5 year ladder vs Cash and 30 year barbell

Discussion of the Bond portion of the Permanent Portfolio

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doodle
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5 year ladder vs Cash and 30 year barbell

Postby doodle » Fri Aug 04, 2017 8:09 am

Im trying to do some upside / downside calculations on whether for capital preservation it makes more sense in the present environment to trade in my (25% - 30 year) / (25% - Cash) barbell style traditional permanent portfolio for a (50% - 5 year ladder). The yield difference between the 5 year and the 30 year is only 1% and I would like to start plotting what the upside vs downside potential for these two strategies would be in both rising and falling rate scenarios. Is there a calculator out there that is good to calculate yield vs price changes for various duration bonds?
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jhogue
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Re: 5 year ladder vs Cash and 30 year barbell

Postby jhogue » Fri Aug 04, 2017 9:02 am

doodle wrote:Im trying to do some upside / downside calculations on whether for capital preservation it makes more sense in the present environment to trade in my (25% - 30 year) / (25% - Cash) barbell style traditional permanent portfolio for a (50% - 5 year ladder). The yield difference between the 5 year and the 30 year is only 1% and I would like to start plotting what the upside vs downside potential for these two strategies would be in both rising and falling rate scenarios. Is there a calculator out there that is good to calculate yield vs price changes for various duration bonds?


doodle,

How will you know for sure that rates will rise or fall?

-Don’t lock up your Cash-designated assets in intermediate/long-term securities.
Your first big chunk of Cash needs to be “Shallow Cash,” dedicated to regular expenses, an emergency fund, and rebalancing.

-Don’t chase yield with your PP Cash.
Banks will try to convince you that you can get a better yield investing with them. That offer always requires that you assume additional risk in safety, stability, or liquidity in your Cash. Don’t be fooled by the sales pitch and don’t take on additional risks with your Cash.

-Don’t overload your IRA with CDs or TIPS.
The tax-deferred space in your IRA is limited. Save that space for potentially higher yielding stocks and 30 year T bonds. Buying I bonds automatically creates new tax deferred space outside of IRAs. They also offer better tax treatment after you reach age 70 ½. You are planning on living that long, aren’t you?
“Groucho Marx wrote:
A stock trader asked him, "Groucho, where do you put all your money?" Groucho was said to have replied, "In Treasury bonds", and the trader said, "You can't make much money on those." Groucho said, "You can if you have enough of them!"
doodle
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Re: 5 year ladder vs Cash and 30 year barbell

Postby doodle » Fri Aug 04, 2017 9:44 am

I don't know for sure if rates will rise or fall but Im simply trying to ascertain the risk vs reward of switching to a 5 ladder should rates get much lower from here.
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Desert
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Re: 5 year ladder vs Cash and 30 year barbell

Postby Desert » Fri Aug 04, 2017 8:22 pm

doodle wrote:I don't know for sure if rates will rise or fall but Im simply trying to ascertain the risk vs reward of switching to a 5 ladder should rates get much lower from here.


Historically, the bond bullet at 5-10 years maturity performed almost identical to the cash/LTT barbell. As you know, it mostly comes down to the average duration of the bond mix. TLT's current duration is about 17.6 years, while the cash duration is near zero. The blended duration will be a bit higher than an intermediate treasury ladder or fund such as Vanguard's VFITX with a duration of 5.3 years. So the interest rate risk of the 5 year bullet should be just a bit lower than the barbell. The blended yield of the barbell is about 0.1% higher than the 5 year treasury bullet ... so as expected, you're getting a tiny bit less yield in exchange for the reduced interest rate risk.

I don't think it'll make much difference. I'd just use whatever is easier in your circumstances.
Hal
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Re: 5 year ladder vs Cash and 30 year barbell

Postby Hal » Fri Aug 04, 2017 11:10 pm

You may wish to do a search on Clive and bond ladder.
I remember he covered this in detail a few years back.
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jhogue
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Re: 5 year ladder vs Cash and 30 year barbell

Postby jhogue » Fri Aug 04, 2017 11:44 pm

You might want to consider a second opinion on the benefits of the barbell strategy.

See:
Ryan Melvy, Stable Investing
“The combination of greater tax efficiency and liquidity make the barbell approach far superior to an intermediate bond fund. In fact, I can’t think of any compelling advantages to the intermediate funds. Perhaps they are easier to watch than the barbell for an undisciplined investor but for an investor who sees the bigger picture, barbells are the way to go.”

http://www.stableinvesting.com/2011/12/ ... rbell.html
“Groucho Marx wrote:
A stock trader asked him, "Groucho, where do you put all your money?" Groucho was said to have replied, "In Treasury bonds", and the trader said, "You can't make much money on those." Groucho said, "You can if you have enough of them!"
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sophie
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Re: 5 year ladder vs Cash and 30 year barbell

Postby sophie » Sat Aug 05, 2017 9:19 am

I think the motivation for doodle's post is the flattening of the yield curve:

Date 1 Mo 3 Mo 6 Mo 1 Yr 2 Yr 3 Yr 5 Yr 7 Yr 10 Yr 20 Yr 30 Yr
08/04/17 1.00 1.08 1.14 1.23 1.36 1.51 1.82 2.08 2.27 2.61 2.84

I really don't know what to do in this situation either. It's not much of a barbell if a 30 year bond gets you less than 0.6% extra interest over a 10 year bond - i.e. the extra 20 years gets you about what you get going from 1 month to 3 years. There's been flattened or even inverted curves before, but we've never discussed how to respond to it. PP simulations just rocket through these periods, so probably nothing disastrous will happen. But if I were in the market for long bonds right now, I'd give serious consideration to buying 10 years as long as this situation holds.

