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Re: Quest for yield versus safety
Old 11-04-2003, 07:27 AM   #21
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Re: Quest for yield versus safety

Far and away the biggest "bill" that will need to be paid by future workers will be that required to pay the social security benefits of future retirees, assuming that these benefits continue to be indexed for inflation.

In addition, future taxpayers will have a legal obligation to pay off the Treasury bonds that are being purchased today to finance today's federal deficit. (Those who purchase them forego current consumption and in the process free up resources for current use by the government.)

But the federal government in the future (in the interest of future taxpayers) could essentially cancel this debt by inflating the money supply -- as it did during the 1970's. There will be strong political pressure from future taxpayers to do so, mainly because the total burden on them to support a growing retired population will be so great, as the result of demographic trends that have nothing to do with the federal deficit.

To say that middle and lower income people are the only ones who bear the tax burden now, or will in the future, is populist nonsense. I think that people with higher incomes should pay taxes at a higher rate, and in fact they do. While I didn't support the recent cuts in upper level tax rates, it is more populist doubletalk to label it as a "gift to the rich" when the government periodically decides to take less from them, but still taxes them at a substantially higher rate than others.

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Re: Quest for yield verus safety
Old 11-05-2003, 05:23 AM   #22
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Re: Quest for yield verus safety

Anyone care to speculate on future effects of the 15% div. tax rate, TIPs, I bonds on yield or for that matter the risk premium. ? are we headed back to pre 1958 where stock div. yields will beat bonds.

Bertstein(Efficient Frontier website) has struggled with TIPs and portfolio policy.
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Re: Quest for yield verus safety
Old 11-05-2003, 07:38 AM   #23
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Re: Quest for yield verus safety

My guess is that the P/E ratio of stocks in the future will tend to decline towards where it was in the past. While I don't expect stock prices to decline, I think that the growth rate will be suppressed by interest rates rising, making bonds relatively more attractive, and by the "supply" of stocks relative to the "demand" for stocks increasing as a growing retired population liquidates its stock holdings to finance its costs of living in retirement.

This is one of the financial mechanisms through which the real cost of supporting non-working retirees will be borne by future workers, i.e., their investments won't deliver as high a rate of return to them.
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Re: Quest for yield verus safety
Old 11-05-2003, 03:35 PM   #24
 
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Re: Quest for yield verus safety

Hello Ted. My broker has been trying to get me to
invest in a "balanced fund'. (some stock, some bonds, etc) I have decided to "stay the course" and avoid all stocks. He has opined that I have "hurt myself" by
staying away from stocks for all these years. I don't care. What I value is predictability. Stocks don't offer it.
'Nuff said!

John Galt
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Re: Quest for yield verus safety
Old 11-06-2003, 04:38 AM   #25
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Re: Quest for yield verus safety

My MSN news recently posted an artilce on 'leveraged muni bond funds' - 'not for the long haul' which strikes me as trying too hard for yield and probably violates my sense of safety at least for 'this ER'. They quote Bill Gross who has 'guru' status at least in this market cycle. The nimble and asute may do o.k. but I fear a lot of people may misunderstand the leverage/interest cycle and get burned.
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Re: Quest for yield verus safety
Old 11-06-2003, 05:17 AM   #26
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Re: Quest for yield verus safety

Regarding John Galt's aversion to stocks... He is certainly correct in believing that stocks are a risky investment. The thing that everyone should realize is that practically every other investment also carries certain risks. About the only one that is almost completely safe, at least in the foreseeable future, is TIPs or I Bonds (which pay less than TIPs but are tax-deferred). Virtually everyone knowledgeable about financial economics agrees that the rational strategy for dealing with this riskiness is to own a diverse selection of assets, including stocks, such that the fluctuations in market value of the various assets tend to compensate. This principle of diversification to provide portfolio stability becomes especially critical when a person is drawing down their assets in retirement.

Regarding the "leveraged muni bond funds" mentioned by unclemick, BEWARE. I don't know the specifics, but the principle of "no free lunch" says that you can't get enhanced return without increased risk. And usually these "innovative" "financial products" are gimmicks with high expenses that cause the probable extra return to be very small in relation to the extra risk.

