Gyroscopic Investing

In his podcast, Craig says to buy LT bonds (25-30 years matrity) but sell them after 20 years.  However, Craig didn't explain why the bonds should be sold at the 20 year mark.

Does anyone know the justification for selling?

Thanks.

Think of a bond as a contract to pay a certain amount for a certain time.  If you adjust the amount of time out further and further, any changes in the agreed upon amount will have greater implications to both parties, and therefore the FMV of said bond will sharply increase or decrease based on even small changes in interest rates after that contract has been entered into.

That being the case, as you hold a bond longer and longer into its life, it becomes a shorter and shorter future contract, and therefore you don't get the volatility you need (yes, you NEED that volatility) when interest rates change when you get past a certain point of "years to maturity."

For instance, if you were to buy a 30 year bond with 1 year of maturity left, the implications of the interest rate on that bond are much smaller (as it will be paid back in just one year) than agreeing on an interest rate for a 30-year period.

I think of the same thing when the Yankees make a bet to pay a guy for 10 years of pitching duty.  On the 10th year, if the guy starts to loose his skill, that's much different than if he starts to lose it in the first year.  The contract has little life left and little implication for the future (Think of "losing skill" as "interest rates rising").

After reading the FAQ and a lot of posts, it would seem that TLT has the most ideal volatility for the PP vs other funds. 

patrickjhall wrote: Does everyone feel that TLT bakes the appropriate level of volatility into its structure?

Compared to other funds, definitely. It's still better to own the bonds directly and sell them at 20 years remaining maturity though. But TLT is a good option if you can't do this.

TLT keeps the duration very close to 15, which is accomplished (as I understand it) by holding bonds with maturity dates very close to 30 years from now.  This increases the usefulness of LT bonds in the PP mix because it elevates their price volatility during periods when LT bond gains are needed to offset declines in other allocations.  Having said that, wouldn't buying the same bonds directly and holding them for 10 years result in reduced volatility as they get older? 

I understand that there are certain costs involved in buying/re-balancing bond holdings, and that TLT has a low expense ratio.  With all of this in mind, does this mean then that it's actually better to hold TLT rather than bonds directly?

TBV wrote: I understand that there are certain costs involved in buying/re-balancing bond holdings, and that TLT has a low expense ratio.  With all of this in mind, does this mean then that it's actually better to hold TLT rather than bonds directly?

In a large portfolio the commissions on buying and selling individual bonds will be lower than the expense ratio and commission on TLT.  With individual bonds there is no counterparty risk from the fund and you have more flexibility for tax management.  That being said, TLT is more convenient and institutional buyers like iShares get tighter bid/ask spreads on bonds than do individuals.  IMO the pros/cons are a wash on portfolios under 7 figures.

I'd add that buying bonds directly can be educational. 

Thanks, but what I was aiming at was the lower "good" volatility that directly-owned 30-year bonds will have as their duration decreases (i.e. as they get closer to the 10th year of ownership.)  So, aside from the cost of ownership aspect, do you get more clout from TLT and its collection of relatively newer 30-year bonds?  Or am I missing something?

TBV wrote: Thanks, but what I was aiming at was the lower "good" volatility that directly-owned 30-year bonds will have as their duration decreases (i.e. as they get closer to the 10th year of ownership.)  So, aside from the cost of ownership aspect, do you get more clout from TLT and its collection of relatively newer 30-year bonds?  Or am I missing something?

You are correct that a brand new 30-year bond will have more interest rate sensitivity than a ten year old 30-year bond, but I don't think it is a significant difference (someone can please correct me if I am mistaken).  The other thing to keep in mind is that as you add to the portfolio and/or rebalance, you will have a mix of maturities.

I wouldn't worry about the difference.

For a PP rookie, there may be some wisdom in using TLT to start with.  That way, if you get it up and running and hate it there will be less expense in un-winding it.

As far as whether TLT or individual bonds are superior, I really don't think it matters.

I think that a person who has been in the PP for a few years and is committed to it would probably want to own some individual bonds.

I own both TLT and individual bonds.  Why?  No reason other than I bought some TLT when I started out and I bought some individual bonds later when it was time to add to the LT bond portion.