Author Topic: Bond alternative?  (Read 11457 times)

ambimammular

  • Bristles
  • ***
  • Posts: 362
  • Age: 41
  • Location: Indiana
Bond alternative?
« on: July 19, 2014, 09:26:44 AM »
So we're 34 and 37 and haven't got a penny in bonds. I'd like to buy maybe 25%-30%, but I can't stomach the idea knowing interest rates are only able to go up from here, therefore bond prices can only go down.

We put extra payments on the house with our bond portion of the investment money where its illiquid. I thought that would make me feel more secure (and it does) but I know I'm gonna feel like a fool not moving some of our stocks into something more secure.

Where can I put them?

matchewed

  • Magnum Stache
  • ******
  • Posts: 4249
  • Location: CT
Re: Bond alternative?
« Reply #1 on: July 19, 2014, 09:37:42 AM »
Well first of all you need to determine a good AA for your investment portfolio and then maintain it or lay out a plan for how it will change over time. Then just spread out your AA as you've determined, the short-term fluctuations of the bond or equity markets be damned.

Make an investment policy statement.

There isn't a great alternative that exists short of cash, CD's, TIPS, and other similar products that are at the whim of interest rates as well.

brewer12345

  • Handlebar Stache
  • *****
  • Posts: 1386
Re: Bond alternative?
« Reply #2 on: July 19, 2014, 09:41:49 AM »
I use CDs, merfx, arbfx, I bonds and GIM.

milesdividendmd

  • Handlebar Stache
  • *****
  • Posts: 1913
  • Location: Portlandia
    • Miles Dividend MD
Bond alternative?
« Reply #3 on: July 19, 2014, 12:41:16 PM »
This is an interesting question.

The best answer has Already been given. Develop an investment policy statement and stick to it.

But this idea that we know what the bond market is going to do in the future because we know current interest rates are low is pervasive, and in my opinion backwards.

The point of Bonds in any portfolio is primarily to act as ballast. When the stock market tanks, as it inevitably will, A person with a healthy proportion of bonds in their portfolio Will lose much less, and have much more dry powder to buy the devalued Stocks when rebalancing.

Any money you make from your bond portfolio is a bonus in my opinion.

Just to demonstrate that bond investing is not as simple as "low interest rates bad: avoid bonds" consider this scenario:

Go back six months to when interest rates were at historical  lows. At that point your reasons for avoiding bonds would be pretty much identical to now.

Now compare the next six months of TLT (long term treasuries) versus SPY (the S&P 500. )

You will be surprised to find that long term treasuries returned more than the S&P 500 (10.7 vs 8.2%) with slightly less volatility. (So at that time when common wisdom would be to avoid long-term treasuries you would've had more return, and less risk investing in long term treasuries versus the S&P 500.)

If you don't want to take interest rate risk, the answer is simple. just put your entire bond allocation in short-term treasuries. Since you're taking no interest-rate risk (and no credit risk) your yield will be quite a bit lower. (SHY is an example of a short-term treasuries ETF). If you want a little more yield but no interest rate risk mix in some short term investment grade corporate (vcsh.)

There is evidence that the most efficient space in treasuries is mid term treasuries, but there is no getting around the fact that you take on a small amount of interest rate risk with mid term treasuries.)

With any well designed, well diversified portfolio some assets will be dogs at any given moment. That is how diversification works: it decreases volatility (going down and going up) and in so doing increases real returns.
« Last Edit: July 19, 2014, 12:49:00 PM by milesdividendmd »

kyleaaa

  • Bristles
  • ***
  • Posts: 327
    • Kyle Bumpus
Re: Bond alternative?
« Reply #4 on: July 20, 2014, 09:11:26 AM »
Don't try and time the market. Buy bonds. If you're really worried, stick to short-term bonds. Even if your absolute worst-case fears come true you'll lose what, like 3-4% and then quickly recover it within a year or two? Do you not see the absurdity in risking a 50% loss by being 100% in stocks in order to avoid risking a 4% loss in bonds?

AssetGrinder

  • Stubble
  • **
  • Posts: 114
  • Location: Victoria BC Canada
    • Asset-Grinder Finance Blog
Re: Bond alternative?
« Reply #5 on: July 21, 2014, 12:15:19 AM »
Maybe try Reits or preferred stock funds for a bond alternative. Both have high yields and both are affected by interest rates like bonds.

milesdividendmd

  • Handlebar Stache
  • *****
  • Posts: 1913
  • Location: Portlandia
    • Miles Dividend MD
Re: Bond alternative?
« Reply #6 on: July 21, 2014, 02:12:33 AM »

Maybe try Reits or preferred stock funds for a bond alternative. Both have high yields and both are affected by interest rates like bonds.

