Building a Treasury Bond Ladder • Hacker News Board

Re: Building a Treasury Bond Ladder

#11

Post by jterenzio » Tue, Aug 28, 2018, 4:11 PM UTC

snikeris wrote: post #8

ctchocula wrote: post #5

This is something I've always wondered: Are treasury bond ladders strictly better than an equivalent treasury bond fund (say VFITX), because the interest rate risk can cause the bond fund to lose value while the treasury bond ladder is guaranteed to not lose value if held to maturation? Or is there some finance black magic that causes treasury bond ladders and treasury bond funds with the same effective maturity to h…

From the article: > Bond prices fall as interest rates rise. You can avoid this by buying individual bonds and holding them until they mature (pay out their full value). You can avoid selling the bond at a loss; however, you are still holding a bond that earns less interest than current bonds are earning. As far as I know, holding to maturity doesn't improve your returns in the face of rising interest rates despite w…

What holding does is lock your returns and sets a floor. When you buy a bond and hold it you will be guaranteed to receive the return. Sure if rates rise afterwards you have opportunity cost because you can't invest that money at a higher rate, but that's what ladders help you do. You get the current rate when you add new bonds to the end. What alternatives exist? You can buy a bond fund which might decline in value if rates rise or just sit on cash but those don't seem optimal.

Re: Building a Treasury Bond Ladder

#12

Post by barbegal » Tue, Aug 28, 2018, 4:12 PM UTC

This seems overly complicated. The market for bonds reflects the current inflation and interest conditions so selling bonds at any moment in time should on average be as profitable as holding them to maturity (except for broker fees which are usually quite small). I would just buy bonds and sell them if and when required.

Re: Building a Treasury Bond Ladder

#13

Post by frgtpsswrdlame » Tue, Aug 28, 2018, 4:12 PM UTC

ctchocula wrote: post #5

This is something I've always wondered: Are treasury bond ladders strictly better than an equivalent treasury bond fund (say VFITX), because the interest rate risk can cause the bond fund to lose value while the treasury bond ladder is guaranteed to not lose value if held to maturation? Or is there some finance black magic that causes treasury bond ladders and treasury bond funds with the same effective maturity to h…

>Or is there some finance black magic that causes treasury bond ladders and treasury bond funds with the same effective maturity to have the same return (ignoring expense ratio for now) after a long period of time?

Yes they converge in the long-term. A treasury bond fund is just a ladder (albeit maybe weighted a little differently) that reinvests in a convenient wrapper. The case being made here is that if you may need to pull money from the bond strategy then the ladder is good because there is always a bond that is very close to maturity.

Re: Building a Treasury Bond Ladder

#14

Post by jterenzio » Tue, Aug 28, 2018, 4:14 PM UTC

ctchocula wrote: post #5

This is something I've always wondered: Are treasury bond ladders strictly better than an equivalent treasury bond fund (say VFITX), because the interest rate risk can cause the bond fund to lose value while the treasury bond ladder is guaranteed to not lose value if held to maturation? Or is there some finance black magic that causes treasury bond ladders and treasury bond funds with the same effective maturity to h…

You are correct in rising interest rate environments where you believe the rates will continue to rise.

With bond funds you can get the same yield as the ladder (interest payments) if you hold forever and never sell, but if you sell you may take a hit because the price has gone down. That doesn't happen with ladders since you always get paid out the face value.

Re: Building a Treasury Bond Ladder

#15

Post by dmoy » Tue, Aug 28, 2018, 4:16 PM UTC

jhfdbkofdcho wrote: post #10

jterenzio wrote: post #6

Earlier quoted context omitted.

I agree for long-term investments a fund might be better (ex. in a retirement account mixed with equity funds) but if you bought those bond funds in the past few years and sold them you might not have made much of a return. For example in the past 1 year the price of VGSH went from 60.83 to 59.87 so you lost over 1% on the price change which cancels out most of the interest yield. My point is that for short-term savi…

Isn’t that ignoring dividend payouts? This says it’s like -0.2% over the last 12 months including payouts vs -1.6%. No idea how accurate this is but it’s an important correction to just the price returns if you’re talking about holding the shares. https://www.etfreplay.com/chart_totalreturn.aspx

Yes that is ignoring dividend payouts, which for a bond (edit: bond fund) is a substantial part of the return.

