Fixed Income - Bonds, Real Return Bonds, Laddered?

Asset allocation, risk, diversification and rebalancing. Pros/cons of hiring a financial advisor. Seeking advice on your portfolio?
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ghariton
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Re: Fixed Income - Bonds, Real Return Bonds, Laddered?

Post by ghariton »

I'll try to avoid getting caught up in semantics.

As far as I'm concerned, the difference between fixed income and equity lies in the types of risk one is exposed to. So for example government bonds expose the investor only to market risk (i.e. interest rate risk) and liquidity risk. The market risk is negligible if you hold long enough, as Shakespeare says. If you hold in the long term, market risk can cause losses.

Liquidity risk can usually be ignored with government bonds. I say "usually", because in 2008 it did become a big concern, and drove up yields on RRBs by over 100 bps.

Credit risk can be ignored on Government of Canada bonds. Neither the interest nor the principal are likely to be affected. Obviously, that's not true for all government bonds, e.g. Spain. But then I question whether an investment today in Spanish bonds is really "fixed income".

Corporate bonds have varying degrees of credit risk. Note however that this is left-hand "tail risk". The corporation has to get into serious trouble before investors are affected. So while the risk is there, and is important to keep in mind, f4ew of us individual investors really take it into account in our financial planning. Few of us estimate probabilities of default and multiply them by recovery ratios and then subtract that from the value of our bonds.

Equities can suffer from market risk and liquidity risk and credit risk. But the main source of risk, overshadowing all of those, is inadequate earnings. This risk is peculiar to equities, although if severe enough, inadequate earnings can shade into credit risk. But usually we don't worrky about insolvency when we invest in equities. Rather, we worry about sustainability of dividends, changes in share prices, etc.

I would argue that it is useful to look at investments as to how sensitive they are to inadequate earnings. So preferreds have some of this risk, as do income trusts. Corporate bonds, very little, regardless of their maturity, etc. Government bonds, no.

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Re: Fixed Income - Bonds, Real Return Bonds, Laddered?

Post by Thorn »

My apologies if I have offended some participants by not responding to criticisms of my comments. I seem to see a wide variety of opinions here. I try to consider each and work it into my overall view of the subject. Since I am very new to forums, perhaps I should read more and write less in the future.

However, two more comments:

(1) Once I have purchased some Canadian corporate bonds that satisfy my criteria, I pay no attention to their current price, which may change often based on new issues of comparable Govt of Canada bonds. What I know is that I will receive the par price at maturity.

(2) Since the topic has become "fixed-income like" vehicles, preferred shares of equities for large, well-established corporations can provide a good dividend for a tax advantage and a share price that does not vary widely over time from the par price, typically $25. There are some ins and outs here e.g. liquidity, callable/non, cumulative/non etc.
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Re: Fixed Income - Bonds, Real Return Bonds, Laddered?

Post by scomac »

Thorn wrote:
(2) Since the topic has become "fixed-income like" vehicles, preferred shares of equities for large, well-established corporations can provide a good dividend for a tax advantage and a share price that does not vary widely over time from the par price, typically $25. There are some ins and outs here e.g. liquidity, callable/non, cumulative/non etc.
The credit crisis from 2008-2009 proved that assumption to be completely false. Lots and lots of perpetual preferred shares from large, well-established corporations traded at discounts up to 40% off par despite not sufferring from any sort of company specific financial issues.
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Re: Fixed Income - Bonds, Real Return Bonds, Laddered?

Post by biker »

scomac wrote:
Thorn wrote:
(2) Since the topic has become "fixed-income like" vehicles, preferred shares of equities for large, well-established corporations can provide a good dividend for a tax advantage and a share price that does not vary widely over time from the par price, typically $25. There are some ins and outs here e.g. liquidity, callable/non, cumulative/non etc.
The credit crisis from 2008-2009 proved that assumption to be completely false. Lots and lots of perpetual preferred shares from large, well-established corporations traded at discounts up to 40% off par despite not sufferring from any sort of company specific financial issues.
Which turned out to be a great buying opportunity which may not be repeated any time soon.
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Re: Fixed Income - Bonds, Real Return Bonds, Laddered?

Post by like_to_retire »

biker wrote:Which turned out to be a great buying opportunity which may not be repeated any time soon.
No kidding, but that doesn't mean that the statement "a share price that does not vary widely over time from the par price, typically $25.", isn't bogus as scomac indicates.