I respectfully disagree with this suggestion. REITs are more equity like than bond like from a diversification standpoint, preferred stocks are more of a hybrid.

Either you want to diversify or you don't. Going half way is the worst of both worlds. Less returns with less downside protection (which is the whole point of owning bonds. )

Figure out your risk tolerance and hold your predefined position in bonds. There is no clever way of getting around the wisdom of that.



PathtoFIRE

  • Bristles
  • ***
  • Posts: 475
  • Age: 39
  • Location: Dallas
Re: Bond alternative?
« Reply #7 on: July 21, 2014, 08:22:19 AM »
With the caveat that I am also in the process of learning about investing so others with more experience/knowledge can correct me if I'm wrong....

A bond is a loan by you to a company/government, where they agree to pay you a fixed percentage for a fixed time (usually), and then (usually) return you your principal at the end of the period. So if you look at a bond today, and like the terms, then it shouldn't matter whether interest rates increase over time, you are still getting what you paid for. Now yes, if you wanted to turn around and sell that bond on the secondary market before it expires, then newer bonds at a potentially higher interest rate would be more attractive to other buyers, reducing the amount your could sell for. But if you were just going to buy and hold to term, then you don't really care what others would pay you for it.

A bond fund that has low turnover should have the same principle, but I guess if the fund has to do a lot of trading to maintain its parameters, then a bond fund might be more exposed to the secondary market risks.

To me, the main risk for bonds is the risk of inflation. If you look at a bond that is paying say 5% and you like the terms and the stability and reliability its payout gives your portfolio, this is based on certain assumptions, especially the rate of inflation. If inflation were to quickly increase to 5% and stay around that for the next decade or so, then your bond investment may no longer be providing you what you expected.

LuckyMe

  • 5 O'Clock Shadow
  • *
  • Posts: 14
Re: Bond alternative?
« Reply #8 on: July 21, 2014, 08:59:26 AM »

I'm fond of this article titled "Why only millionaires should invest in bonds directly":
http://www.theglobeandmail.com/globe-investor/investor-education/why-only-millionaires-should-invest-in-bonds-directly/article625673/


Thanks for sharing that article, great explanation of the differences between bonds and bond funds. 

Jack

  • Magnum Stache
  • ******
  • Posts: 4745
  • Location: Atlanta, GA
Re: Bond alternative?
« Reply #9 on: July 21, 2014, 10:15:46 AM »
We put extra payments on the house with our bond portion of the investment money where its illiquid. I thought that would make me feel more secure (and it does) but I know I'm gonna feel like a fool not moving some of our stocks into something more secure.

I say you should keep doing what you're doing. Paying off your "negative bond" (i.e., mortgage) has better risk/return than anything you're going to find in the market, and the only downside is that you can't rebalance as easily. (You could refinance or buy stock funds with a HELOC or something, or you could "rebalance by adjusting new contributions only," which is what I do.)

Since you're in the accumulation phase, the fact that paying off the mortgage is "illiquid" is mostly irrelevant. If you think you need more liquid assets, the real issue is that your emergency fund isn't big enough.

rmendpara

  • Pencil Stache
  • ****
  • Posts: 602
Re: Bond alternative?
« Reply #10 on: July 21, 2014, 10:46:27 AM »
You should get into bonds in a small way, probably don't need more than 5-10% (again, very general range and you could definitely go zero bonds until age 50 if you can handle the volatility in equities).

If you are trying to manage interest rate risk, then you do that by investing in relatively short duration bonds (i.e. less than 5 years).

The price will suffer when rates rise, but not as much as if you are in a long-term bond fund.

As long as the fund has reasonable turnover, the rates will catch up to the market, but just be a little slow.

Since you are investing for the long-term, this shouldn't be a problem.

FWIW, I am 25 and allocate 5% of my 401k contributions to a bond fund with a 3 yr duration (not a suggestion, just saying what I'm doing). I could easily go 100% equities, but it's such a small amount anyway it won't make or break me anyway. My plan once rates "normalize" for 10yr US bonds around 3.5%+, to add another 5% contribution into longer duration bond fund and then leave it as is.

Equities, I believe, will greatly outperform fixed income for the next 20+ years, but having an allocation means being disciplined... so I'll just do that now.

milesdividendmd

  • Handlebar Stache
  • *****
  • Posts: 1913
  • Location: Portlandia
    • Miles Dividend MD
Re: Bond alternative?
« Reply #11 on: July 21, 2014, 10:50:38 AM »
We put extra payments on the house with our bond portion of the investment money where its illiquid. I thought that would make me feel more secure (and it does) but I know I'm gonna feel like a fool not moving some of our stocks into something more secure.