However - I wouldn't abandon the barbell structure. Having cash is just way too valuable to give up. The only modification I'd make is to shorten the maturities of the long bonds.
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Mark Leavy
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Re: 5 year ladder vs Cash and 30 year barbell

Postby Mark Leavy » Sat Aug 05, 2017 3:11 pm

I really appreciated this post Sophie. Thank you.

I rebalanced recently - and (not surprisingly) cashed in on some profits from equities. I refreshed my cash reserve. A very nice feeling. And... to lessen the tax blow, I have been debating on whether or not to do some tax loss harvesting by selling bonds and rebuying similar but different coupons. Your comments now have me thinking that it might make sense to sell 30's and buy 10's - as part of the process of registering the tax losses. Some serious thinking to do.

As always, thank you for your well thought out comments.
Mark


sophie wrote:I think the motivation for doodle's post is the flattening of the yield curve:

Date 1 Mo 3 Mo 6 Mo 1 Yr 2 Yr 3 Yr 5 Yr 7 Yr 10 Yr 20 Yr 30 Yr
08/04/17 1.00 1.08 1.14 1.23 1.36 1.51 1.82 2.08 2.27 2.61 2.84

I really don't know what to do in this situation either. It's not much of a barbell if a 30 year bond gets you less than 0.6% extra interest over a 10 year bond - i.e. the extra 20 years gets you about what you get going from 1 month to 3 years. There's been flattened or even inverted curves before, but we've never discussed how to respond to it. PP simulations just rocket through these periods, so probably nothing disastrous will happen. But if I were in the market for long bonds right now, I'd give serious consideration to buying 10 years as long as this situation holds.

However - I wouldn't abandon the barbell structure. Having cash is just way too valuable to give up. The only modification I'd make is to shorten the maturities of the long bonds.
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Desert
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Re: 5 year ladder vs Cash and 30 year barbell

Postby Desert » Sat Aug 05, 2017 4:01 pm

jhogue wrote:You might want to consider a second opinion on the benefits of the barbell strategy.

See:
Ryan Melvy, Stable Investing
“The combination of greater tax efficiency and liquidity make the barbell approach far superior to an intermediate bond fund. In fact, I can’t think of any compelling advantages to the intermediate funds. Perhaps they are easier to watch than the barbell for an undisciplined investor but for an investor who sees the bigger picture, barbells are the way to go.”

http://www.stableinvesting.com/2011/12/ ... rbell.html


More recently, Mr. Melvy has moved to a bogle 3-fund portfolio and holds TBM.
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Kbg
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Re: 5 year ladder vs Cash and 30 year barbell

Postby Kbg » Sat Aug 05, 2017 10:04 pm

Somewhere on this board a month or two ago I posted an analysis...and if one's assumption is that rates are going up using a bullet was a no brainer. After interest rates get higher then it makes sense to extend again...of course, good luck predicting interest rates.

The simple mechanics to remember...early in the cycle you get crushed if you are long and especially at the rates we are now. After a while interest rate increases do less damage and you get more compensated as the coupon size increases.
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Desert
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Re: 5 year ladder vs Cash and 30 year barbell

Postby Desert » Sat Aug 05, 2017 10:51 pm

Kbg wrote:Somewhere on this board a month or two ago I posted an analysis...and if one's assumption is that rates are going up using a bullet was a no brainer. After interest rates get higher then it makes sense to extend again...of course, good luck predicting interest rates.

The simple mechanics to remember...early in the cycle you get crushed if you are long and especially at the rates we are now. After a while interest rate increases do less damage and you get more compensated as the coupon size increases.


I would state it just a bit differently: If the yield curve is expected to steepen, the bullet wins. If the yield curve is expected to flatten, the barbell wins. But those are second order effects. The most important, first order effect is the duration. And typically the barbells discussed here have a longer duration than the bullets considered. In that case, the bullet will obviously outperform in a rising rates environment.
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Desert
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Re: 5 year ladder vs Cash and 30 year barbell

Postby Desert » Sat Aug 05, 2017 10:58 pm

Oh, and of course I agree with you, kbg, that it's impossible to predict which direction the yield curve is heading. So choosing the average duration is important, but choosing between a barbell and bullet requires a prediction of future yield curve shape changes. And those fluctuations are likely to average out over time, in which case it won't matter much whether one goes with a barbell or bullet.

Regarding holding cash, I simply don't see the purpose because an intermediate treasury fund or ladder can be turned into cash very quickly. The taxable versus tax-deferred account space may influence the decision in some cases. My approach is to average out the entire duration to equate to an intermediate treasury fund of 5-7 years maturity, choosing the best options available to me, whether they're treasuries, CD's, savings accounts, I bonds, etc.

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