Gyroscopic Investing

This might be moronic but that hasn't stopped me yet from posting...

I have a question about the bond portion of the PP. I just implemented the PP at the beginning of this year and all the bonds I bought are 11/15/43 issues with a 3.75% coupon. Just got my first interest payments on 5/15/14 and I have to say that felt good (and may be skewing my thinking a bit here as well). A bit of background... I am 55 years old and my PP is set up with individual LTTs, IAU & S&P 500 in retirement accounts with just a bit of cash for rebalancing. The rest of the PP cash I hold is in EE and I-bonds outside the retirement accounts. I'll gradually change the retirement account allocation over the next ten years so that there is a normal 25/25/25/25 asset allocation in my IRAs (actually less IAU because some of the gold allocation will be in coins outside of the IRAs). Those IRAs will eventually fund my retirement to a large extent.

So, here is the question. I know that the recommendation on T-bonds is to replace older bonds with newer ones. Would I be doing something dumb by eyeballing a bond with a higher coupon for the sake of more income? For example, right now I see a 2/15/41 issue with a 4.75% coupon and a YTM of 3.289. I also see an 11/15/42 issue with a 2.75% coupon and a YTM of  3.296. I'd like to have a steady stream of bond income later in life but my guess is that folks here will tell me what I am asking is a complete wash (that either one is fine and it won't really make a difference in the long run which one I choose).

I seem to remember PS posting a few months back that he preferred bonds with a higher yield assuming that they met the long-term requirement. Any thoughts would be much appreciated.

It's a wash in that selling an existing bond to buy new ones with a higher coupon will require that you sell more bonds to buy fewer, since the higher coupon bonds have a higher price. So you will have fewer bonds that individually provide you with more income, which is what the yield to maturity figure is trying to tell you; it's basically a "cost-adjusted" yield. The fact that the 4.75% bond has a lower yield to maturity than the 2.75% bond is probably representative of the fact that it both costs more to purchase it and it also has a 1.75 fewer years before maturity.

All else being equal, I prefer bonds with a higher coupon, but all else is not equal here.

Thanks PS. That helps. I was overlooking the fact that the total number of bonds held in the PP is important as well. Also I was figuring that all things were "more or less equal" in the scenario I laid out. I still feel with the reptilian part of my brain that the higher coupon bonds are better but your line of logic makes total sense.

Another thing to keep in mind is that the bond with the lower coupon should be slightly more volatile than a higher coupon bond of the same maturity.

The metric you're looking for is duration.  A higher coupon will have a shorter duration, thus relatively less volatility.

I just bought bonds on the secondary market a while ago, and I went for the one with the highest yield, taking buy price into account.  Ironically, it was the one with the 2.875% coupon.  It works because (as PS pointed out) you buy more of them with the same $$ than you would of the higher coupon issue.  I bet the yield for the low-coupon is higher because of that natural tendency to go for the higher coupon - resist it and look at the yields!!!

sophie wrote: I just bought bonds on the secondary market a while ago, and I went for the one with the highest yield, taking buy price into account.  Ironically, it was the one with the 2.875% coupon.  It works because (as PS pointed out) you buy more of them with the same $$ than you would of the higher coupon issue.  I bet the yield for the low-coupon is higher because of that natural tendency to go for the higher coupon - resist it and look at the yields!!!

This morning I learned two things about bonds from this forum that I didn't know - 1.) That duration and maturity are not the same thing and 2.) The highest coupon is not necessarily the best deal.

But mostly I learned that the advice in the Fidelity bond buying tutorial to just scroll to the end and pick the one on the bottom is probably a good idea.