I say you should keep doing what you're doing. Paying off your "negative bond" (i.e., mortgage) has better risk/return than anything you're going to find in the market, and the only downside is that you can't rebalance as easily. (You could refinance or buy stock funds with a HELOC or something, or you could "rebalance by adjusting new contributions only," which is what I do.)
Since you're in the accumulation phase, the fact that paying off the mortgage is "illiquid" is mostly irrelevant. If you think you need more liquid assets, the real issue is that your emergency fund isn't big enough.

Paying off a mortgage as a  "negative bond" would be a reasonable thing to do with extra money.  In my opinion, however, it should not be a replacement for holding bonds in proportion to one's risk tolerance in their portfolio.

Having more equity in your home will not help your portfolio at all during the next downturn.  You will not be able to pull out home equity, quickly, free of interest, and fee free, in order to rebalance your portfolio (as you would be able to sell bond funds.)  As such you will not be able to buy devalued stocks at a discount.  In other words you will miss out on the rebalancing bonus, which increases returns and decreases risk in your portfolio.

Jack

  • Magnum Stache
  • ******
  • Posts: 4745
  • Location: Atlanta, GA
Re: Bond alternative?
« Reply #12 on: July 21, 2014, 01:51:02 PM »
Having more equity in your home will not help your portfolio at all during the next downturn.  You will not be able to pull out home equity, quickly, free of interest, and fee free, in order to rebalance your portfolio (as you would be able to sell bond funds.)  As such you will not be able to buy devalued stocks at a discount.  In other words you will miss out on the rebalancing bonus, which increases returns and decreases risk in your portfolio.

I addressed this in my post, although perhaps not as eloquently. Even without relatively-liquid bond funds from which to rebalance, you can still capture at least some of the rebalancing bonus by adjusting the percentage of new money you put towards mortgage repayment vs. equities purchase (e.g., if the market drops far enough then you might stop prepaying your mortgage and put 100% of your savings into index funds).

(The difference between the above and market-timing, by the way, is that you're choosing the contribution percentage mechanically according to the ratio of your net home equity to your equity portfolio.)

I think the underlying cause of our difference in perspective is due to differences in how far along the accumulation phase we each are. If you're near the beginning (where your periodic contributions are relatively large compared to your total portfolio) then you can capture most of the rebalancing bonus without having to sell anything and therefore treating the mortgage as a negative bond makes sense, while if you're near the end (where periodic contributions are small relative to your total portfolio) then you really need to sell in order to rebalance effectively and you need relatively-liquid bonds to do it.

milesdividendmd

  • Handlebar Stache
  • *****
  • Posts: 1913
  • Location: Portlandia
    • Miles Dividend MD
Re: Bond alternative?
« Reply #13 on: July 21, 2014, 02:02:15 PM »

Having more equity in your home will not help your portfolio at all during the next downturn.  You will not be able to pull out home equity, quickly, free of interest, and fee free, in order to rebalance your portfolio (as you would be able to sell bond funds.)  As such you will not be able to buy devalued stocks at a discount.  In other words you will miss out on the rebalancing bonus, which increases returns and decreases risk in your portfolio.

I addressed this in my post, although perhaps not as eloquently. Even without relatively-liquid bond funds from which to rebalance, you can still capture at least some of the rebalancing bonus by adjusting the percentage of new money you put towards mortgage repayment vs. equities purchase (e.g., if the market drops far enough then you might stop prepaying your mortgage and put 100% of your savings into index funds).

(The difference between the above and market-timing, by the way, is that you're choosing the contribution percentage mechanically according to the ratio of your net home equity to your equity portfolio.)

I think the underlying cause of our difference in perspective is due to differences in how far along the accumulation phase we each are. If you're near the beginning (where your periodic contributions are relatively large compared to your total portfolio) then you can capture most of the rebalancing bonus without having to sell anything and therefore treating the mortgage as a negative bond makes sense, while if you're near the end (where periodic contributions are small relative to your total portfolio) then you really need to sell in order to rebalance effectively and you need relatively-liquid bonds to do it.

Jack,

That's an interesting point about rebalancing early versus late in your accumulation phase.

I would argue, however, that in the event of a major correction (something like 2008 where equities go down 50% in bonds go up 5-10%) it would be very difficult to rebalance quickly while prices are depressed with simple incremental contributions.

In fact if we imagine such a scenario, where someone has all of their fixed income allocation in a mortgage and hundred percent of the portfolio dedicated to Stocks there would be absolutely no difference in behavior following the crash relative to before.(The person would simply keep on making contributions to 100% stocks, or maybe stop making extra payments and contribute a little bit more each month from the mortgage prepayment side to the equities.

This has nowhere near as dramatic an effect as drawing down liquid bonds and purchasing cheap stocks en masse.

