Gyroscopic Investing

guys,


long bonds rates have been dropping for 20+ years... what happens if long bond rates start creeping up for 20+ years after the fed stops holding them down artificially?


would it better to hold AGG rather then TLT in that case?  whats your thoughts on this.

thanks

sk,

I'm not sure if I follow your logic.  What do you see as a potential advantage to holding AGG vs. TLT?  The idea of holding long-term bonds is they are extremely susceptible to fluctuations in interest rates, which allows them to sustain the portfolio during deflation, when the rest of the portfolio crashes.  The reason to hold treasuries is that there is no default risk.  The US govt can always print money to make payments; therefore all of the price movement is from interest rate changes.

From the quick once-over I did on AGG, it seems like you would lose (or reduce) the sustaining power of the long-term bond given that an aggregate bond index should have a shorter average maturity than a long-term bond fund.  You also lose the security of holding only US treasuries. 

As interest rates rise, you will see a reduction in principal value of existing lower coupon bonds, but you will also see an increase in yield on newly issued bonds, which will help to offset some (but probably not all) of the principal losses.  Your cash should also be earning more as interest rates rise.

In a situation of rising interest rates, your stock or your gold will likely be sustaining the portfolio, whereas your long-term bonds will probably be the lagging asset.

There are others on here who have more knowledge of the historical situations where this has happened.  I'll leave it to them to chime in in that regard.

this was more for my bond allocation in my VP.

for example in 1970, wouldn't i rather hold a bond index with shorter duration than TLT.

sk55 wrote: would it better to hold AGG rather then TLT in that case?  whats your thoughts on this.

Yes it would, but a central precept of the PP is that we don't try to to time the market. There is no way to predict if or when this will happen, so we hold all four assets at all times.

If bonds were losing, some other part of the PP should be keeping the whole portfolio afloat.

The nice thing about when bonds are losing, though, is that you are still collecting a dividend from them, even if their underlying value is deteriorating.

Also, if you rebalance because of bond losses there is a chance you may be locking in very high future returns due to the high interest rates bonds would be paying under such conditions.

Overall, PP experience teaches you to expect that at least one PP asset will always be losing, and you learn not to care which one it happens to be at a given time.

sk55 wrote: guys,


long bonds rates have been dropping for 20+ years... what happens if long bond rates start creeping up for 20+ years after the fed stops holding them down artificially?


would it better to hold AGG rather then TLT in that case?   whats your thoughts on this.

thanks

No, it would be cash.  A sustained rise in rates is detrimental to any duration exposure.  Generally though, a 5-year yield of anything is 95% of longer duration yields, but with less volatility.

MG

Clive wrote: A 5 year ladder with each rung held to maturity will have one rung maturing each year for zero capital loss even if yields have risen, and will roll the proceeds into the higher yield when yields have risen.

I strongly suspect Clive knows this and this point may have been made before, but I think it's worth mentioning (even again) that a continually rolling 5-year ladder is really no different than owning a fund with the same duration.  The capital value of the ladder goes up and down with prevailing interest rates in exactly the same way (and by nearly exactly the same amount) as the capital value of a fund.  Owning a 5-year ladder of treasuries might make it feel like you don't lose capital if interest rates go up, but you most assuredly do.  On the other hand you can always get your "original" capital back in either case - with the ladder you stop funding the rungs as they mature, while with a fund you liquidate and buy a zero coupon bond that matures on the same date the last rung would mature. There's more on this on the bogleheads wiki, see http://www.bogleheads.org/wiki/Individu ... _Bond_Fund.

I recall at one point Clive suggested a Rate Tart approach to a 5 year ladder. The idea, as I understand it, is to buy the best yield available at 5 years or below. This might improve returns slightly over a fund that holds a rigid 5 year ladder especially in cases where interest rates are changing rapidly or the yield curve is inverted.

sk55 wrote: this was more for my bond allocation in my VP.

for example in 1970, wouldn't i rather hold a bond index with shorter duration than TLT.

Why are you holding bonds in your VP? Are you doing some sort of 60/40 split or are you actually speculating with the funds? Mostly when I hear VP I think speculation, and if I was expecting rising interest rates I probably wouldn't be holding bonds at all.  In the case of a 60/40 split I would think that you would want the bonds to handle deflation so I'd probably still be in something like TLT.  It really all depends on what your grounds for making the investment and what you want to be prepared to handle.

hoost wrote: Why are you holding bonds in your VP? Are you doing some sort of 60/40 split or are you actually speculating with the funds? Mostly when I hear VP I think speculation

I have some bonds in my vP as well. To put it simply, I want to own some 5- and 10-YR treasury notes, and they don't belong in the permanent portfolio.

hoost,

i am doing a custom blend in VP, which i wanted to include corp bonds, and other leveraged etf, etc.

I was playing with the boogleheads back-testing excel file, it seems to show the short term bonds do well in rising inflation.

sk55 wrote: hoost,

i am doing a custom blend in VP, which i wanted to include corp bonds, and other leveraged etf, etc.

I was playing with the boogleheads back-testing excel file, it seems to show the short term bonds do well in rising inflation.

I see.  Unfortunately I don't have much insight into AGG, as I think I mentioned. 

Just to challenge your thought process a little more, and hopefully enlighten me as well, why do short term bonds do well in rising inflation?  If this is true, would it be better to go with the shortest duration T-Bill?

Also bear in mind that once you venture away from Treasuries you're introducing default risk to the equation.  Might it be better just to choose one of the shorter-duration treasury funds from ishares to accomplish what you want?

Again, I don't have the answers, just trying to explore the idea a little more because it isn't something I've really thought about and I'm curious to learn more.

sk55 wrote: Just to challenge your thought process a little more, and hopefully enlighten me as well, why do short term bonds do well in rising inflation?  If this is true, would it be better to go with the shortest duration?

I don't think it's that they really "do well," so much as it is that they keep up.  

hoost wrote:

sk55 wrote: hoost,

Just to challenge your thought process a little more, and hopefully enlighten me as well, why do short term bonds do well in rising inflation?  If this is true, would it be better to go with the shortest duration T-Bill?

yes i after checking it out more 2-3 yr treasury seemed to do well.  The basically return about the same amount as stocks but with alot less volatility.  CAGR about 7.4  std 3.34  (during 1970s)
When inflation starts to spike, i think people just start fleeing out of long term bonds to go to the shorter end.  Which is the exact opposite of the deflation when people jump into the 30yr bonds.

Tbills did about 1% less in CAGR.