Long bonds and a new, well off investor

[6 Iron]

I have a friend that has been following the PP for about a year, and while he has internalized the concepts, is still having a hard time buying long bonds. In all honesty, it is much easier for me to own them as part of my portfolio than it would be to buy all of them today. He is at present running a portfolio of 50% cash and shorter duration bills/notes, with 25 % gold and 25 % stocks. He cannot  (will not) pull the trigger on long bonds at one time. Would you advise slowly dollar cost averaging into long bonds,  or is this pushing the warranty so much that he is unlikely to become a successful permanent portfolio investor?

[melveyr]

DCA has emotional benefits but no theoretical financial benefits for a rational investor. Only he can answer if DCA is right for him; from my perspective DCA into any asset is stupid. It's one of those "common sense" things that sounds and feels right.

Regardless, a portfolio of gold, stocks, and cash would see a tremendous reduction in risk if LTT were added to the mix. If DCA is the only emotional way for him to do it I guess it is better than nothing.

[6 Iron]

My concern is that his holdout is based on a continued belief in market timing, but my thought in supporting DCA is that it would allow him to have a stake in all of the assets of the portfolio, and watch how they respond to the unexpected in the future with some skin in the game. Certainly, all in would be best.

[6 Iron]

On another thread, Gosso wrote the following:

"Honestly, I see no problem with someone converting the STT/LTT to an intermediate bond holding with an average duration of 5 years.  Below are the real CAGR of a portfolio with 50% allocated to a bond fund with an average duration of 5 years (this can be replicated with a 10 year bond ladder), 25% stocks, 25% gold -- compared to the standard 4x25% PP:
 
                       25/25/50        4x25% PP
1972-1977         5.0%            4.9%
1977-1982         3.4%            3.5%
1982-1987         7.6%            7.9%
1987-1992         3.2%            2.9%
1992-1997         6.3%            6.4%
1997-2002         3.3%            3.2%
2002-2007         7.0%            7.0%
2007-2011         6.8%           7.1%
Overall               5.15%         5.17%

Data Source: Simba

LLT may provide a short-term reduction in volatility, but over a few years the overall returns are not significantly impacted.

I'll admit that I hate LTT, but I also understand that they are priced this way because stocks do not look promising and inflation is not on the radar.  But that can change.

Ultimately, it doesn't really matter, but if someone is more comfortable with intermediate bonds than the STT/LTT, then I'd say go with the intermediate bonds."

This may make for a less enjoyable ride in our current deflationary environment, but does seem like a reasonable idea. Thanks, and I will see if I can get him to become a poster and not a lurker.

[MediumTex]

He thinks he is reducing his portfolio risk by avoiding LT treasuries when he is actually increasing it.

One of the things new PP investors should get comfortable with right off the bat is the idea that one or more of their assets probably WILL decline in value after it is purchased, and that is okay.

[Alanw]

I was skeptical of LTT's when I implemented my PP almost two years ago and they were yielding around 4.25% because rates can't go any lower.  I was skeptical last year when LTT's were in the 3+% range and I am skeptical today at 2.7%.  I'll probably still be skeptical if and when they yield 2%.  Am I going to limit my exposure to LTT's?  No way. 

[murphy_p_t]

I was skeptical of LTT's when I implemented my PP almost two years ago and they were yielding around 4.25% because rates can't go any lower.  I was skeptical last year when LTT's were in the 3+% range and I am skeptical today at 2.7%.  I'll probably still be skeptical if and when they yield 2%.  Am I going to limit my exposure to LTT's?  No way.

i share your experience...only i didn't really understand bonds until I got into the PP

[Gosso]

Does he understand that a STT/LTT barbell is very similar to a 10 year bond.  Both have a duration of around 8.5 years.  If that is still too risky for him then I'd put him into something with a duration of around 5 years (1-10 year ladder or IEI).  That will give most of the same protection as the STT/LTT barbell. 

LTTs mainly protect from falling interest rates, they don't offer any more protection than cash during a sustained deflation, except for a slightly higher yield.

[murphy_p_t]

this article might help http://www.zerohedge.com/news/2012-12-0 ... on-america

how the LTT bull market keeps going

[christina]

Does he understand that a STT/LTT barbell is very similar to a 10 year bond.  Both have a duration of around 8.5 years.  If that is still too risky for him then I'd put him into something with a duration of around 5 years (1-10 year ladder or IEI).  That will give most of the same protection as the STT/LTT barbell. 

LTTs mainly protect from falling interest rates, they don't offer any more protection than cash during a sustained deflation, except for a slightly higher yield.

Hi there,
Don't you lose some of your buy-low-sell-high ability if you don't do a barbell and opt for the middle ground?

[Gosso]

Hi there,
Don't you lose some of your buy-low-sell-high ability if you don't do a barbell and opt for the middle ground?

Not really.  The majority of the LTT returns are derived from its coupon, so the price is usually more or less stable.  The recent move higher in LTTs is pretty unusual.


Source: FRED, http://www.federalreserve.gov/releases/h15/data.htm

I guess there could be a small rebalancing bonus, but you would still be able to capture most of that with intermediate bonds.

I'm not suggesting that intermediate is better than the barbell.  They both accomplish roughly the same goal.

***

I was thinking that a decent PP tweak would be to invest in the STT/LTT barbell when the yield curve is steep, then switch to intermediate bonds when the curve flattens.  I did some sloppy backtesting with this, but didn't find much of a bonus (plus I didn't factor in taxes or slippage).

[murphy_p_t]

"Not really.  The majority of the LTT returns are derived from its coupon, so the price is usually more or less stable.  The recent move higher in LTTs is pretty unusual."