Now if the person is truly okay with losing 50% of their investment portfolio, then perhaps 100% stock allocation was wise in the first place. But for a person who wants to smooth out the ride and decrease risk, prepaying the mortgage, is simply not an equivalent substitution to a portfolio with bonds in it.



beltim

  • Magnum Stache
  • ******
  • Posts: 2797
Re: Bond alternative?
« Reply #14 on: July 21, 2014, 02:32:05 PM »
For those using bonds as an uncorrelated asset with equities, beware!  There are long periods of time (decades) that stocks and bonds are correlated (https://media.pimco.com/Documents/PIMCO_Quantitative_Research_Stock_Bond_Correlation_Oct2013.pdf).  There are, of course, other reasons to hold bonds unaffected by this.

Also, one bond-like alternative that hasn't been mentioned is peer to peer lending, like LendingClub.  It has its own risks, but definitely fits the category of "bond alternative" 


Jack

  • Magnum Stache
  • ******
  • Posts: 4745
  • Location: Atlanta, GA
Re: Bond alternative?
« Reply #15 on: July 21, 2014, 03:02:17 PM »
In fact if we imagine such a scenario, where someone has all of their fixed income allocation in a mortgage and hundred percent of the portfolio dedicated to Stocks there would be absolutely no difference in behavior following the crash relative to before.(The person would simply keep on making contributions to 100% stocks, or maybe stop making extra payments and contribute a little bit more each month from the mortgage prepayment side to the equities.)

This has nowhere near as dramatic an effect as drawing down liquid bonds and purchasing cheap stocks en masse.

Let's assume somebody has $3000/month to invest, and in "normal" circumstances they're putting $1500/month into equities and $1500/month into mortgage prepayment (above and beyond the minimum). Let's also assume they have a $100,000 house and owe $80,000 (at 4%), and have $20,000 in equities. If the market crashed 50% (and the housing market didn't), then they'd need to "rebalance" $5000 from the mortgage to equities. If they did that by reallocating the $1500/month mortgage prepayment, it would only take them a little over 3 months to rebalance, which (IMO) isn't bad.

In contrast, they could have put the money in BND and be able to rebalance the $5000 immediately, but at the cost of making 2.5% yield instead of saving 4% in interest. Maybe they come out ahead (if the market rebounds within 3 months, and they actually executed the rebalance within that window rather than waiting for a "normal" annual rebalance or whatever) in the unusual 50% drop scenario, but they're losing 1.5% the rest of the time.

I admit, this is an extreme example, both because it's a very small portfolio and because it's a very large market correction. A "normal" portfolio would be larger than that and therefore take longer to rebalance... but a "normal" correction would be smaller and therefore require less rebalancing in the first place. I assert (without proof) that the factors more or less cancel each other out.

Now if the person is truly okay with losing 50% of their investment portfolio, then perhaps 100% stock allocation was wise in the first place. But for a person who wants to smooth out the ride and decrease risk, prepaying the mortgage, is simply not an equivalent substitution to a portfolio with bonds in it.

You can't consider the "investment portfolio" in a vacuum; instead you should consider total net worth. If person A has $100,000 in stocks, $0 in bonds, and $50,000 in home equity and the value of their stock drops to $50,000, then they're no worse off than person B who had $100,000 in stocks, $50,000 in bonds, and $0 in home equity. Person B lost 1/3 of his net worth just like person A did.

Now, if you actually need to use the money (i.e., you're not in the accumulation phase) that's different... but that's not what we we're talking about either.

beltim

  • Magnum Stache
  • ******
  • Posts: 2797
Re: Bond alternative?
« Reply #16 on: July 21, 2014, 03:09:04 PM »
In contrast, they could have put the money in BND and be able to rebalance the $5000 immediately, but at the cost of making 2.5% yield instead of saving 4% in interest. Maybe they come out ahead (if the market rebounds within 3 months, and they actually executed the rebalance within that window rather than waiting for a "normal" annual rebalance or whatever) in the unusual 50% drop scenario, but they're losing 1.5% the rest of the time.

I admit, this is an extreme example, both because it's a very small portfolio and because it's a very large market correction. A "normal" portfolio would be larger than that and therefore take longer to rebalance... but a "normal" correction would be smaller and therefore require less rebalancing in the first place. I assert (without proof) that the factors more or less cancel each other out.

Don't forget that bonds can lose money too  so in addition to the 1.5% annual difference, there's the (pretty good) chance that when you want to sell the bonds and buy stocks with the proceeds, the bonds will be worth less than what you paid for them!

This is another factor that may impact your decision.

milesdividendmd

  • Handlebar Stache
  • *****
  • Posts: 1913
  • Location: Portlandia
    • Miles Dividend MD
Re: Bond alternative?
« Reply #17 on: July 21, 2014, 05:33:16 PM »
For those using bonds as an uncorrelated asset with equities, beware!  There are long periods of time (decades) that stocks and bonds are correlated (https://media.pimco.com/Documents/PIMCO_Quantitative_Research_Stock_Bond_Correlation_Oct2013.pdf).  There are, of course, other reasons to hold bonds unaffected by this.