Re: Building a Treasury Bond Ladder

#16

Post by piker » Tue, Aug 28, 2018, 4:16 PM UTC

barbegal wrote: post #12

This seems overly complicated. The market for bonds reflects the current inflation and interest conditions so selling bonds at any moment in time should on average be as profitable as holding them to maturity (except for broker fees which are usually quite small). I would just buy bonds and sell them if and when required.

> (except for broker fees which are usually quite small)

Not quite. Commissions are charged on equities. Markups are charged on bonds. Markups are the difference between what the broker paid and how much a retail investor has to pay the broker and are much more opaque. They can be quite hefty. One just doesn't notice.

Re: Building a Treasury Bond Ladder

#17

Post by cirgue » Tue, Aug 28, 2018, 4:16 PM UTC

snikeris wrote: post #8

ctchocula wrote: post #5

This is something I've always wondered: Are treasury bond ladders strictly better than an equivalent treasury bond fund (say VFITX), because the interest rate risk can cause the bond fund to lose value while the treasury bond ladder is guaranteed to not lose value if held to maturation? Or is there some finance black magic that causes treasury bond ladders and treasury bond funds with the same effective maturity to h…

From the article: > Bond prices fall as interest rates rise. You can avoid this by buying individual bonds and holding them until they mature (pay out their full value). You can avoid selling the bond at a loss; however, you are still holding a bond that earns less interest than current bonds are earning. As far as I know, holding to maturity doesn't improve your returns in the face of rising interest rates despite w…

Yeah, the idea is that at any give price, holding any bond or selling it and using the proceeds to purchase bonds at the current rate are equivalent from a return perspective.

Re: Building a Treasury Bond Ladder

#18

Post by [deleted] » Tue, Aug 28, 2018, 4:16 PM UTC

ctchocula wrote: post #5

This is something I've always wondered: Are treasury bond ladders strictly better than an equivalent treasury bond fund (say VFITX), because the interest rate risk can cause the bond fund to lose value while the treasury bond ladder is guaranteed to not lose value if held to maturation? Or is there some finance black magic that causes treasury bond ladders and treasury bond funds with the same effective maturity to h…

[deleted]

Re: Building a Treasury Bond Ladder

#19

Post by jterenzio » Tue, Aug 28, 2018, 4:19 PM UTC

piker wrote: post #16

barbegal wrote: post #12

This seems overly complicated. The market for bonds reflects the current inflation and interest conditions so selling bonds at any moment in time should on average be as profitable as holding them to maturity (except for broker fees which are usually quite small). I would just buy bonds and sell them if and when required.

> (except for broker fees which are usually quite small) Not quite. Commissions are charged on equities. Markups are charged on bonds. Markups are the difference between what the broker paid and how much a retail investor has to pay the broker and are much more opaque. They can be quite hefty. One just doesn't notice.

It depends. In my article I pointed out that with Fidelity there are no commissions or markups on treasuries on the secondary market. If there were, it would definitely change the calculus.

Re: Building a Treasury Bond Ladder

#20

Post by mywittyname » Tue, Aug 28, 2018, 4:19 PM UTC

ctchocula wrote: post #5

This is something I've always wondered: Are treasury bond ladders strictly better than an equivalent treasury bond fund (say VFITX), because the interest rate risk can cause the bond fund to lose value while the treasury bond ladder is guaranteed to not lose value if held to maturation? Or is there some finance black magic that causes treasury bond ladders and treasury bond funds with the same effective maturity to h…

When you buy the bonds directly, you're choosing an explicit exit date and you know exactly what your return will be.

When you buy a bond fund, your principal is going to be reinvested, so there's a risk of interest rates going up right before you sell.

Some firms offer target maturity bond funds which will is the best of both worlds.