Real Return Bonds

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ghariton
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Re: Real Return Bonds

Post by ghariton »

big easy wrote:A week and a half later and now it's 0.48% on the 2021. Is that a misprint? :shock:

http://www.globeinvestor.com/servlet/Pa ... ype=fedgov
Well, the link shows the nominal yield on a nominal government bond maturing in 2022 at 3.22%. If you believe that inflation will average 2.0% over the next ten years, that's a real return of 1.22% -- and you bear the risk of unexpected inflation. If you believe that inflation will average 3.0% over the next ten years, that's a real return of 0.22% -- and you still bear the risk of unexpected inflation higher than 3.0%.

I would say that the prices of nominal government bonds and real return bonds are reasonably well aligned. Both give very low real returns. There are a lot of theories out there as to why this is so. But it is so, it's not going away soon, and investors have to deal with it.

If you want higher real returns, you have to move up to corporate bonds or equities, as James Hymas has said upthread. I think that adds risk (but others may disagree). What you do depends on your tolerance for extra risk. Mine is lower than it used to be.

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Re: Real Return Bonds

Post by parvus »

newguy wrote:
rhenderson wrote:I'm obviously missing something here. My marginal rate is 40% and each time that I deregister funds from my RRSP they are taxed at that rate, so what's the difference :?:
While ghariton's explanation is almost certainly correct, I'd explain a psychological problem with your statement. You think the money in your RRSP is your's. If you put it in and take it out with a 40% marginal rate, then the money was never all yours in the first place, but 40% belonging to the gov't. They just lent it to you.

newguy
Not true. They lent the returns on the investment, not the capital. Pull out the capital, you pay back the deduction on the capital invested. Pull out the capital and the returns, then you pay back the deduction plus. You're veering here into a mirror image of Canadian Centre for Policy Alternatives territory, where the theory is that private savings through RRSPs are bad, and savings through RPPs (preferably through DB plans) are good, even though there's the same tax credit at source -- and the same tax payable upon withdrawal. Surely you're not suggesting that public sector pension plans, for example, are a government shell game? :mrgreen:
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ghariton
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Re: Real Return Bonds

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For those of you who calculate asset allocations (or at least take them seriously), based on the proportions of your holdings in various asset classes, how do you treat RRSPs as opposed to TFSAs and unregistered accounts? Do you take into account that you will have to pay a lot of tax on amounts in an RRSP, a bit of tax on amounts in an unregistered account, and no tax on amounts in a TFSA?

In other words, do you subtract estimated taxes and do your asset allocation on a net-of-tax basis?

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Re: Real Return Bonds

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parvus wrote:Surely you're not suggesting that public sector pension plans, for example, are a government shell game? :mrgreen:
No they're the same thing. It would be better to compare a RRSP with the same rates on contribution and withdrawal to a TFSA. Then you could see how it really works. Either way it's still the best place for RRB's


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Re: Real Return Bonds

Post by Peculiar_Investor »

ghariton wrote:For those of you who calculate asset allocations (or at least take them seriously), based on the proportions of your holdings in various asset classes, how do you treat RRSPs as opposed to TFSAs and unregistered accounts? Do you take into account that you will have to pay a lot of tax on amounts in an RRSP, a bit of tax on amounts in an unregistered account, and no tax on amounts in a TFSA?

In other words, do you subtract estimated taxes and do your asset allocation on a net-of-tax basis?

George
Your point is well taken, but I've chosen to calculate without the impact of taxes. I recognize that there will be a tax impact at some unknown point down the road, at some unknown tax rate. Governments may change tax rates or we may move again, so the provincial tax rate could change. Even though the current rate could be used as an approximation, it changes the asset allocation calculation from using known values to using somewhat abstract values.

We saved a bundle of tax as a result of moving from ON to AB in 2004. If you'd asked me 2 years earlier, this move wasn't on our radar screen. So I am keenly aware of the significant impact of changing provincial tax rates. Most of our family ties remain in Ontario, so it is possible that we'd move back someday in the future. So what tax rate should I choose?

My investment policy already includes target ranges (plus/minus) which helps guide if/when asset allocation moves need to occur. I'm not sure how I would benefit if I tried to calculate using net-of-tax basis and add that variable to our calculation of asset allocation.
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newguy
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Re: Real Return Bonds

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ghariton wrote:In other words, do you subtract estimated taxes and do your asset allocation on a net-of-tax basis?
I do my asset allocation on a market timing basis so I don't think it matters :lol: . When I grow up I'd like to do my AA to maximize my after tax expected return, and that includes which asset goes in which account and even which assets to buy. I'm not even sure it works out best to have bonds in the RRSP and stocks outside.

newguy

ps. sounding ot now.
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Re: Real Return Bonds

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ghariton wrote:For those of you who calculate asset allocations (or at least take them seriously), based on the proportions of your holdings in various asset classes, how do you treat RRSPs as opposed to TFSAs and unregistered accounts? Do you take into account that you will have to pay a lot of tax on amounts in an RRSP, a bit of tax on amounts in an unregistered account, and no tax on amounts in a TFSA?