Also, one bond-like alternative that hasn't been mentioned is peer to peer lending, like LendingClub.  It has its own risks, but definitely fits the category of "bond alternative"

Beltim,

Your article is about long term treasuries so it's message is quite beside the point.  Read the thread and when bonds have been recommended for diversification, they have been short to midterm and treasuries or investment grade. 

Why not just share a paper that shows that junk bonds are correalated to equities?   It would be equally unsuprising.  (Actually, I see that you went on to recommend holding P2P in your bond basket! which is like suggesting a high fee junk bond with more credit risk as a diversifier to equities.  Not good advice, IMHO.)

If you think short term (or even mid term) treasuries are poor diversifiers of equities please consider this graph.  It shows short term treasuries and the total bond market as well as the S&P.

http://www.morningstar.com/invest/proxy/quotes_morningstar_com/chart/fund/chart?t=VFIRX&region=usa&culture=en-US&dataParams=%7B%22zoomKey%22%3A10%2C%22version%22%3A%22US%22%2C%22showNav%22%3Atrue%2C%22defaultShowName%22%3A%22name%22%2C%22mainSettingId%22%3A%22main%22%2C%22navSettingId%22%3A%22nav%22%2C%22benchmarkSettingId%22%3A%22benchmark%22%2C%22sliderBgSettingId%22%3A%22sliderBg%22%2C%22volumeSettingId%22%3A%22volume%22%2C%22defaultBenchmark%22%3Afalse%2C%22id%22%3A%22FOUSA02SNT%7CXIUSA04G92%22%2C%22type%22%3A%22FO%7CXI%22%2C%22name%22%3A%22XNAS%3AVFIRX%7CIXUS%3ASPYZ%22%2C%22defaultBenchmarks%22%3A%5B%22%24FOCA%24GS%24%24%7CShort%20Government%7CCA%5DFO%22%2C%22XIUSA000MC%7CBarclays%20US%20Agg%20Bond%20TR%20USD%7CXI%22%5D%2C%22chartType%22%3A%22growth%22%2C%22startDay%22%3A%2210%2F28%2F1991%22%2C%22endDay%22%3A%2207%2F20%2F2014%22%2C%22chartWidth%22%3A955%7D
« Last Edit: July 21, 2014, 05:36:22 PM by milesdividendmd »

beltim

  • Magnum Stache
  • ******
  • Posts: 2797
Re: Bond alternative?
« Reply #18 on: July 21, 2014, 06:36:11 PM »
For those using bonds as an uncorrelated asset with equities, beware!  There are long periods of time (decades) that stocks and bonds are correlated (https://media.pimco.com/Documents/PIMCO_Quantitative_Research_Stock_Bond_Correlation_Oct2013.pdf).  There are, of course, other reasons to hold bonds unaffected by this.

Also, one bond-like alternative that hasn't been mentioned is peer to peer lending, like LendingClub.  It has its own risks, but definitely fits the category of "bond alternative"

Beltim,

Your article is about long term treasuries so it's message is quite beside the point.  Read the thread and when bonds have been recommended for diversification, they have been short to midterm and treasuries or investment grade. 

Why not just share a paper that shows that junk bonds are correalated to equities?   It would be equally unsuprising.  (Actually, I see that you went on to recommend holding P2P in your bond basket! which is like suggesting a high fee junk bond with more credit risk as a diversifier to equities.  Not good advice, IMHO.)

If you think short term (or even mid term) treasuries are poor diversifiers of equities please consider this graph.  It shows short term treasuries and the total bond market as well as the S&P.


Sure, short term treasuries are fine diversifiers of equities.  But up to $100k there's essentially no reason to hold short-term treasuries, as you're giving up yield compared to FDIC-insured savings accounts.  I suspect that the total bond market is more similar to intermediate Treasury bonds than short terms notes, though, as shown here:
http://www.google.com/finance?chdnp=1&chdd=1&chds=1&chdv=1&chvs=maximized&chdeh=0&chfdeh=0&chdet=1405989162426&chddm=98532&chls=IntervalBasedLine&cmpto=NYSEARCA:AGG;NYSEARCA:IEF&cmptdms=0;0&q=NYSEARCA:SHV&ntsp=1&ei=2rDNU8j_IcjXqgG364GIAQ

You're right, though, long term treasuries are poor mimics of the "total" bond market.  I'm having trouble finding data on the correlation of the "total" bond market to equities, though.

dragoncar

  • Walrus Stache
  • *******
  • Posts: 8065
  • Registered member
Re: Bond alternative?
« Reply #19 on: July 21, 2014, 07:07:33 PM »


At which point on this graph did you start saying "bonds can only go up from here"?

milesdividendmd

  • Handlebar Stache
  • *****
  • Posts: 1913
  • Location: Portlandia
    • Miles Dividend MD
Re: Bond alternative?
« Reply #20 on: July 21, 2014, 07:19:43 PM »


At which point on this graph did you start saying "bonds can only go up from here"?