I'm probably stating the obvious...but if (when?) LTT revert to the mean...you give up the equivalent of 5-15 years worth of interest coupon payments

Of course, this is just looking at LTT in isolation.

[dualstow]

6 Iron, why not have your friend make LTT a full 25% of a smaller pp. Outside of the pp, he can continue to invest in short-term treasuries. If he likes the performance of the pp, he can increase its size. If not, if bonds have tanked a great %, it won't translate to a lot of dollars lost in his sample pp. That's how I started.

[melveyr]

I would take a look at using an intermediate fund such as TLH.

He could do:
25% VTI
25% GLD
50% TLH

It seems less crazy than the 4 way split while economically being almost identical 

Edit: Ah MangoMan already mentioned this. But it's worth a look!

[Bean]

I would take a look at using an intermediate fund such as TLH.

He could do:
25% VTI
25% GLD
50% TLH

It seems less crazy than the 4 way split while economically being almost identical 

Edit: Ah MangoMan already mentioned this. But it's worth a look!

I am not sure if it was mentioned elsewhere, but what would be the rebalanced triggers with this 3 way split?  I always got the impression that the 4 way split allows for selling overvalued asset classes for undervalued assets in a very systematic way.

[melveyr]

I would take a look at using an intermediate fund such as TLH.

He could do:
25% VTI
25% GLD
50% TLH

It seems less crazy than the 4 way split while economically being almost identical 

Edit: Ah MangoMan already mentioned this. But it's worth a look!

I am not sure if it was mentioned elsewhere, but what would be the rebalanced triggers with this 3 way split?  I always got the impression that the 4 way split allows for selling overvalued asset classes for undervalued assets in a very systematic way.

You could do annual or set up some band. Perhaps if any asset class deviates 10 percentage points from its target weighting, which would make it almost identical to the vanilla PP.

[Tyler]

One of the things new PP investors should get comfortable with right off the bat is the idea that one or more of their assets probably WILL decline in value after it is purchased, and that is okay.

Yep -- that took me a little while, but eventually I came to accept that if every investment is going up at the same time then you're not truly diversified.

[lazyboy]

I would take a look at using an intermediate fund such as TLH.

He could do:
25% VTI
25% GLD
50% TLH

It seems less crazy than the 4 way split while economically being almost identical 

Edit: Ah MangoMan already mentioned this. But it's worth a look!

I am not sure if it was mentioned elsewhere, but what would be the rebalanced triggers with this 3 way split?  I always got the impression that the 4 way split allows for selling overvalued asset classes for undervalued assets in a very systematic way.

You could do annual or set up some band. Perhaps if any asset class deviates 10 percentage points from its target weighting, which would make it almost identical to the vanilla PP.

I was looking up duration for TLH and found this article:
http://etfdailynews.com/2011/07/14/know ... h-tlt-edv/
the article has a nice duration chart. THL seems to be right in the middle of the curve for all treasury funds.

[melveyr]

I was looking up duration for TLH and found this article:
http://etfdailynews.com/2011/07/14/know ... h-tlt-edv/
the article has a nice duration chart. THL seems to be right in the middle of the curve for all treasury funds.

Yeah I really think its perfect and will give you results almost identical to the PP, probably a little better.

[lazyboy]

I was looking up duration for TLH and found this article:
http://etfdailynews.com/2011/07/14/know ... h-tlt-edv/
the article has a nice duration chart. THL seems to be right in the middle of the curve for all treasury funds.

Yeah I really think its perfect and will give you results almost identical to the PP, probably a little better.

Thanks, melveyr. Over the new year, I rebalanced, sold TLT and moved into TLH for most of my 50% bond exposure- except for setting aside about a year's worth of estimated cash living expenses  which I placed in a MM fund, my bank account and a short term TIPS ETF=VTIP. It does simplify the bond allocation for me and I'll see how it plays out over the next year, at least. I plan to rebalance either once a year or at 10 points from target allocation. Note that from Vanguard's perspective, it looks like I'm concentrating my bond portfolio in long term bonds. They're likely considering any bonds beyond 5-10 year duration to be "long term." 

[Lonestar]

On another thread, Gosso wrote the following:

"Honestly, I see no problem with someone converting the STT/LTT to an intermediate bond holding with an average duration of 5 years.  Below are the real CAGR of a portfolio with 50% allocated to a bond fund with an average duration of 5 years (this can be replicated with a 10 year bond ladder), 25% stocks, 25% gold -- compared to the standard 4x25% PP:

                      25/25/50        4x25% PP
1972-1977        5.0%            4.9%
1977-1982        3.4%            3.5%
1982-1987        7.6%            7.9%
1987-1992        3.2%            2.9%
1992-1997        6.3%            6.4%
1997-2002        3.3%            3.2%
2002-2007        7.0%            7.0%
2007-2011        6.8%          7.1%
Overall              5.15%        5.17%

Data Source: Simba

LLT may provide a short-term reduction in volatility, but over a few years the overall returns are not significantly impacted.

I'll admit that I hate LTT, but I also understand that they are priced this way because stocks do not look promising and inflation is not on the radar.  But that can change.

Ultimately, it doesn't really matter, but if someone is more comfortable with intermediate bonds than the STT/LTT, then I'd say go with the intermediate bonds."

This may make for a less enjoyable ride in our current deflationary environment, but does seem like a reasonable idea. Thanks, and I will see if I can get him to become a poster and not a lurker.

Does anyone have this type of overall return data with TLH or 10 year bond?  I don't know why but I think I could feel more comfortable combining my short & long term treasuries.  Most simple and lowest expense might be to buy treasuries with same maturity as the duration of TLH.