Do bonds in RRSP/TFSA still make sense?

Asset allocation, risk, diversification and rebalancing. Pros/cons of hiring a financial advisor. Seeking advice on your portfolio?
thedude99
Bronze Ring
Bronze Ring
Posts: 10
Joined: 28 Sep 2017 14:29

Do bonds in RRSP/TFSA still make sense?

Post by thedude99 » 28 Sep 2017 14:32

First off my TFSA, RRSP are all maxed. I had always read that tax disadvantaged income (interest, foreign income) should be placed into non taxable accounts and tax favorable income (ie Cdn eligible dividends) into taxable accounts. Although at the time I remember thinking does this make sense given bond funds were paying 2.5% to 3% while most of the stocks I was in were in the 3% to 5% range (banks, telcos, pipelines, etc).

I have about a 65/35 portfolio. Unfortunately given the negative return on bond funds lately I have some large losses in my RRSP/TFSA account pertaining to these holdings. For example, PH&N bond fund which I’ve dollar cost averaged for many years has a $6,900 loss on $147,000 cost basis or 4.3%. I’m scratching my head abit on that one as PH&N over the last few years has showed positive returns, however that is with reinvested distributions and I choose to take distributions in cash rather than have them re-invested so I believe that explains that.

My salary at work is about 120K so the strategy seems to make sense to me as I would otherwise get hammered at tax time with the interest income (although I do pay a fair bit already due to my investment income). However seeing these losses in my RRSP I can’t help but wonder if I’d be better off with those in my taxable accounts as surely I could use the capital loss carry forwards in the future, never mind the lost growth potential in my RRSP to build up the tax deferred account. Besides my contributions from into my RRSP the last two years it’s pretty much done nothing besides spit out the interest income.

My ultimate investment goal is to generate about $60,000 in interest in dividends while staying under OAS clawback territory and the strategy I’ve currently been doing will work but right now it seems as though I’ve bungled this up pretty badly.

beachcomber
Bronze Ring
Bronze Ring
Posts: 28
Joined: 08 Jan 2017 13:51

Re: Does bonds in RRSP/TFSA still make sense?

Post by beachcomber » 28 Sep 2017 19:44

Well, we've been drawing down our RIFs for a number of years now, and I'm wondering now if RRSPs were such a good idea, even though we thought the immediate tax deferrals obtained were worth it at the time. We've had our OAP clawed back for the past few years - as a result of investment mutual funds nailing us with taxable capital gains that we had no say in! So I would suggest that anyone with a defined benefit pension plan seek some professional advice.

We incorporated our family business about 25 years ago - so that has somewhat mitigated our personal income tax issues. Don't quite know how Trudeau's current tax attack on small business enterprises will affect us, and what defensive tactics our accountant will come up with!

We've held PH&N bond funds for over 25 years - and they have always exceeded our expectations. Their returns have have recently diminished, and although this may only be a short term trend we are slowly switching most of our investments to index funds, dividend paying stocks and ETFs.

OnlyMyOpinion
Silver Ring
Silver Ring
Posts: 665
Joined: 24 Jan 2014 23:17

Re: Does bonds in RRSP/TFSA still make sense?

Post by OnlyMyOpinion » 28 Sep 2017 21:33

thedude99 wrote:
28 Sep 2017 14:32
First off my TFSA, RRSP are all maxed. I had always read that tax disadvantaged income (interest, foreign income) should be placed into non taxable accounts and tax favorable income (ie Cdn eligible dividends) into taxable accounts. Although at the time I remember thinking does this make sense given bond funds were paying 2.5% to 3% while most of the stocks I was in were in the 3% to 5% range (banks, telcos, pipelines, etc).

I have about a 65/35 portfolio. Unfortunately given the negative return on bond funds lately I have some large losses in my RRSP/TFSA account pertaining to these holdings. For example, PH&N bond fund which I’ve dollar cost averaged for many years has a $6,900 loss on $147,000 cost basis or 4.3%. I’m scratching my head abit on that one as PH&N over the last few years has showed positive returns, however that is with reinvested distributions and I choose to take distributions in cash rather than have them re-invested so I believe that explains that.