That's a great point. And it really shows the persistence of this bull market in bonds. Of course there is the zero lower bound....

Other than the zero lower bound though, looking at your yield graph, it is hard not to draw parallels to all of the "but the stock market has never been higher" threads.

The final points is, how sweet would it have been to begin investing in 1980? A long bull market in bonds, a long bull market in stocks, you almost couldn't lose...

beltim

  • Magnum Stache
  • ******
  • Posts: 2797
Re: Bond alternative?
« Reply #21 on: July 21, 2014, 07:27:38 PM »
I wonder what the total return over the next 30 years would be if that chart were reflected around today.

But yes, excellent illustration.

dragoncar

  • Walrus Stache
  • *******
  • Posts: 8065
  • Registered member
Re: Bond alternative?
« Reply #22 on: July 21, 2014, 08:42:18 PM »
Sure there's a zero bound, but that graph be logarithmic, yo

Also, who wouldn't want a 30 year treasury paying 14%?  People who fear crazy inflation or government default I guess.  That's really blood in the streets territory up there.

milesdividendmd

  • Handlebar Stache
  • *****
  • Posts: 1913
  • Location: Portlandia
    • Miles Dividend MD
Re: Bond alternative?
« Reply #23 on: July 21, 2014, 10:02:39 PM »

Sure there's a zero bound, but that graph be logarithmic, yo

Also, who wouldn't want a 30 year treasury paying 14%?  People who fear crazy inflation or government default I guess.  That's really blood in the streets territory up there.

True but the current yield on the tbill is an arithmetic 0.11%!

There's not too much further down to go I would say.



milesdividendmd

  • Handlebar Stache
  • *****
  • Posts: 1913
  • Location: Portlandia
    • Miles Dividend MD
Re: Bond alternative?
« Reply #24 on: July 21, 2014, 10:04:04 PM »


Sure there's a zero bound, but that graph be logarithmic, yo

Also, who wouldn't want a 30 year treasury paying 14%?  People who fear crazy inflation or government default I guess.  That's really blood in the streets territory up there.

True but the current yield on the tbill is an arithmetic 0.11%!

There's not too much further down to go I would say.

And to answer your second question, someone who had just bought a  30 year treasury with a coupon of 10%.



dragoncar

  • Walrus Stache
  • *******
  • Posts: 8065
  • Registered member
Re: Bond alternative?
« Reply #25 on: July 21, 2014, 11:17:56 PM »

Sure there's a zero bound, but that graph be logarithmic, yo

Also, who wouldn't want a 30 year treasury paying 14%?  People who fear crazy inflation or government default I guess.  That's really blood in the streets territory up there.

True but the current yield on the tbill is an arithmetic 0.11%!

There's not too much further down to go I would say.

Homework for tonight:  How much does the price of your 30-year bond go up if the yield drops from 2% to 1%?

milesdividendmd

  • Handlebar Stache
  • *****
  • Posts: 1913
  • Location: Portlandia
    • Miles Dividend MD
Re: Bond alternative?
« Reply #26 on: July 21, 2014, 11:30:46 PM »


Sure there's a zero bound, but that graph be logarithmic, yo

Also, who wouldn't want a 30 year treasury paying 14%?  People who fear crazy inflation or government default I guess.  That's really blood in the streets territory up there.

True but the current yield on the tbill is an arithmetic 0.11%!

There's not too much further down to go I would say.

Homework for tonight:  How much does the price of your 30-year bond go up if the yield drops from 2% to 1%?

100% assuming a fixed coupon.

Yield = coupon/current value.



beltim

  • Magnum Stache
  • ******
  • Posts: 2797
Re: Bond alternative?
« Reply #27 on: July 21, 2014, 11:36:16 PM »
34.4%

dragoncar

  • Walrus Stache
  • *******
  • Posts: 8065
  • Registered member
Re: Bond alternative?
« Reply #28 on: July 22, 2014, 09:56:00 AM »

milesdividendmd

  • Handlebar Stache
  • *****
  • Posts: 1913
  • Location: Portlandia
    • Miles Dividend MD
Re: Bond alternative?
« Reply #29 on: July 22, 2014, 01:16:59 PM »

beltim

  • Magnum Stache
  • ******
  • Posts: 2797
Re: Bond alternative?
« Reply #30 on: July 22, 2014, 01:23:31 PM »

34.4%

This is what I got...