In other words, do you subtract estimated taxes and do your asset allocation on a net-of-tax basis?
A famous article I've previously mentioned is Reichenstein's.
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ghariton
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Re: Real Return Bonds

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adrian2 wrote:A famous article I've previously mentioned is Reichenstein's.
Thanks Adrian. That's a great article and I had not seen it previously.

(I should follow your posts more carefully. :wink:)

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Re: Real Return Bonds

Post by Springbok »

I stopped for a coffee today at Coffee Way and as usual only papers to read were Sun and Star. The Star business section had an article about asset allocation:

http://www.moneyville.ca/article/985282 ... nvestments

The study depicted in the chart shows that a high fixed income asset allocation won hands down over the past 10 years. This is apparently based on Morningstar's Andex charts

Maybe it is time to re-look at FI allocation. But back to the question - how should we dial in taxation?
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Re: Real Return Bonds

Post by Springbok »

ghariton wrote:
adrian2 wrote:A famous article I've previously mentioned is Reichenstein's.
Thanks Adrian. That's a great article and I had not seen it previously.

(I should follow your posts more carefully. :wink:)

George
Interesting that this comes up. I had just been playing with some numbers to try and compare different types of investments in registered and unregistered accounts.

Following on from the corporate tax discussions, I was trying to include the corporate tax seeing as owner of a piece of the company, this would apply to the shareholder too.

Is it better to invest my $100 in a taxable corporation's common shares, or in it's preferred shares or in it's bond or notes? Or what would the relative yields have to be to make each investment equal? And how does this change between registered and unregistered accounts.

Has this type of study been done based on our tax system?
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Re: Real Return Bonds

Post by big easy »

I think I've decided to keep my RRB's, even at these pitiful low yields. As LTR points out, where else am I going to find a 2% real yield. Well I could invest in corporates but this entails more risk - risk is for equities, bonds are for safety. The RRB's are only 15% of my total portfolio, so I'm content to hold them to maturity & get my 2% real return.

This is about the same as the long, long term real return on long term corporate bonds anyway. See here for example: http://www.investorsfriend.com/Time%20I ... Market.htm

The real return on US long term corporates has been 6% since 1980 but only 3% since 1929. The most recent returns occurred because of falling inflation and interest rates. The best case scenario going forward is for stable interest rates and inflation, in which case LT corporates could give 2-3% real. I'll take my guaranteed 2% over a best case 3%.

Still, its tempting to trade in and out of RRB's based on todays low yields. I think I'll just buy more if the yield ever gets back to 3%.
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Re: Real Return Bonds

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big easy wrote:I think I've decided to keep my RRB's, even at these pitiful low yields. As LTR points out, where else am I going to find a 2% real yield. Well I could invest in corporates but this entails more risk - risk is for equities, bonds are for safety. The RRB's are only 15% of my total portfolio, so I'm content to hold them to maturity & get my 2% real return.
I think I've decided to keep mine too, and at only 5% of my total portfolio, it's somewhat easier to think I've decided. :wink:

But don't fool yourself: you're going to get ~.95% real to maturity from today's prices, not 2%.
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Re: Real Return Bonds

Post by Bylo Selhi »

ockham wrote:But don't fool yourself: you're going to get ~.95% real to maturity from today's prices, not 2%.
He's not fooling himself. He's saying, "I'm content to hold them to maturity & get my 2% real return", i.e. that's the effective YTM on the RRBs he already owns.
big easy wrote:I think I'll just buy more if the yield ever gets back to 3%.
Hold your RRBs by all means, but don't hold your breath waiting for market yields to go back to 3% real ;)
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Re: Real Return Bonds

Post by big easy »

ockham wrote:But don't fool yourself: you're going to get ~.95% real to maturity from today's prices, not 2%.
Maybe I've got the math wrong but I figured if I'd sold, I'd have to get roughly 1.3% real going forward (to 2026) to break even with the RRBs. This was not compelling evidence to sell.

I took the original investment & assumed a 4% return (2% real + 2% inflation) to get the future value, FV. Then I calculated the required return on the current value of the RRB's that would give me the same FV. (if I assumed more inflation, I would have to earn a higher return to breakeven with the RRB's).
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Re: Real Return Bonds

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This information is believed to be from reliable sources but may include rumor and speculation. Accuracy is not guaranteed
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Re: Real Return Bonds

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Bylo Selhi wrote: ....
big easy wrote:I think I'll just buy more if the yield ever gets back to 3%.
Hold your RRBs by all means, but don't hold your breath waiting for market yields to go back to 3% real ;)
Ah yes, the good old days of around 3% to 4% real in 2000. :?
I only bought in at around 3% and then rather modestly.
I agree with Bylo that the chance of seeing anything close to that again soon is extremely unlikely - in the next 10 years? - or in my lifetime??