My salary at work is about 120K so the strategy seems to make sense to me as I would otherwise get hammered at tax time with the interest income (although I do pay a fair bit already due to my investment income). However seeing these losses in my RRSP I can’t help but wonder if I’d be better off with those in my taxable accounts as surely I could use the capital loss carry forwards in the future, never mind the lost growth potential in my RRSP to build up the tax deferred account. Besides my contributions from into my RRSP the last two years it’s pretty much done nothing besides spit out the interest income.

My ultimate investment goal is to generate about $60,000 in interest in dividends while staying under OAS clawback territory and the strategy I’ve currently been doing will work but right now it seems as though I’ve bungled this up pretty badly.
I'm a bit confused, you say yourself that your apparent poor return is because you are not counting the interest payents you've been taking as cash rather than reinvesting into the bond fund?

The bottom line is how much have you actually contributed to your RRSP and how much is it now worth?

As to whether interest income should be preferentially sheltered, I would say 'it depends'.You will read arguments on both sides of this issue. If it helps, here is a (3yr old) article by Dan Bortolotti that supports your approach. It happens to be my approach as well:

http://www.moneysense.ca/save/investing ... n-an-rrsp/.
"What about the coming decade?... we can’t draw any sweeping conclusions from our findings. Bond yields are much lower today than they were in 2003, and the situation might have changed. Going forward, is holding bonds in an RRSP still the right asset location strategy? Again, no one can know this in advance. But investors need to make a decision, and we believe it still makes sense to follow the conventional wisdom and keep bonds in an RRSP and equities (when necessary) in a taxable account".

As to OAS clawback, if you end up with enough income that your senior's welfare gets clawed back, are you saying "gee, I wish I was a lower income senior"? Personally I think OAS is at risk of being clawed back to a greater degree by future governments as it gets too expensive. So I wouldn't mourn its absence in my retirement income stream.

longinvest
Gold Ring
Gold Ring
Posts: 1451
Joined: 10 Sep 2012 17:26
Location: QC

Re: Does bonds in RRSP/TFSA still make sense?

Post by longinvest » 28 Sep 2017 22:08

A good way to minimize the bite of the clawback is to delay OAS to age 70. This increases OAS to $9,230. As a result, it won't be fully clawed back unless one cumulates more than $136,322 in taxable income during the year (this excludes TFSA withdrawals as well as return of capital and half capital gains from taxable investments). That's four times the median employment income in Canada (source: Median employment income).
Bogleheads investment philosophy | Simple index portfolios | Lifelong Portfolio: 25% each of (domestic/international)stocks/(nominal/inflation-indexed)bonds | VCN/VXC/VAB/ZRR

User avatar
GreatLaker
Silver Ring
Silver Ring
Posts: 133
Joined: 16 Dec 2014 13:02
Location: Toronto

Re: Does bonds in RRSP/TFSA still make sense?

Post by GreatLaker » 29 Sep 2017 19:59

Here is an interesting perspective from Jim Dahl at The White Coat Investor.
https://www.whitecoatinvestor.com/asset ... n-taxable/

Note that the article is written about US tax rates and investment products. He concludes that it is more optimal to keep bonds in a taxable account. But I'm not sure the analysis applies in Canada.
  • He compares a Roth IRA to a non-registered account. I don't think TFSAs would be large enough to hold most investor's bond allocation
  • He uses marginal tax rate of 33%. Many Canadian investors would have higher MTR while working.
  • He assumes bonds placed in a non-registered account would be tax advantaged municipal bonds. I don't think Canada has a comparable tax-advantaged bonds
I have not run the numbers using Canadian assumptions but I'm not sure his conclusion would apply to Canada. So why did I post it? He does a great job defining his assumptions and laying out the calculations, if anyone wants to update his analysis for Canada.