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Re: Fixed Income - Bonds, Real Return Bonds, Laddered?

Post by CROCKD »

Scomac

Wrt your post of August 29 I just had a frustrating conversation with a BMOIL rep. who claimed she was a licensed bond trader. She just steered me through their on line corporate bond offerings supposedly yielding 3% or better. Here is a screen copy:- (the columns are a bit out of whack)

Current Date: 25 September 2012

CDN Bonds (Currency: CDN , All Offerings, Type: Straight Bonds , Sector: Corporates , Maturity Range: 3 to 5 Years, Minimum Yield: More than 3% Annually, Approximate Par Value: $1,000 CDN)
Results are listed in ascending order of Maturity/Call Date. The yields shown are based on your entered par value. Any changes to this par value will change the exact yield and total order value.
Description
(Click on security to proceed to order entry) Call
Date Days To
Expiry Quantity
Available Price
/$100 S/A
Yield Annual
Yield Halted Minimum
Purchase
GENWORTH MI DD 4.59% 15DEC2015
38,000 $108.650 CDN 1.806 1.814 $1,000
HOME CAP GROUP 5.20% 04MAY16
40,000 $110.280 CDN 2.213 2.225 $1,000
H&R REIT DDCALL 4.778% 27JUL16
8,000 $110.700 CDN 1.869 1.877 $1,000
BROOKFIELD OFC PR 4.30%17JAN17
10,000 $108.450 CDN 2.228 2.241 $1,000
1ST CAP REALTY DD 5.85%31JAN17
27,000 $115.400 CDN 2.116 2.128 $1,000
H&R REIT DD 5.902% 03FEB2017
16,000 $115.450 CDN 2.159 2.171 $1,000
COMINAR REIT DD 4.274% 15JUN17
256,000 $107.300 CDN 2.617 2.634 $1,000
ENBRIDGE INC FUND 5% 22JUN17
10,000 $113.100 CDN 2.078 2.089 $1,000

I pointed out that the yields were no better than were available with GICs. (I had to point this out)
That GICs were CDIC insured and on top of that the website did not indicate the quality of the bonds (I asked for BBB or better)
Looks like it's going to be an all GIC ladder.

EDITED.

After discussion with different 5* rep. yields shown were because of $1000 entered purchase.
At $20000 four offerings are shown yielding 3%+ maturities 2015 to 2017.
According to BMOIL they don't keep anything less than a BBB rating in their inventory. However you have to link to the rating agency if you want to look it up.
Last edited by CROCKD on 25 Sep 2012 15:24, edited 1 time in total.
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Re: Fixed Income - Bonds, Real Return Bonds, Laddered?

Post by like_to_retire »

I pointed out that the yields were no better than were available with GICs. (I had to point this out)
That GICs were CDIC insured and on top of that the website did not indicate the quality of the bonds (I asked for BBB or better)
Looks like it's going to be an all GIC ladder.
For 5 years with a guarantee and no liquidity, it's very hard to beat a GIC. They pay about 2.5% today.

But (as Scomac points out), if you accept a BBB rating and then up the term between 5 and 7 years, you can get a decent rate with liquidity on a corporate bond.

If I look at that range at TDW right now I see the following below. You can see the H&R REIT pays an ASK Yield of 3.48% to Feb 2018. That's a little over 5 years for a BBBm bond. That's 3.48% on 5K. On 10K it pays 3.52%, on 20K it pays 3.53%, etc.

Code: Select all

 H&R REAL ESTATE INVEST TR CAD  4.900   02/02/2018   27,000     3.88067  104.873   106.829    3.48759  CORPORATE BOND  BBBm 
 BELL ALIANT REGIONAL COMM CAD  4.880   04/26/2018   1,000,000  3.67988  105.998   108.268    3.24661  CORPORATE BOND  BBBm 
 INTER PIPELINE FUND CAD        3.839   07/30/2018   784,000    3.1057   103.884   105.941    2.73046  CORPORATE BOND  BBBh 
 MANITOBA TELECOM SV (MTN) CAD  4.590   10/01/2018   540,000    3.27218  107.135   108.948    2.95366  CORPORATE BOND  BBBm 
 BRP FINANCE CAD                5.250   11/05/2018   43,000     3.68153  108.500   110.901    3.26492  CORPORATE BOND  BBBh 
 FIRST CAPITAL REALTY INC CAD   4.950   11/30/2018   133,000    3.80212  106.257   108.361    3.43431  CORPORATE BOND  BBBm 
 ENBRIDGE INCOME FUND CAD       4.000   12/20/2018   20,000     3.63288  102.025   104.117    3.2633   CORPORATE BOND  BBBh 
 CAPITAL POWER LP CAD           4.850   02/21/2019   10,000     4.5033   101.904   103.708    4.18259  CORPORATE BOND  BBBm 
ltr
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Re: Fixed Income - Bonds, Real Return Bonds, Laddered?