Wow. I just now realize that RRBs were below 1% real a few days ago. See bottom of page at Bank of Canada
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Re: Real Return Bonds

Post by poedin »

So ... if one was looking to further diversify their fixed income portion of their portfolio, then this would not be an opportune time to buy RRBs at their current real yield? Perhaps a patient 5+ year buy in approach?
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Re: Real Return Bonds

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poedin wrote:So ... if one was looking to further diversify their fixed income portion of their portfolio, then this would not be an opportune time to buy RRBs at their current real yield? Perhaps a patient 5+ year buy in approach?
It depends (from my perspective). Let me illustrate with the following two extreme positions.

Individual #1 - age 60+, out of work with little prospect of future employment, with preservation of savings a paramount concern, not willing to roll the dice and so perhaps diminish the savings in hand, worried about inflation increasing, etc. This individual should find the 1% RRB attractive.

Individual #2 - age 30 with an education who is not worried about asset preservation at this stage of his life. Realizes that he can take some risks, as he has 30+ years to recover should his investments stumble, etc. This individual may not be interested in a 1% real return, albeit very safe, via RRBs.

Just my opinion.

The gray area between #1 and #2 is where it becomes difficult to know what to do with RRBs.
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Re: Real Return Bonds

Post by poedin »

Thanks George$ for confirming my thoughts ...
I'm in that gray area, but a small(er) investment at this time remains in the plan.
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Re: Real Return Bonds

Post by ghariton »

Today's CPI report was 3.7%, year-over-year, to May 2011.

With real yields on RRBs averaging about 1.0%, that's a nominal yield of 4.7%. By contrast, the nominal yield on comparable long term Government of Canada bonds is less than 3.5%. Does that mean that investors are expecting disinflation? I don't think so.

In passing, I notice that the Bank of Canada reports average (nominal) rates of return on GICs ranging from 1% on the one year to 2% on the five year. That means that everyone holding a five-year GIC ladder is getting a negative real yield on that part of their portfolio. Supports my belief that, if one is worried about inflation, going short with nominal instruments is not a very safe solution.

(But then I'm biased against five-year ladders of GICs or bonds.)

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Re: Real Return Bonds

Post by IdOp »

ghariton wrote:In passing, I notice that the Bank of Canada reports average (nominal) rates of return on GICs ranging from 1% on the one year to 2% on the five year. That means that everyone holding a five-year GIC ladder is getting a negative real yield on that part of their portfolio.
I'm not sure that conclusion necessarily follows for "everyone"; the rates on GICs vary markedly by institution. Here is an example (at one particular point in time).
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Re: Real Return Bonds

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IdOp wrote:the rates on GICs vary markedly by institution. Here is an example (at one particular point in time).
Fair enough.

But even the highest rate for the 5-year, 2.95%, results in a negative real rate of return of 0.75%. The whole ladder is under (real) water by at least 1.2%, at this point in time, of course.

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Re: Real Return Bonds

Post by Bylo Selhi »

ghariton wrote:But even the highest rate for the 5-year, 2.95%, results in a negative real rate of return of 0.75%. The whole ladder is under (real) water by at least 1.2%, at this point in time, of course.
Even those rates are less than what's achievable, e.g. current rates from BNS for "good" customers:

2 yr • 2.60%
3 yr • 2.80%
4 yr • 2.95%
5 yr • 3.25%

The 5-year bond ladders I'm running for family members currently average ~4%.

Note too that yesterday's 3.7% is due mostly to a spike in gasoline prices. We won't know it it's a "one off" or "the new normal" or "the good old days" for a while yet ;)

(Still sitting smugly on my RRBs "for the duration.")
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Re: Real Return Bonds

Post by brucecohen »

Bylo Selhi wrote: Note too that yesterday's 3.7% is due mostly to a spike in gasoline prices. We won't know it it's a "one off" or "the new normal" or "the good old days" for a while yet
Also note that the standard 5-year GIC ladder offers an annual opportunity to adjust 20% of the ladder for the then-current outlook for inflation.
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Re: Real Return Bonds

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Bylo Selhi wrote:The 5-year bond ladders I'm running for family members currently average ~4%.
I assume that the 4% is calculated on current market value, however you obtain the FMV.
Note too that yesterday's 3.7% is due mostly to a spike in gasoline prices. We won't know it it's a "one off" or "the new normal" or "the good old days" for a while yet ;)
Yes, well, forecasting inflation is almost as hard as forecasting interest rates or FX. I've come to believe that the current inflation rate is the best predictor we have of future inflation, although I understand the attraction of using the Bank of Canada's target of 2% -- or even "core CPI" at 1.8%. You get to pick. :wink:

Even if future inflation for the next five years comes in at 2% or 1.8%, if one believes the Bank of Canada yields for GICs, a lot of those ladders will have negative yields.

And that goes to my point. Five-year ladders of GICs can fail as a safeguard against inflation.

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