I still keep my fixed income in tax deferred RRSP and LIRA accounts, largely based on the Moneysense article by Dan Bortolotti linked above.
The first principle in speculating is never give anyone advice to buy or sell shares,
because, where perspicacity is weakened, the most benevolent advice can turn out badly.
Joseph de la Vega

User avatar
Mordko
Silver Ring
Silver Ring
Posts: 167
Joined: 24 Jan 2016 09:26

Re: Do bonds in RRSP/TFSA still make sense?

Post by Mordko » 30 Sep 2017 11:36

Everyone's circumstances are different. The answer depends on your/your spouses tax rates and the purpose of your bonds.

My strategy is to have a set amount in fixed income (FI), with the target of $250K. Regardless of age and total portfolio value, the FI basket will stay the same as long as the stocks go up in value. This FI allocation is around 10% of net worth and the purpose is to keep us out of trouble during the lean years when the shares are plunging. Then we would start to deplete the FI basket while staying invested in the stockmarket. Of course the risk is that the "lean" years last for 10 years or longer but the probability of this scenario is relatively low so the FI basket still provides a degree of protection. The real value of this FI basket will go down with inflation which is just fine because our life expectancy is also going down.

To cut a long story short, for us it makes sense to keep FI in a taxable account because we need quick access and the expected return on FI is very low. Therefore we expect to pay less total tax than if we used TFSA/RRSP room for bonds and had to have more high-return assets in a taxable account.

I can see scenarios where using RRSP for bonds makes sense - depending on your strategy - but very few circumstances when it makes sense to hold bonds in a TFSA.

Saintor
Newcomer
Newcomer
Posts: 2
Joined: 07 Nov 2017 11:13

Re: Do bonds in RRSP/TFSA still make sense?

Post by Saintor » 07 Nov 2017 11:34

I am also giving up with bonds. It is giving me some discomfort but their performances in the last 3-5 years combined with long term US Federal Reserve management of interest rates kill their appeal. I basically moved all of this in Canadian Banks dividends funds.

bill
Bronze Ring
Bronze Ring
Posts: 13
Joined: 27 Nov 2017 19:30

Re: Do bonds in RRSP/TFSA still make sense?

Post by bill » 27 Nov 2017 20:00

Saintor wrote:
07 Nov 2017 11:34
I am also giving up with bonds. It is giving me some discomfort but their performances in the last 3-5 years combined with long term US Federal Reserve management of interest rates kill their appeal. I basically moved all of this in Canadian Banks dividends funds.
I can't bring myself to go that far. I share your discomfort, and I've reduced my bond holdings to around 20%, with dividend stocks overweighted, but I can't bring myself to go lower than that.

Thegipper
Gold Ring
Gold Ring
Posts: 1233
Joined: 14 Mar 2015 16:58

Re: Do bonds in RRSP/TFSA still make sense?

Post by Thegipper » 28 Nov 2017 08:43

I used to have an overall weighting of 40% stocks 60% bonds. I am now 55% stocks and 45% bonds. Almost all my bonds are corporate and are laddered over an 8 year cycle. My yield to maturity is about 4%. I have concerns about sticking with this level of bonds.

User avatar
Peculiar_Investor
Gold Ring
Gold Ring
Posts: 7187
Joined: 01 Mar 2005 14:52
Location: Calgary
Contact:

Re: Do bonds in RRSP/TFSA still make sense?

Post by Peculiar_Investor » 28 Nov 2017 09:06

Thegipper wrote:
28 Nov 2017 08:43
Almost all my bonds are corporate and are laddered over an 8 year cycle. My yield to maturity is about 4%. I have concerns about sticking with this level of bonds.
Our situation is somewhat similar although our bond mix isn't as aggressive. When adding/replacing bonds on the ladder I'm cautious to remember the reason for holding bonds in a portfolio is not about return, it's about balancing volatility and reducing overall portfolio risk. That's sometimes hard to swallow when government bond yields are so low, but I try and remind myself that the equity portion of the asset allocation is where you take risk, not the fixed income portion. If you need a higher portfolio return, then you probably need to increase the equity allocation, not move downwards on the creditworthiness of your fixed income holdings.