A good recent example involved the Heartland mutual fund company that offered, I believe, two funds investing in "high yield" municipal bonds. These funds collapsed and resulted in legal action against Heartland when much of their holdings turned out to be so junky as to be unmarketable. I was particularly aware of this because I have some money in the Heartland Value Fund, which has done very well and fortunately was not affected.
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Re: Quest for yield verus safety
Old 11-06-2003, 03:16 PM   #27
 
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Re: Quest for yield verus safety

Well, I had an opportunity today to shift a significant
amount (for me) into stocks. I demurred. Instead
I went even further out (26 years) in order to maximize
yield while keeping risk at a minimum. Predictability
remains my primary focus. I can twist and alter my plans,
but not having some assurance of what is coming in
(and when) just won't do.
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Re: Quest for yield verus safety
Old 11-06-2003, 05:27 PM   #28
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Re: Quest for yield verus safety

Quote:
About the only one that is almost completely safe, at least in the foreseeable future, is TIPs or I Bonds (which pay less than TIPs but are tax-deferred).
Ted, I'm opening brokerage accounts at Vanguard so I can start buying TIPS over the next few months. I'm planning to put 50% of my portfolio into TIPS, with about 2/3 of that into 30 year TIPS, and 1/3 into 10 year TIPS. I'm thinking 2.5% may not be too bad for 30 year TIPS. They're at 2.41% today. Do you expect to see 3% again? I'm thinking they're going to become more scarce, and that 2.5% might be a reasonable time to move. Thoughts?
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Re: Quest for yield verus safety
Old 11-07-2003, 03:20 AM   #29
 
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Re: Quest for yield verus safety

You can buy government backed AAA rated bonds
that yield over 6% (to maturity) if you go out far enough. True, they
don't have the built in inflation protection of TIPS, but
you don't start out at 2% either. In the end it's all
a big crap shoot anyway IMHO.

BTW, I saw the other day where someone said
"More money has been lost chasing yield than at the
point of a gun!" So true!

John Galt
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Re: Quest for yield verus safety
Old 11-07-2003, 04:37 AM   #30
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Re: Quest for yield verus safety

Bob,

I think that a 3% (plus inflation) return on long-term TIPs is about as high as I would expect them to go. In theory, the market expectation is for the basic interest rate on them to gradually decline to the short term basic rate, as they mature. I agree that there is likely to be a rising demand for long-term TIPs that should sustain their price, although there has been discussion in the Treasury Dept. about renewing the issuance of TIPs with a term longer than 10 years. (I don't think that would seriously depress the price of outstanding TIPs because all issues have the same guarantee. And what John Galt overlooks in comparing the basic yield on TIPs to the yield on conventional bonds is that the basic yield on TIPs is IN ADDITION TO whatever inflation actually occurs. Thus, TIPs with a basic yield of 2% are actually yielding about 3.5% to 4% with inflation currently at 1.5% to 2%.)

The relative immunity of TIPs to loss of value when long term interest rates in general rise, I think, is illustrated by comparing this year's performance of Vanguard's Inflation Protected Securities fund to its "conventional" bond funds. I would guess that the average maturity of bonds in this fund is around 7 years, making them "intermediate term." The fund has a total return of 6.2% year to date. In comparison, the Vanguard Intermediate Term Corporate Fund is up 4.3% and the Intermediate Term Treasury Fund is up just 0.9%. If (and when) inflation really heats up, the relative performance of TIPs will be even better.

While I think that the idea of "laddering" bonds is kind of a gimmick that causes the average maturity of people's bond holdings to sometimes be too short, you might consider having some TIPs of, say 5-year maturity so that you could switch them to longer maturity if the basic rate on TIPs rises. But I think that the allocation that you have in mind is reasonable, and far better than investing in any long-term conventional bonds at this time. (The only other bonds that I think are reasonably priced right now are intermediate term high yield bonds, which will benefit from the likely economic recovery.)
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Re: Quest for yield verus safety
Old 11-07-2003, 06:17 PM   #31
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Re: Quest for yield verus safety

Thanks Ted and John. I have been in the accumulation phase for some time and focused very little on bonds. I've always held bonds in mutual funds, so I have never purchased individual bonds on the secondary market. I logged into my new brokerage account at Vanguard, and here are the details they provided regarding one TIPS offering:

Qty: 1001/1001
CUSIP: 912810FD5
Issue: T Tips (Tips)
Coupon: 3 5/8
Maturity: 04/15/2028
Bid Price: 119-22
Offer Price: 120-10
Bid Yield: 2.539
Offer Yield: 2.508

I could use some help from anyone who has purchased individual bonds on the secondary market. Could you confirm, expand-upon, or correct my understanding of the above data pertaining to this bond?

1. I think there are 1,001 of these specific bonds for sale, is that correct? Just curious, why 1001 and not 1000? I noticed others on the list also had 1001.

2. CUSIP identifies the specific lot sold at the original treasury auction, correct? Is this of any use to me beyond checking for price changes after I buy them?