Show your work!

A 30-year bond with 2% coupon will have a final value of (1.02^30) = 1.81136 times the starting value assuming the coupons are reinvested.  If yields go to 1%, the question is what price will allow that 30-year bond to have 1% annual returns for the next 30 years?
1.81136/(1.01^30) = 1.34785. 
1.34785 ^ (1/30) = 1.34389

Mr Mark

  • Handlebar Stache
  • *****
  • Posts: 1149
  • Location: Planet Earth
  • Achieved Financial Independence summer 2014. RE'18
Re: Bond alternative?
« Reply #31 on: July 22, 2014, 05:26:19 PM »
And if USA yields go Japanese? Just curious.

beltim

  • Magnum Stache
  • ******
  • Posts: 2797
Re: Bond alternative?
« Reply #32 on: July 22, 2014, 05:33:01 PM »
And if USA yields go Japanese? Just curious.

Plug in the numbers. A 30 year bond going from 3.4% to 1.67% (the current 30 year Japanese bond yield) would increase the value of the bond by 66%.

Mr Mark

  • Handlebar Stache
  • *****
  • Posts: 1149
  • Location: Planet Earth
  • Achieved Financial Independence summer 2014. RE'18
Re: Bond alternative?
« Reply #33 on: July 22, 2014, 06:01:14 PM »
Thanks!


frugalecon

  • Bristles
  • ***
  • Posts: 463
Re: Bond alternative?
« Reply #34 on: July 23, 2014, 06:51:14 PM »
We put extra payments on the house with our bond portion of the investment money where its illiquid. I thought that would make me feel more secure (and it does) but I know I'm gonna feel like a fool not moving some of our stocks into something more secure.

I say you should keep doing what you're doing. Paying off your "negative bond" (i.e., mortgage) has better risk/return than anything you're going to find in the market, and the only downside is that you can't rebalance as easily. (You could refinance or buy stock funds with a HELOC or something, or you could "rebalance by adjusting new contributions only," which is what I do.)

Since you're in the accumulation phase, the fact that paying off the mortgage is "illiquid" is mostly irrelevant. If you think you need more liquid assets, the real issue is that your emergency fund isn't big enough.

Depending on what the interest rate is on your mortgage, you might be better off buying bonds that offset your payment. I am working on a bond ladder that is calibrated to offset mortgage payments, working from the end of the mortgage backwards. I am using zero-coupon Treasuries for this purpose, which I hold in a brokerage account. The strategy permits me to arbitrage interest rates, because I can lock in a higher after-tax return on the Treasuries than I would from pre-paying the mortgage. Plus, the Treasuries are far more liquid. As long as comparable investments (comparable in risk terms) are available at a higher after-tax return, prepaying a mortgage is a loser.

beltim

  • Magnum Stache
  • ******
  • Posts: 2797
Re: Bond alternative?
« Reply #35 on: July 23, 2014, 07:27:27 PM »
Depending on what the interest rate is on your mortgage, you might be better off buying bonds that offset your payment. I am working on a bond ladder that is calibrated to offset mortgage payments, working from the end of the mortgage backwards. I am using zero-coupon Treasuries for this purpose, which I hold in a brokerage account. The strategy permits me to arbitrage interest rates, because I can lock in a higher after-tax return on the Treasuries than I would from pre-paying the mortgage. Plus, the Treasuries are far more liquid. As long as comparable investments (comparable in risk terms) are available at a higher after-tax return, prepaying a mortgage is a loser.

The current 30-year Treasury is about 3.3%, and zero coupons are about the same.  Is your mortgage rate less than that?  You have a good mortgage rate!

Mr Mark

  • Handlebar Stache
  • *****
  • Posts: 1149
  • Location: Planet Earth
  • Achieved Financial Independence summer 2014. RE'18
Re: Bond alternative?
« Reply #36 on: July 23, 2014, 07:50:32 PM »
To play the long term bond market game, while covering my bets and taking a federally supported long term inflation hedge, I support being into short term/medium term bond funds yet long on long term fixed rate negative bonds, ie fixed rate 30 year mortgages at 4.3%. I have zero long term treasuries or corporate bonds.




foobar

  • Pencil Stache
  • ****
  • Posts: 731
Re: Bond alternative?
« Reply #37 on: July 23, 2014, 07:58:31 PM »
So we're 34 and 37 and haven't got a penny in bonds. I'd like to buy maybe 25%-30%, but I can't stomach the idea knowing interest rates are only able to go up from here, therefore bond prices can only go down.

We put extra payments on the house with our bond portion of the investment money where its illiquid. I thought that would make me feel more secure (and it does) but I know I'm gonna feel like a fool not moving some of our stocks into something more secure.