As to the tax efficiency question of bonds in a RRSP/TFSA, for those of us lucky enough to have enough investable assets that they exceed the room in our RRSPs and TFSAs, I still subscribe to the theory that you hold the least tax efficient assets, i.e. those taxed at the highest marginal rate, in a registered account. Because the tax profile of fixed income investments is known in advance and they are taxed at the highest rate, I would (and do) hold them in our registered accounts. While it can be argued that potential capital gains, even at a lower tax rate, could better be server being sheltered in a registered account, one does not know in advance if the potential will be achieved, and therefore I'd stick with sheltering the known returns on assets.

At the end of the day, like most investing 'rules of thumb', these are general guidance and everyone's circumstances (asset allocation, tax rates) will be different so there is no one solution for everyone.
Imagefiniki, the Canadian financial wiki New editors wanted and welcomed, please help collaborate and improve the wiki.

Normal people… believe that if it ain’t broke, don’t fix it. Engineers believe that if it ain’t broke, it doesn’t have enough features yet. – Scott Adams

Taggart
Gold Ring
Gold Ring
Posts: 6263
Joined: 05 Dec 2005 07:34

Re: Do bonds in RRSP/TFSA still make sense?

Post by Taggart » 28 Nov 2017 10:46

I invest in the RRSP and TFSA separately, not allocated as one unit. The TFSA is allocated at 10% to TD e-Series bond fund. The rest of the portfolio all indexed equity funds. The RRSP is allocated at 40% to a mixture of TD e-Series bond fund, Vanguard Short Term Bond ETF and a Canada Real Return bond I purchased years ago.

I'm well aware that bonds have been under-performing lately but I just shrug it off. I'm a bit of a contrarian, so I also know that some time in the future bonds will have their day in the sun. Perhaps when least expected.

User avatar
AltaRed
Diamond Ring
Diamond Ring
Posts: 18621
Joined: 05 Mar 2005 20:04
Location: Ogopogo Land

Re: Do bonds in RRSP/TFSA still make sense?

Post by AltaRed » 28 Nov 2017 11:57

bill wrote:
27 Nov 2017 20:00
Saintor wrote:
07 Nov 2017 11:34
I am also giving up with bonds. It is giving me some discomfort but their performances in the last 3-5 years combined with long term US Federal Reserve management of interest rates kill their appeal. I basically moved all of this in Canadian Banks dividends funds.
I can't bring myself to go that far. I share your discomfort, and I've reduced my bond holdings to around 20%, with dividend stocks overweighted, but I can't bring myself to go lower than that.
I think people could regret not having some FI allocation set aside during their withdrawal years, if for no reason other than unexpected needs coinciding with a 'down' equity market. It is fine to say one can live off pension income, aka CPP and some DB annuity if lucky, supplemented by a dividend stream from stocks, but reality often delivers a curve ball. There is nothing like a 2008/2009 event and some kind of family emergency making one wish they had a 'reserve' to tap into.

Where that FI resides depends on where the bulk of one's assets are located. In my case, only about 8% of my investable net worth is in registered accounts, so that is where I choose to hold my FI. I supplement that with pseudo-FI (preferred shares) in my taxable account.... for an overall allocation of 15%. For others, especially in accumulation phase, it may be more effective to have their 'high return' assets sheltered in an RRSP, albeit it all becomes 'Other Income' upon withdrawal. Mordko's post above articulates it quite well. There is no single right answer.
Imagefiniki, the Canadian financial wiki The go-to place to bolster your financial freedom

OhGreatGuru
Gold Ring
Gold Ring
Posts: 1093
Joined: 27 Mar 2010 16:01

Re: Do bonds in RRSP/TFSA still make sense?

