Vanguard Blog: Why I still own Treasuries

[lazyboy]

Nothing new to PP holders but an interesting post validating the need for LTT.

http://www.vanguardblog.com/2012.03.15/ ... uries.html

"But what if U.S. interest rates rise a lot, as in the 1970s and early 1980s?

Should U.S. interest rate rise dramatically at some point over the next several years, the immediate losses and volatility of Treasury bonds wouldn’t be pleasant. But I try to remind myself every time I look at my portfolio that over the long term, it’s interest income—and the reinvestment of that income—that accounts for the largest portion of total returns for many bond funds. The impact of price fluctuations can potentially be offset by staying invested and reinvesting income, even if the future is similar to the rising-rate environment of the late 1970s and early 1980s.

During this period, the yield on the 10-year Treasury bond nearly doubled, rising from approximately 8.0% in December 1975 to as high as 15.3% in September 1981. At the end of 1983, the 10-year Treasury yield remained in double-digits, standing at 11.8%. Yet a hypothetical $10,000 investment (with all investment income reinvested) in the Barclays’ Capital U.S. Aggregate Bond Index (the benchmark for the Vanguard Total Bond Market Index) made on December 31st, 1975 would have increased to over $13,500 by September 1981 and would have actually doubled to $20,000 by the end of 1983—not necessarily a disastrous outcome given the period’s secular rise in interest rates. Moreover, the high interest rates in the early 1980s subsequently fell as inflation expectations declined and monetary policy became more restrictive, setting the stage for even higher bond returns over the following decade.

For me, the key is staying invested and reinvesting income. That has meant periodically rebalancing my portfolio and “selling”? bonds for stocks when bonds have beaten stocks, and vice versa. While I find these steps fairly simple, and suitable for me, everyone should remember to construct their portfolios based on their own financial situation. Should rates rise this year, a certain percentage of the Treasury and other bonds would mature, and those proceeds would be reinvested in higher-yielding securities."

[dualstow]

Good blog post. Thanks for the link!

[MediumTex]

That's a pretty good case for holding bonds at all times (though I think it minimizes the damage inflation did to an all-bond portfolio in the 1975-1983 period).

To me, the beauty of the PP is that it allows an investor to participate in the steady income provided by bonds for 50% of the portfolio, since t-bill rates have historically been only a little lower than 30 year bond rates, and sometimes even higher when the yield curve is inverted, while protecting the investor from market conditions that are unfavorable for bonds by holdings stocks and gold as well.

To give you a sense of what inflation would have done to a bond portfolio in the 1975-1983 window here is the CPI for those years:

1975: 9.2%
1976: 5.75%
1977: 6.5%
1978: 7.62%
1979: 11.22%
1980: 13.58%
1981: 10.35%
1982: 6.15%
1983: 3.22%

Over this 9 year period, inflation averaged 8.17%

If a person saw the nomial value of a bond investment double over this period, it would mean that it earned an average annual return of 8%.  In other words, a bond investor over this 9 year period lost .17% a year in inflation-adjusted terms, which to me isn't very impressive.

Contrast the above scenario with the PP, which had the following returns in the 1975-1983 period:

1975: 8.3%
1976: 12.2%
1977: 5.6%
1978: 12.1%
1979: 42.1%
1980: 13.4%
1981: (3.9%)
1982: 23.3%
1983: 4.2%

Over this 9 year period the PP averaged 13.03% in nominal returns, and with inflation at 8.17%, the PP would have provided 4.86% in inflation adjusted returns, which is exactly what it is supposed to do (i.e., provide inflation adjusted returns in the 4-5% range).

[alvinroast]

Contrast the above scenario with the PP, which had the following returns in the 1975-1983 period:

1975: 8.3%
1976: 12.2%
1977: 5.6%
1978: 12.1%
1979: 42.1%
1980: 13.4%
1981: (3.9%)
1982: 23.3%
1983: 4.2%

Over this 9 year period the PP averaged 13.03% in nominal returns, and with inflation at 8.17%, the PP would have provided 4.86% in inflation adjusted returns, which is exactly what it is supposed to do (i.e., provide inflation adjusted returns in the 4-5% range).

Beautiful. That even includes the infamous year of 1981. Thanks for posting the inflation adjusted returns.

[lazyboy]

That's a pretty good case for holding bonds at all times (though I think it minimizes the damage inflation did to an all-bond portfolio in the 1975-1983 period).

To me, the beauty of the PP is that it allows an investor to participate in the steady income provided by bonds for 50% of the portfolio, since t-bill rates have historically been only a little lower than 30 year bond rates, and sometimes even higher when the yield curve is inverted, while protecting the investor from market conditions that are unfavorable for bonds by holdings stocks and gold as well.

To give you a sense of what inflation would have done to a bond portfolio in the 1975-1983 window here is the CPI for those years:

1975: 9.2%
1976: 5.75%
1977: 6.5%
1978: 7.62%
1979: 11.22%
1980: 13.58%
1981: 10.35%
1982: 6.15%
1983: 3.22%

Over this 9 year period, inflation averaged 8.17%

If a person saw the nomial value of a bond investment double over this period, it would mean that it earned an average annual return of 8%.  In other words, a bond investor over this 9 year period lost .17% a year in inflation-adjusted terms, which to me isn't very impressive.

Contrast the above scenario with the PP, which had the following returns in the 1975-1983 period:

1975: 8.3%
1976: 12.2%
1977: 5.6%
1978: 12.1%
1979: 42.1%
1980: 13.4%
1981: (3.9%)
1982: 23.3%
1983: 4.2%

Over this 9 year period the PP averaged 13.03% in nominal returns, and with inflation at 8.17%, the PP would have provided 4.86% in inflation adjusted returns, which is exactly what it is supposed to do (i.e., provide inflation adjusted returns in the 4-5% range).

Thanks, MT.  As a side issue, I'm a retiree in a PP withdrawal phase. Would it make more sense to have LTT interest (and Stock dividends) moved to MM or reinvested?

[MediumTex]

Thanks, MT.  As a side issue, I'm a retiree in a PP withdrawal phase. Would it make more sense to have LTT interest (and Stock dividends) moved to MM or reinvested?

I would say have all dividends across the whole portfolio go into cash.  If you use the cash as your drawdown source, this approach should delay rebalancing for as long as possible.