Where can I put them?

Why do you only think interest rates can go up? We are at 2.5% on the 10 year.  We were .5% lower two years ago. Japan has been at about 0 for a decade now. Some European countries went negative for a while.

Rates look low now.  They might stay there for a while though. Between 1935-1957 (thats a lot of years), 10 years traded between 2-3%. The other thing to think about is what if it takes 10 years to go from 2.5% to 6%.  What would be your total return? Would it it be more or less than the return you get by investing in cash? Given the US governments huge need to keep rates low (do the math on what it will cost to finance the deficits we have run up over the past 30 years with a 8% rate)  I wouldn't be shocked to see another 10 years of low rates or a gradual creep (i.e. rates go back up to 5% over a decade)

If you really fear bond returns and are willing to lock up your money (you basically still lose money when the rates go up with penalties. If it is better or worse than bonds is very timing dependant) go with CDs. Or iBonds if  you have the space.

frugalecon

  • Bristles
  • ***
  • Posts: 463
Re: Bond alternative?
« Reply #38 on: July 23, 2014, 08:03:12 PM »
Depending on what the interest rate is on your mortgage, you might be better off buying bonds that offset your payment. I am working on a bond ladder that is calibrated to offset mortgage payments, working from the end of the mortgage backwards. I am using zero-coupon Treasuries for this purpose, which I hold in a brokerage account. The strategy permits me to arbitrage interest rates, because I can lock in a higher after-tax return on the Treasuries than I would from pre-paying the mortgage. Plus, the Treasuries are far more liquid. As long as comparable investments (comparable in risk terms) are available at a higher after-tax return, prepaying a mortgage is a loser.

The current 30-year Treasury is about 3.3%, and zero coupons are about the same.  Is your mortgage rate less than that?  You have a good mortgage rate!

I live in a jurisdiction with high state taxes. Because the imputed interest on zero coupon Treasuries is state-tax free, while I receive a state tax deduction for mortgage interest, my break even interest rate is 2.75%. I have easily beat that, though I am deferring further purchases at current low rates. I suspect they will be higher in six months.

dragoncar

  • Walrus Stache
  • *******
  • Posts: 8065
  • Registered member
Re: Bond alternative?
« Reply #39 on: July 23, 2014, 09:43:43 PM »
Depending on what the interest rate is on your mortgage, you might be better off buying bonds that offset your payment. I am working on a bond ladder that is calibrated to offset mortgage payments, working from the end of the mortgage backwards. I am using zero-coupon Treasuries for this purpose, which I hold in a brokerage account. The strategy permits me to arbitrage interest rates, because I can lock in a higher after-tax return on the Treasuries than I would from pre-paying the mortgage. Plus, the Treasuries are far more liquid. As long as comparable investments (comparable in risk terms) are available at a higher after-tax return, prepaying a mortgage is a loser.

The current 30-year Treasury is about 3.3%, and zero coupons are about the same.  Is your mortgage rate less than that?  You have a good mortgage rate!

I live in a jurisdiction with high state taxes. Because the imputed interest on zero coupon Treasuries is state-tax free, while I receive a state tax deduction for mortgage interest, my break even interest rate is 2.75%. I have easily beat that, though I am deferring further purchases at current low rates. I suspect they will be higher in six months.

Interesting, but isn't the coupon also state tax free?

frugalecon

  • Bristles
  • ***
  • Posts: 463
Re: Bond alternative?
« Reply #40 on: July 24, 2014, 03:45:56 AM »
Depending on what the interest rate is on your mortgage, you might be better off buying bonds that offset your payment. I am working on a bond ladder that is calibrated to offset mortgage payments, working from the end of the mortgage backwards. I am using zero-coupon Treasuries for this purpose, which I hold in a brokerage account. The strategy permits me to arbitrage interest rates, because I can lock in a higher after-tax return on the Treasuries than I would from pre-paying the mortgage. Plus, the Treasuries are far more liquid. As long as comparable investments (comparable in risk terms) are available at a higher after-tax return, prepaying a mortgage is a loser.

The current 30-year Treasury is about 3.3%, and zero coupons are about the same.  Is your mortgage rate less than that?  You have a good mortgage rate!

I live in a jurisdiction with high state taxes. Because the imputed interest on zero coupon Treasuries is state-tax free, while I receive a state tax deduction for mortgage interest, my break even interest rate is 2.75%. I have easily beat that, though I am deferring further purchases at current low rates. I suspect they will be higher in six months.

Interesting, but isn't the coupon also state tax free?

Yes, coupons are state tax-free as well. I decided to do this with zeros b/c that is a close analogue to prepaying the mortgage. Prepaying your mortgage is very similar to buying a zero coupon bond. There is some reinvestment risk if you do it with non-zeros.