Post by OhGreatGuru » 29 Nov 2017 19:02

thedude99 wrote:
28 Sep 2017 14:32
... Unfortunately given the negative return on bond funds lately I have some large losses in my RRSP/TFSA account pertaining to these holdings. For example, PH&N bond fund which I’ve dollar cost averaged for many years has a $6,900 loss on $147,000 cost basis or 4.3%. I’m scratching my head abit on that one as PH&N over the last few years has showed positive returns, however that is with reinvested distributions and I choose to take distributions in cash rather than have them re-invested so I believe that explains that. ...
Do you know what Internal Rate of Return (IRR) is, and how to calculate it?

PS. The reason I ask is that you are convinced you have suffered a loss on your bond fund(s), because you are comparing your total purchase costs vs. present value, while ignoring the many distributions you have received.
Last edited by OhGreatGuru on 01 Dec 2017 09:07, edited 1 time in total.

longinvest
Gold Ring
Gold Ring
Posts: 1451
Joined: 10 Sep 2012 17:26
Location: QC

Re: Do bonds in RRSP/TFSA still make sense?

Post by longinvest » 29 Nov 2017 22:13

thedude99 wrote:
28 Sep 2017 14:32
... Unfortunately given the negative return on bond funds lately ...
For those who like market timing, the initial post written on September 28 was an excellent contrarian indicator. In October 2017, Vanguard's Canadian Aggregate Bond Index ETF (VAB) had a 1.65% return in a single month!

It's weird. When bonds go down, we hear all about it. But, when they go up, nobody seems to notice.
Bogleheads investment philosophy | Simple index portfolios | Lifelong Portfolio: 25% each of (domestic/international)stocks/(nominal/inflation-indexed)bonds | VCN/VXC/VAB/ZRR

User avatar
ghariton
Diamond Ring
Diamond Ring
Posts: 11913
Joined: 18 Feb 2005 18:59
Location: Ottawa

Re: Do bonds in RRSP/TFSA still make sense?

Post by ghariton » 30 Nov 2017 13:13

longinvest wrote:
29 Nov 2017 22:13
thedude99 wrote:
28 Sep 2017 14:32
... Unfortunately given the negative return on bond funds lately ...
For those who like market timing, the initial post written on September 28 was an excellent contrarian indicator. In October 2017, Vanguard's Canadian Aggregate Bond Index ETF (VAB) had a 1.65% return in a single month!

It's weird. When bonds go down, we hear all about it. But, when they go up, nobody seems to notice.
Returns on bonds are all about institutional investors' expectations as to future returns. Past performance is totally meaningless.

George
The plural of anecdote is NOT data.

longinvest
Gold Ring
Gold Ring
Posts: 1451
Joined: 10 Sep 2012 17:26
Location: QC

Re: Do bonds in RRSP/TFSA still make sense?

Post by longinvest » 30 Nov 2017 13:20

George,
ghariton wrote:
30 Nov 2017 13:13
Returns on bonds are all about institutional investors' expectations as to future returns.
I'm not even sure I believe that. I try to limit what I believe about investments, including bonds, to what can proven using mathematics.
ghariton wrote:
30 Nov 2017 13:13
Past performance is totally meaningless.
I agree, when it's about predicting future returns. It's not limited to bonds, though. I include stocks, gold, bitcoin, real estate, and everything else in there.
Bogleheads investment philosophy | Simple index portfolios | Lifelong Portfolio: 25% each of (domestic/international)stocks/(nominal/inflation-indexed)bonds | VCN/VXC/VAB/ZRR

FI40
Bronze Ring
Bronze Ring
Posts: 27
Joined: 05 Nov 2015 20:47

Re: Do bonds in RRSP/TFSA still make sense?

Post by FI40 » 01 Dec 2017 11:05

I guess I subscribe to the conventional wisdom, and hold bonds in tax advantaged accounts. Like OP they are all maxed and are filled up with the fixed income portion.

In the past few years I'm sure this was suboptimal. But we make the best decisions we can with the information we have at the time. For me the reasons have not changed so I have no plan to change. Holding higher risk assets in registered accounts is great when times are good, but brutal in bad times since you don't even get a deduction. It's a double-edged sword. Let's hope Justin doesn't change the capital gains and dividend tax rates...if they become higher the conventional wisdom may need to change.