3. Is there any minimum or maximum purchase? Could I buy as few as 10 of these, for example? What about 103 bonds - or would that be considered an odd lot and include more transaction costs?

4. The "offer price" is "120-10". Here is what I think this bond costs. Is my math and the process I used correct?
a) "120-10" is the same as saying "120 and 10/32"
b) So this bond costs 120 and 10/32 percent of the original $1,000 auction price.
c) 120 and 10/32 percent = 1.203125
d) 1.203125 x 1000 = $1,203.13 which is the offer price of this bond

5. This bond would yield $30.17 per year initially, correct? ($1,203.13 x 2.508% = $30.17). Subsequent interest payments would be 2.508% of whatever the inflation adjusted principle is.

6. What happens when I decide to buy online? Do I simply buy at the offer price? Or is there room for negotiation between the bid and offer prices? How does that process actually work?

7. Do the staff at Vanguard's Bond Desk add any value, or are they just looking at the same list I see? Are there any reasons I may not want to buy online?

8. Vanguard charges a maximum of $75 for a transaction for online treasury purchases. Are there any other hidden fees (on top of Vanguard's fees) that aren't readily obvious to a bond trading novice? Or is $75 the entire cost?

Any advice would be appreciated.
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Re: Quest for yield verus safety
Old 11-08-2003, 09:30 AM   #32
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Re: Quest for yield verus safety

Bob,

There are a number of your questions that your broker can and should answer, but I'll address a couple that relate particularly to TIPs.

Item 4. Your calculation would be correct for a conventional bond, but not for TIPs, because of the unique feature that the principal amount of TIPs changes with inflation. (In one post I was partially incorrect in saying that the principal amount will not decrease if there is deflation. It can, but the principal amount paid at maturity will not be less than the initial par value of $1,000.)

The quote for the TIPs should include the current "accrued principal" on the particular issue. That is the current "par value" that has been determined by the U.S. Treasury by adjusting the original par value of $1,000 to account for inflation since the bond was issued. For example, this particular issue now has an accrued principal (par value) of about $1,143 per bond. The market price of the bond is quoted as a percentage of its current par value. The "offer" price of one of these bonds is therefore (1.203125 x $1,143) = $1,375.

The next 6-month interest payment on this bond is determined by the coupon rate and the accrued principal. It is (1/2 x .0375 x $1,143) = $21.43.

The "yield" that is quoted is the yield to maturity, ASSUMING NO CHANGE IN THE PRESENT ACCRUED PRINCIPAL. It is less than the "current yield" in this case because the market price is at a premium to the accrued principal, which means that the bond would lose some value over its remaining life (reducing its yield to maturity) if there were no inflation. But the actual yield to maturity will doubtless be much greater than 2.5% as the par value of the bond is bumped up in the future to account for future inflation.

Items 6-8. In purchasing any kind of bonds, a person is effectively paying the difference between the bid price and offered price. In other words, if you bought some bonds you would pay the offered price, plus the broker's commission, and then if you decided to immediately sell them, you would pay the (lower) bid price, plus another commission. The main service that the brokerage firm provides is to find you a seller and to insure that each party to the transaction will get what their money/securities in a timely manner, with all necessary transfers of registration taken care of.

You can buy TIPs direct from the Treasury Department, but I think that this only applies to new issues, which currently have a 10 year maximum term.

An interesting question is whether there would be any legal prohibition in an individual offering over the Internet to sell securities that they own. I think that would be illegal, although a person may sell securities to people they know if they don't advertise it publicly.

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Re: Quest for yield verus safety
Old 11-08-2003, 01:06 PM   #33
 
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Re: Quest for yield verus safety

Hey Ted! How did you ever get so immersed in TIPS?
I understand the appeal, but let's face it. There are
a plethora of choices for your money. Why TIPS?
I for one, am not impressed.
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Re: Quest for yield verus safety
Old 11-08-2003, 01:56 PM   #34
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Re: Quest for yield verus safety

Quote:
For example, this particular issue now has an accrued principal (par value) of about $1,143 per bond.
Thanks Ted. Now I get it. The missing piece was the accrued principle. I see they post those figures on the Treasury Department's web site under "CPI Numbers and Daily Index Ratios".