Post by Springbok »

like_to_retire wrote: But (as Scomac points out), if you accept a BBB rating and then up the term between 5 and 7 years, you can get a decent rate with liquidity on a corporate bond.

If I look at that range at TDW right now I see the following below. You can see the H&R REIT pays an ASK Yield of 3.48% to Feb 2018. That's a little over 5 years for a BBBm bond. That's 3.48% on 5K. On 10K it pays 3.52%, on 20K it pays 3.53%, etc.

Code: Select all

 H&R REAL ESTATE INVEST TR CAD  4.900   02/02/2018   27,000     3.88067  104.873   106.829    3.48759  CORPORATE BOND  BBBm 
 B
ltr
Another option for H&R and others, may be a convertible debenture. For example,
H&R Real Estate HR.DB.D
Cou[pon 5.90%
Maturity 30-Jun-20
Current price 111.95
Yield to maturity 4.09%
Conversion price $23.50
Current price $25.19

See anything wrong with that option?
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Re: Fixed Income - Bonds, Real Return Bonds, Laddered?

Post by tedster »

Just curious, but how much more risk does one entail if instead of 5 year laddered BBB bonds one buys Berhsire Hathaway B? Is there really more risk? is there more "upside" potential with the latter?
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Re: Fixed Income - Bonds, Real Return Bonds, Laddered?

Post by Shakespeare »

How much more risk is in an apple than an orange?
Sic transit gloria mundi. Tuesday is usually worse. - Robert A. Heinlein, Starman Jones
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Re: Fixed Income - Bonds, Real Return Bonds, Laddered?

Post by tedster »

Shakespeare wrote
How much more risk is in an apple than an orange?
Thanks for re-stating my question. I am currently looking to re-locate the management of my RRIF. The people with whom I talk, all tell me that to "safeguard my capital", (at my age) I should have at least 50% in fixed income. I am questioning this. To me, that is like putting half my capital in a safety deposit box and putting the rest in equities. To me, why not put the entire amount in equities, but at least 40% in those similar to Berkshire. I do not speak from a high level of knowledge here. Which is why I am asking. lol
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Re: Fixed Income - Bonds, Real Return Bonds, Laddered?

Post by BRIAN5000 »

(at my age) I should have at least 50% in fixed income
How old are you? I'm 55 with 65% in fixed income, earning negative something.
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Re: Fixed Income - Bonds, Real Return Bonds, Laddered?

Post by Shakespeare »

There are two incompatible schools of thought.

One says, if you have more than enough capital, why risk the excess above what you need?

The other says, if you have more than enough capital, why not risk the excess?
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Or his desserts are small
Not to put it to the touch¹
To win or lose it all.
1. To roll the dice.
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Re: Fixed Income - Bonds, Real Return Bonds, Laddered?

Post by Springbok »

tedster wrote:Just curious, but how much more risk does one entail if instead of 5 year laddered BBB bonds one buys Berhsire Hathaway B? Is there really more risk? is there more "upside" potential with the latter?
I may be wrong, but my understanding is that Berkshire pays no dividends. So if you were looking for income, it wouldn't provide any cash flow while a bond portfolio would.

In a bond portfolio, you would get your capital back as each bond matured. No capital gains and losses only if a company defaults.

With Berkshire, you would presumably be investing for capital growth. (But in retirement does that make sense?). If you had bought Berkshire 5 years ago, you would not have gained or lost any capital (same as bonds). But you would not have had the cash yield that the bonds would have paid.

Does that make sense?
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Re: Fixed Income - Bonds, Real Return Bonds, Laddered?

Post by tedster »

I bought Berkshire this past 12 months and it went from around $83 to $89. All I was asking, and I am certain I can not "defend either position, was is it really necessary to put 35 to 40% into fixed income (bonds) in order to protect capital? Can one not protect capital using some form of equity? Bonds do earn some interest, true, but equities can produce dividends, and or capital gain and of course losses.