I also supplement FI allocation in taxable accounts with preferred shares, since I needed more FI but didn't have room in the registered accounts. I feel it's a good compromise as they are a hybrid type investment. Only 5% of my allocation though.

tdiddy
Bronze Ring
Bronze Ring
Posts: 47
Joined: 18 Jan 2015 11:28

Re: Do bonds in RRSP/TFSA still make sense?

Post by tdiddy » 01 Dec 2017 12:49

agree that this is a personal decision

i'll weigh in on bonds in taxable account, as that's my plan (along with Cdn equity)

I look at how much absolute tax savings does the RRSP holding generate vs holding same fund in non-reg. With the low yield of the bonds, and the availability of tax advantaged bond funds, I feel for me there are more absolute savings to be had on cap gains, dividends, of equity (particularly foreign) in RRSP. In my circumstances I am also looking for increased RRSP space and equities will grow this contribution room, not concerned about large RRIF withdrawals down the line. I think OAS will be severely restricted by the time I am 65.

Note that the Dan Bortolotti article references a white paper with conventional bond ETFs and uses 1/3 of RRSP space for Cdn equities. I think if this was redone with just US/international in RRSP, bonds and Cdn in taxable, and more conservative estimate for bond yields the equity in RRSP may come out better.

milton
Silver Ring
Silver Ring
Posts: 119
Joined: 16 Feb 2007 15:33

Re: Do bonds in RRSP/TFSA still make sense?

Post by milton » 02 Dec 2017 14:09

Anyone consider GICs a bond substitute in RRSP/TFSA? Vanguard VAB yield to maturity is 2.3%, less 0.1 for MER and you pocket 2.2%

You can get five year GIC today for 2.76% (BMO Investorline quote, boutique firms may offer higher). That's a bonus return of 25%. Better credit quality to boot because backed by CDIC.

User avatar
AltaRed
Diamond Ring
Diamond Ring
Posts: 18621
Joined: 05 Mar 2005 20:04
Location: Ogopogo Land

Re: Do bonds in RRSP/TFSA still make sense?

Post by AltaRed » 02 Dec 2017 14:26

milton wrote:
02 Dec 2017 14:09
Anyone consider GICs a bond substitute in RRSP/TFSA? Vanguard VAB yield to maturity is 2.3%, less 0.1 for MER and you pocket 2.2%

You can get five year GIC today for 2.76% (BMO Investorline quote, boutique firms may offer higher). That's a bonus return of 25%. Better credit quality to boot because backed by CDIC.
Some people consider a 5 year GIC ladder as a substitute for a short term bond ETF, not a medium term bond ETF. It is important to recognize one must execute staggered 5 year maturities in a 5 year GIC ladder for it to work, so a 2.76% GIC is only relevant for a 5 year GIC that would be maturing now in that 5 year GIC ladder. Anyone with a currently operating GIC ladder would have a weighted average of all the GICs currently in force.
Imagefiniki, the Canadian financial wiki The go-to place to bolster your financial freedom

User avatar
adrian2
Diamond Ring
Diamond Ring
Posts: 11617
Joined: 19 Feb 2005 08:42
Location: Greater Toronto Area

Re: Do bonds in RRSP/TFSA still make sense?

Post by adrian2 » 03 Dec 2017 11:57

milton wrote:
02 Dec 2017 14:09
Anyone consider GICs a bond substitute in RRSP/TFSA? Vanguard VAB yield to maturity is 2.3%, less 0.1 for MER and you pocket 2.2%

You can get five year GIC today for 2.76% (BMO Investorline quote, boutique firms may offer higher). That's a bonus return of 25%. Better credit quality to boot because backed by CDIC.
On average, VAB should return more than the YTM - MER, due to the "ride-the-yield-curve" effect.
Imagefiniki, the Canadian financial wiki
“It doesn't matter how beautiful your theory is, it doesn't matter how smart you are. If it doesn't agree with experiment, it's wrong.” [Richard P. Feynman, Nobel prize winner]

User avatar
Quebec
Silver Ring
Silver Ring
Posts: 686
Joined: 24 Oct 2009 16:49
Location: Quebec City

Re: Do bonds in RRSP/TFSA still make sense?

