Need Advice on 25% Bond Allocation

[rickb]

One thing that's confusing me here is where the 20% higher price comes from - is that from selling the bond to someone else, or the relative worth of the bond and its yield?

I'm not sure how $5000 @ 6.75% is worth 20% more because newer bonds are only being sold at 4%.

Bonds pay a constant interest amount during their lifetime, so their current price floats with the prevailing interest rates.  Decreasing interest rates cause bond values to rise, while increasing interest rates cause bond prices to fall.  Think of it this way - if you buy a 10-year $5000 bond @ 6.75% and then a year later interest rates are at 4%, would you rather have the (now) 9-year bond paying $337.50 per year or a new 9-year $5000 bond paying only $200 per year?  Given that anyone would rather have the 9-year bond paying $337.50, its market price goes up.  It goes up enough so that its current yield to maturity more or less matches a bond you can buy now (i.e. the price will reflect a YTM of about 4%).  YTM is not quite this simple, but if you multiply out the remaining interest payments you'll get a rough idea of how much more than $5000 the older bond is worth.  9 x $337.50 = $3037.50.  9 x $200 = $1800.  So the older bond should cost roughly $3037.50 - $1800 = $1237.50 more than $5000.

[LonerMatt]

One thing that's confusing me here is where the 20% higher price comes from - is that from selling the bond to someone else, or the relative worth of the bond and its yield?

I'm not sure how $5000 @ 6.75% is worth 20% more because newer bonds are only being sold at 4%.

Bonds pay a constant interest amount during their lifetime, so their current price floats with the prevailing interest rates.  Decreasing interest rates cause bond values to rise, while increasing interest rates cause bond prices to fall.  Think of it this way - if you buy a 10-year $5000 bond @ 6.75% and then a year later interest rates are at 4%, would you rather have the (now) 9-year bond paying $337.50 per year or a new 9-year $5000 bond paying only $200 per year?  Given that anyone would rather have the 9-year bond paying $337.50, its market price goes up.  It goes up enough so that its current yield to maturity more or less matches a bond you can buy now (i.e. the price will reflect a YTM of about 4%).  YTM is not quite this simple, but if you multiply out the remaining interest payments you'll get a rough idea of how much more than $5000 the older bond is worth.  9 x $337.50 = $3037.50.  9 x $200 = $1800.  So the older bond should cost roughly $3037.50 - $1800 = $1237.50 more than $5000.

Right, thanks for the explanation - how are bonds sold then? To a broker? Back to the government? Or is it a little ephemeral?

Clive, thanks for the details - it's consistently impressive how much thought and time you're spending on me .

[stone]

Loner Matt, to illustrate, I bought some UK 50year treasuries with a 4% coupon at £0.92 earlier this year and sold some of them at £1.23 recently because the yield has fallen (I'm a bit nervous and have strayed to keeping the rebalancing bands closer than 15%-35%). Perhaps next year, the yield will increase and the price fall back down to £0.90 or whatever (or it might go to £0.50 or £1.50). LTT prices swing around a lot.

As an Australian investor, your problem with US LTT is that they would not fit properly into the gap between the other Australian PP assets. For an Australian investor, US LTT would be a mash up of currency risk and US interest rate risk whilst the role you are needing to fill is pure Australian interest rate risk and that is covered by Australian LTT (or 12 year bonds which are the closest thing available). In the PP, gold covers the currency risk.

Imagine if a Japanese investor had held US LTT instead of Japanese LTT within an otherwise Japanese PP from 1989 onwards. It would have been a catastrophe. It was Japanese LTT that saved the Japanese PP when stocks fell >80% (and have stayed down for two decades).

[LonerMatt]

Ok - but if I consider Clive's advice in having some US Small caps and US LTT doesn't that "protect" me from such collapses?

I'm certainly not considering using US LTTs in place of Australia bonds.

What I am considering is starting with an "All Australian PP" and then rebalancing with purchases in the US market. What I'm wondering about is what the US offers that other countries don't - there are other high value, stable currencies (the Pound, for instance, or the Canadian Dollar). I suppose there's the USD always being in demand, globally, and that there's a wealth of information here about bonds/stocks/ETFs that fit the PP's requirements, which is a plus, too.

[stone]

I suppose the USA is the largest and most global market. Entities such as oil rich sovereigns etc used to save primarily in the US market. The problem is that that is starting to break down. The Abu-Dahbi sovereign wealth fund now has all of its treasury holdings as emerging market treasuries (Brazil, Malaysia etc government bonds in those currencies).

Canada and Australia are fairly similar in that they are  commodity driven economies. Japan is the opposit. Japan imports commodities and exports manufactured goods. Amoungst emerging markets, Brazil and Russia export commodities and China exports manufactured goods.

I think the great thing about the PP is that it works for any given country's assets. Gold covers all the global exposure requirements. If your own country goes belly up (as with Iceland in 2008) gold gives the lifeline to global wealth.
I think holding a combination of various national PP might give some extra benefit but it would be a lot more hassle for a little gain. The extra taxes and transaction costs would eat into the (possible) extra gain. If you feel compelled to do that then perhaps holding very very diverse countries PP might be best eg Japan and Brazil.

I definately would not advise a fluid transition amoungst various international asset classes. To focuss your mind on how dangerous that would be, imagine rebalancing out of Japanese stocks in 1989 into US LTT rather than Japanese LTT or holding US stocks in an Iceland PP rather than Iceland stocks during the 1999 to 2007 period.

[LonerMatt]

I definitely think those gold prices are a little whack - at least in 2000-2011. I'm amending them now.

Perth Mint have a file that has the gold price for each day of each year dating back into the 1970s (http://www.perthmint.com.au/investment_ ... rices.aspx) - I'll use that to amend your data .

[LonerMatt]

Awesome,

Looks quite similar to the one I bang out.

The reason we're having trouble finding data from the early 70s is that in that time, Australia was Pounds and Pennies, not Dollars and Cents - so most data for Dollar price will end in 1974.

[AB]

For anyone who stumbles across this thread, there's more discussion of Australian Government bonds in the HBPP at http://gyroscopicinvesting.com/forum/ht ... ic.php?t=4