I am 77. ISTM to have 65% in fixed income and earn negative something is a flag that something should change.
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Re: Fixed Income - Bonds, Real Return Bonds, Laddered?

Post by CROCKD »

Referring to my previous post on reinvestment of my LIF capital.

I have determined that splitting it 70% GIC ladder and 30% corporate bonds (3 - 5 yr. maturity) would increase the effective annual yield to 2.63% from 2.27% for an all GIC ladder i.e. a delta of 0.36%.
I do not need liquidity as my mandatory RIF withdrawal already provides more than enough income, so the minimum LIF withdrawal is on top, the corporate bonds would be held to maturity and the maturing GIC each year would provide the income for withdrawal with the balance reinvested.
It all boils down to how much risk you want to take so Shakes post is appropos.
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Re: Fixed Income - Bonds, Real Return Bonds, Laddered?

Post by like_to_retire »

tedster wrote:I bought Berkshire this past 12 months and it went from around $83 to $89.
And if it went from $83 to $77 instead, that wouldn't have protected your capital. You would be wishing you had your $83 back along with the 3% that a bond would have realized for you.

Only invest the amount of capital in equities that you're willing to gamble and lose, the rest should probably go to fixed income. The returns are low at present, but so is inflation.

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Re: Fixed Income - Bonds, Real Return Bonds, Laddered?

Post by like_to_retire »

CROCKD wrote:Referring to my previous post on reinvestment of my LIF capital.

I have determined that splitting it 70% GIC ladder and 30% corporate bonds (3 - 5 yr. maturity) would increase the effective annual yield to 2.63% from 2.27% for an all GIC ladder i.e. a delta of 0.36%.
I do not need liquidity as my mandatory RIF withdrawal already provides more than enough income, so the minimum LIF withdrawal is on top, the corporate bonds would be held to maturity and the maturing GIC each year would provide the income for withdrawal with the balance reinvested.
It all boils down to how much risk you want to take so Shakes post is appropos.
Your ladder yield will increase once you're able to take the maturing 3 and 4 year GIC's and repurchase 5 year GIC instead.
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Re: Fixed Income - Bonds, Real Return Bonds, Laddered?

Post by Springbok »

tedster wrote:I bought Berkshire this past 12 months and it went from around $83 to $89. All I was asking, and I am certain I can not "defend either position, was is it really necessary to put 35 to 40% into fixed income (bonds) in order to protect capital? Can one not protect capital using some form of equity? Bonds do earn some interest, true, but equities can produce dividends, and or capital gain and of course losses.

I am 77. ISTM to have 65% in fixed income and earn negative something is a flag that something should change.
I agree that having money in FI earning a negative real return doesn't make much sense.

Other than CPP/OAS, we live off our savings. When we retired, my plan was to have zero FI in our taxable accounts, but about 60% in our registered accounts (where most of our savings are). Toward end of 2008 and early 2009, we saw the FI % in those accounts go over 70%, just because the equities plummeted. Right now, those percentages are much lower (45%) because of the gain in equity value.

Using percentages can be misleading. I now look at how much we could exist on, if markets hit rock bottom, say in a situation like the Great Depression. FI is about 90% of that number. So, for example, if drop dead number is $30k/yr + CPP/OAS and I want to withdraw at 4%, then I would need $750k of which $675 would be FI. If markets recovered the $750k could become $1.5MM and FI would now be only 45%.

We still have one or two left over GICs bought when rates were attractive, but most of our fixed income is in corporate bonds. It seems to me that corporate bonds are equity like, in that there is almost equal risk of default. I hate to buy FI if yield is lower than our 4% withdrawal rate or 1.5 to 2% above inflation, and this limits availability.

Because of lack of FI available that meets my criteria, I have recently been looking at convertible debentures that provide some of benefits of both FI and equity.

I realize that many here take a more conservative approach than I do. But even I would not go to 100% equity even if some of the equity was rock solid like your Berkshire example.
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Re: Fixed Income - Bonds, Real Return Bonds, Laddered?