Post by Quebec » 03 Dec 2017 12:45

AltaRed wrote:
02 Dec 2017 14:26
Some people consider a 5 year GIC ladder as a substitute for a short term bond ETF, not a medium term bond ETF.
I agree. The broad market bond ETFs have a longer duration than a 5-year GIC ladder.

The closest equivalent to a 5 year GIC ladder with CDIC insurance would be an ETF made up of 1-5 year federal government bonds.

My understanding is that because the bonds in such an ETF are very liquid, they should yield less than the equivalent non-redeemable GICs.
Imagefiniki, the Canadian financial wiki: a knowledge base of financial subjects written from a Canadian perspective

FI40
Bronze Ring
Bronze Ring
Posts: 27
Joined: 05 Nov 2015 20:47

Re: Do bonds in RRSP/TFSA still make sense?

Post by FI40 » 04 Dec 2017 11:34

Locking up the money in a GIC is problematic as well if used as one's only bond position. In an equity crash where your allocation is telling you to sell bonds and buy equities, you can't. Even if it's laddered you are still constrained by the amounts available at the maturity dates each year. A bond ETF is liquid so it's a lot different.

I think at current rates if you wanted to use a GIC or laddered GICs, even in a registered account, and you are okay with illiquidity you can go ahead but it may be very close to a wash when compared to a govt bond ETF. You might do a little better.
adrian2 wrote:
03 Dec 2017 11:57
On average, VAB should return more than the YTM - MER, due to the "ride-the-yield-curve" effect.
Assuming rates rise in the future, right? Or are you talking about something else?

milton
Silver Ring
Silver Ring
Posts: 119
Joined: 16 Feb 2007 15:33

Re: Do bonds in RRSP/TFSA still make sense?

Post by milton » 04 Dec 2017 12:53

adrian2 wrote:
03 Dec 2017 11:57
On average, VAB should return more than the YTM - MER, due to the "ride-the-yield-curve" effect.
This 'ride-the-yield-curve' effect is really cool, never heard of it before. Is this how it works?--Let's say 30yr bond yields 2.23% and 1 yr bond yields 1.36%. The yield curve is the curve between 1.36 - 2.23. If an investor buys $1000 of the 30yr and sells in year 29, he can sell the $1000 bond for $1639.71, because the 30yr bond is now equivalent to a 1yr bond ($1639.71*2.23%=$13.60). Once the investor cashes in, he can reinvest the $1639.71 in another 30yr, so 'picks up' a little extra versus holding to maturity. This of course assuming the yield curve stays the same. A steeper curve will result in more gain and if the yield curve is flat then there is no gain. If the yield curve is inverted, then the investor would simply hold to maturity.

Is there a way to calculate how many basis points the 'ride-the-yield-curve' effect adds to VAB? Even back of napkin calculation?

User avatar
adrian2
Diamond Ring
Diamond Ring
Posts: 11617
Joined: 19 Feb 2005 08:42
Location: Greater Toronto Area

Re: Do bonds in RRSP/TFSA still make sense?

Post by adrian2 » 04 Dec 2017 14:50

FI40 wrote:
04 Dec 2017 11:34
adrian2 wrote:
03 Dec 2017 11:57
On average, VAB should return more than the YTM - MER, due to the "ride-the-yield-curve" effect.
Assuming rates rise in the future, right? Or are you talking about something else?
No, it's assuming a normal yield curve, in which longer bonds yield more than shorter ones.
No changes in the yield curve are required.
Imagefiniki, the Canadian financial wiki
“It doesn't matter how beautiful your theory is, it doesn't matter how smart you are. If it doesn't agree with experiment, it's wrong.” [Richard P. Feynman, Nobel prize winner]

Post Reply