0.87% a year.

TLT has no capital gains from turnover like this (you only see CGs when you rebalance) and the expense ratio is only 0.15%.  Does this not mean that (over the last 40 years, at least) TLT is a MUCH better buy than direct treasuries in a taxable account?

Please correct me if I'm wrong before I change my attitude about direct treasuries again.  

Tyler wrote:
(snip)

According to Craig's data, the CAGR for LTTs from 1972-2008 was 9.0%.  So over ten years, the original 10k investment grew on average to $23,674 with $13,674 in capital gains (not counting reinvested interest).

(snip) 

Please correct me if I'm wrong before I change my attitude about direct treasuries again.  

I believe Craig's CAGR data includes reinvested interest.  I don't know this for fact, but I suspect most (maybe 2/3?) of the increase is actually interest.

That would help, but even if only 1/3rd of that increase is capital gains, then the money you pay for CG taxes for direct treasuries turnover is still double the TLT expense ratio.  

EDIT: Yeah, it looks like the CAGR from capital appreciation alone is about 1.6% since 1978 (best data I could find quickly).  That still results in an average annual "fee" of about 0.22% per year (in CG taxes from turnover) when holding the treasuries themselves.  So yes, that's much more reasonable, but I think it still makes a fixed 0.15% expense ratio in TLT look pretty desirable for a taxable investor.  Even charitably rounding down if you think rates may rise soon (or rounding up if you include the state tax concerns in TLT) and calling it a wash, over long timeframes it appears to take the "lower expenses" off the table as a reason to favor direct treasuries.  

There are still good reasons to prefer direct (counter-party risk, etc).  Just providing info for the other side of the argument.  But again, correct me if I'm missing something.  :)

Tyler wrote:There are still good reasons to prefer direct (counter-party risk, etc).  Just providing info for the other side of the argument.  But again, correct me if I'm missing something.

The period you cite was one of generally declining long-term rates.  If the opposite were true, you would have harvested capital losses.

With TLT you may not have to realize capital gains (or losses) like you would holding Treasury bonds directly, but you would have them if you had to rebalance.  So during the period you cite (and assuming TLT was available) you would have had both the expense ratio and the capital gains generated during rebalancing of TLT.

The capital gain/loss door swings both ways.

Was there a hiccup in this thread? I thought Tyler posted about the tax implications of having to sell long bonds with only 20 years left on them, and I replied. Now I can't find either of the two posts.  Edit: Now I can find Tyler's post (on page 1), but not mine. Oh well.

By the way, thank heavens for treasuries. There should be a Schoolhouse Rock cartoon (a la "I'm just a bill sitting on Capitol Hill") in which the treasury bond laments his thankless job.

WildAboutHarry wrote: With TLT you may not have to realize capital gains (or losses) like you would holding Treasury bonds directly, but you would have them if you had to rebalance.  So during the period you cite (and assuming TLT was available) you would have had both the expense ratio and the capital gains generated during rebalancing of TLT.

True.  But since you'd have to rebalance both TLT and direct treasuries when they hit the bands (that's how the PP works) I wasn't worried about that.  I'm focusing on the CG taxes from selling 20-year bonds only just to compare the TLT fees to the cost of carrying treasuries directly.  

I suppose there are some scenarios where the rebalancing naturally prevents any bonds from sneaking through to 20 years over long-ish periods of time, which would also serve to bring the taxable costs of direct treasuries down over time.  But assuming you eventually do need to sell a 20-year treasury, I guess all I'm saying is that the expense ratio for direct treasuries in a taxable account is not zero. In that sense, one could argue that the 0.15% ER in TLT is insurance against capital gains caused by prolonged periods of falling rates like we've seen for a while.  Sometimes it costs you money -- sometimes it saves you money.  

It's true that the past 30-ish years have had a major tailwind of declining rates.  We may see that reverse, and you'll start having regular losses on direct bonds and no capital gains.  But I do find it interesting that over most of the period where the PP is relevant (post gold standard) the tailwind is real.  Perhaps that's coincidence.  Maybe not.  I honestly don't know.

EDIT: I can see your posts, Dualstow.  

Has anyone here who holds direct long term treasury bonds ever sold it all to do a tax loss harvest?  If so was it simple? Did you just sell all and re buy new 30 year bonds? Also if you do your own income tax is it as easy as sale of an ETF where you can just sell it all and tax time just list the purchase date as various (for short term) and do it with one entry on tax software or do each of the bonds have a different number and have to be entered separately?

I have done this many times with ETFs in a matter of minutes and it was simple.

steve wrote: Has anyone here who holds direct long term treasury bonds ever sold it all to do a tax loss harvest?  If so was it simple? Did you just sell all and re buy new 30 year bonds? Also if you do your own income tax is it as easy as sale of an ETF where you can just sell it all and tax time just list the purchase date as various (for short term) and do it with one entry on tax software or do each of the bonds have a different number and have to be entered separately?

I have done this many times with ETFs in a matter of minutes and it was simple.

Would selling 5 year old 30Y bonds and immediately buying new 30Y bonds be considered a wash sale?  Or are you considering waiting 31 days between selling the old bonds and buying the new ones?  I would hate to be out of the LTT market for such a period of time.

fnord123 wrote:Would selling 5 year old 30Y bonds and immediately buying new 30Y bonds be considered a wash sale?

Wash sales do not matter tax-wise on gains, and a 25-year old bond is substantially different from a 30-year old bond.

So, in my non-tax-adviser all-caveats-apply opinion, no.

I agree with WAH... The wash-sale rule hasn't been vetted in courts/regs very well to give really good bright lines.  5-to-30 switch would seem far and away sufficient to me to avoid the wash sale rule.

Further, I think it's something that causes little if any audit red flags.

Another thing to consider is that long bond funds/etf's are sitting on large unrealized capitol gains due to the huge runnup last year.  I see EDV has unrealized gains equal to 22% of NAV now.  Other long bond funds/etf's are also sitting on 10-15% unrealized gains too I'd imagine.  Buying bonds means no annual fee plus a substantial tax advantage. 

FarmerD wrote: Another thing to consider is that long bond funds/etf's are sitting on large unrealized capitol gains due to the huge runnup last year.  I see EDV has unrealized gains equal to 22% of NAV now.  Other long bond funds/etf's are also sitting on 10-15% unrealized gains too I'd imagine.  Buying bonds means no annual fee plus a substantial tax advantage. 

Would it also be true that anyone who bought bonds before the huge run be sitting on the same unrealized gain?

If you do your own taxes and you are a mostly taxable investor whether or not you have realized gains from rebalancing or losses from tax loss harvesting which is less complicated at tax time when you do your tax return?
The answer would be of help in making a decision on holding directly or using a bond fund or etf.