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Using percentages can be misleading. I now look at how much we could exist on, if markets hit rock bottom, say in a situation like the Great Depression. FI is about 90% of that number. So, for example, if drop dead number is $30k/yr + CPP/OAS and I want to withdraw at 4%, then I would need $750k of which $675 would be FI. If markets recovered the $750k could become $1.5MM and FI would now be only 45%.
I use the same idea as you I think, 50% equity drop. I don't think 50% is " rock bottom" however. I would be 80% FI with a 50% equity drop. I use a 3% withdraw and want as best a guarantee I can get on $60,000. If markets drop 50% and stay there for a period of time there may be a little stress on the system so I'm not counting on CPP/OAS. Also being 55 and 52 we won't have CPP/OAS for some time yet.
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Re: Fixed Income - Bonds, Real Return Bonds, Laddered?

Post by ghariton »

This could have gone into one of several threads.

New York Times:
As if it wasn’t bad enough for the millions of Americans scraping by on paltry interest payments, now they face another threat: the loss of principal on their bonds and other fixed-income assets.

The month of May, and this first week of June, were terrible for many fixed-income investors who have spent the last few years reaching for higher yields.

<snip>

Vanguard’s Extended Duration Treasury Index fund was down more than 6 percent in the last month. In the mortgage area, Annaly Capital Management, a popular real estate investment trust that invests in mortgages, fell 8.7 percent, and an iShares mortgage exchange-traded fund lost 10.4 percent. Pimco’s Corporate Opportunity Fund, which is managed by the star analyst Bill Gross and which invests in a mix of corporate bonds and mortgage-backed securities and uses some borrowing, lost nearly 13.4 percent. Annualized, such declines are off the charts.

“There are many closed-end bond funds and mortgage funds that were just annihilated in May,” said Anthony Baruffi, a senior portfolio manager at SNW Asset Management in Seattle, which specializes in fixed-income assets.

<snip>

Whether or not the current sell-off continues, the plunge has startled investors who may not have realized how much risk was embedded in their portfolios. “The only thing I guarantee for sure is that someday we will have high interest rates again,” Mr. Cohn said.

“It may take 50 years, but rates are going to go higher. We have an entire generation of investors who have never experienced a rising rate environment.”

Mr. Beinner said investors need to reconsider their traditional fixed-income allocations, nearly all of which carry interest rate risk. “It’s an asset class with a negative expected return without any other positive offsetting properties. So why have it as a part of your portfolio?”

He said the simplest and safest approach is simply to park funds in a low-volatility money market fund and accept near-zero returns.
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Re: Fixed Income - Bonds, Real Return Bonds, Laddered?

Post by scomac »

Mr. Beinner wrote:the simplest and safest approach is simply to park funds in a low-volatility money market fund and accept near-zero returns.
The simplest and safest approach is to roll your own bond/GIC ladder! Much has been said about the lack of diversification, implied risk and opaque pricing that impacts the returns of an individual bond holder, however the sorts of return volatility and downside that has been experienced by the funds mentioned in the article that George linked to clearly illustrates just how much risk can be built into managed investment products.

The beauty of the bond/GIC ladder is that there is no guessing involved with respect to interest rates; you simply add a new longer term bond to replace a maturing rung in the ladder. It's as passive as buying the total market in the form of an ETF with one important advantage -- you know precisely what your return is going to be the moment you purchase the bond because you know the YTM. Mark-to-market may say that you have suffered a paper loss in the interim on an individual bond, but, as long as you hold to maturity you will have made a positive return that will have handily outpaced money market funds over the duration regardless of current interest rates and the future direction.
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Re: Fixed Income - Bonds, Real Return Bonds, Laddered?

Post by adrian2 »

scomac wrote:you know precisely what your return is going to be the moment you purchase the bond because you know the YTM. Mark-to-market may say that you have suffered a paper loss in the interim on an individual bond, but, as long as you hold to maturity you will have made a positive return that will have handily outpaced money market funds over the duration regardless of current interest rates and the future direction.
It's likely you "will have handily outpaced money market funds over the duration regardless of current interest rates and the future direction", but it's not guaranteed; future money market returns may as well exceed the YTM you have accepted.
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Re: Fixed Income - Bonds, Real Return Bonds, Laddered?

Post by parvus »

Wouldn't that depend on the duration characteristics of a continuous bond ladder (i.e., buy and replace)?
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Re: Fixed Income - Bonds, Real Return Bonds, Laddered?

Post by adrian2 »

parvus wrote:Wouldn't that depend on the duration characteristics of a continuous bond ladder (i.e., buy and replace)?
Scott's comparison was (as I understood it) a one time bond purchase, held to maturity, vs. a MMF or equivalent, held for the same period. At current rates, it would be hard(er) to believe that a MMF can win, but it is conceivable.
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