One thing I can't figure out: If the bond price is $1375, and the 6 month interest payment is $21.43, I get a yield of about 3.1% instead of the 2.5% it is supposed to yield. What am I missing?
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Re: Quest for yield verus safety
Old 11-08-2003, 02:16 PM   #35
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Re: Quest for yield verus safety

Quote:
Hey Ted! *How did you ever get so immersed in TIPS? I understand the appeal, but let's face it. *There are a plethora of choices for your money. *Why TIPS? I for one, am not impressed.
John, for me it is a way to make most of my portfolio bullet proof from inflation (between stocks and TIPS). I could probably do better over the short term, but long term I'm not so sure. TIPS got my attention when I plugged them into FIRECalc. SWRs improved. But for me it is all about eliminating another element of risk and sleeping better at night.
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Re: Quest for yield verus safety
Old 11-09-2003, 05:59 AM   #36
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Re: Quest for yield verus safety

Quote:
If the bond price is $1375, and the 6 month interest payment is $21.43, I get a yield of about 3.1% instead of the 2.5% it is supposed to yield. What am I missing?
The 3.1% is the current yield. *The 2.5% is the yield to maturity, which takes into account the "capital loss" that would occur as the bond matured, as the result of the market price at the time of purchase being at a premium to the par value. *This is technically referred to as "amortization of premium" and is not reported as a capital loss for tax purposes.

In response to Jonh Galt's question about why I am "immersed" in TIPs..... what I am really "immersed" in is portfolio diversification. *But TIPs are unique among all financial assets in that they provide a reasonable rate of return with virtually no risk beyond that of minor short term price fluctuations. *So they are ideal investments for many people -- particularly retirees. *And yet they are not owned nearly as widely as the logically should be, for two reasons:
1. People don't understand that the the yield on them that is reported is the yield before the annual inflation adjustment, which makes a huge difference in the actual return. *This lack of understanding is apparent from numerous posts in this forum.
2. *They are not aggressively marketed. *After all, the U.S. Treasury isn't supposed to be spending tax money on marketing, and brokerage firms don't "push" Treasury securities because the market for them is so efficient that the firms don't make nearly as much commission from trading them as they do on stocks and, especially, on gimmicky "financial products" such as loaded mutual funds and deferred annuities.

I basically believe in free markets and understand that the flow of truthful information is essential for them to function properly. *I also understand many ways in which that flow is distorted by self-interests. *So I do what I can to counter that.

Naturally, it makes sense to question the motives of anyone giving financial advice, but I can't imagine why anyone other than perhaps John Snow would have a self-interest in promoting Treasury securities. You can be assured, however, that this post is not a Snow job
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Re: Quest for yield verus safety
Old 11-09-2003, 01:31 PM   #37
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Re: Quest for yield verus safety

Quote:
The 3.1% is the current yield. *The 2.5% is the yield to maturity, which takes into account the "capital loss" that would occur as the bond matured, as the result of the market price at the time of purchase being at a premium to the par value. *This is technically referred to as "amortization of premium" and is not reported as a capital loss for tax purposes.
Thanks Ted. This is complex. I'm trying to get the whole picture and I appreciate your patience. So assuming inflation is zero for the life of the bond, I pay $1375 for the bond, get a 3.1% yield on my $1375, but I only get $1143 back in the end, correct? And it is the difference between the $1375 I paid, and the $1143 I'll get in the end that accounts for the difference between 3.1% and 2.5%, is that right? So will I actually be getting 3.1% in regular interest payments (instead of the 2.5% I was expecting), but correspondingly less in accumulation of principle? If I plan to hold until maturity and use the interest to live on, that would seem to be a very good thing because I won't be required to liquidate bonds quite as often to keep pace with my spending. That would serve to reduce risk even more. Do I understand this correctly, or am I still off the mark?
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Re: Quest for yield verus safety
Old 11-10-2003, 05:16 AM   #38
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Re: Quest for yield verus safety

Quote:
So assuming inflation is zero for the life of the bond, I pay $1375 for the bond, get a 3.1% yield on my $1375, but I only get $1143 back in the end, correct? And it is the difference between the $1375 I paid, and the $1143 I'll get in the end that accounts for the difference between 3.1% and 2.5%, is that right?
This is correct. *

In actual fact, however, it is virtually certain that inflation will continue and that the accrued principal of the bond will therefore keep increasing every year. *In fact, you will need to pay tax on both the interest and the annual increase in accrued principal unless the TIPs are held in a retirement account (which is a good idea). *When the bond matures, the Treasury will pay you the accrued principal. *It will not be subject to capital gains tax because you will have been paying tax on the increase in accrued principal every year.

Also, note that the interest payments will increase every year too, since they are determined by applying the coupon rate (which is fixed) to the accrued principal (which is increasing).

The "yield to maturity" on all bonds is calculated the same way, but it is easier to understand on conventional bonds that have a fixed par value of $1,000.
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Re: Quest for yield verus safety
Old 11-10-2003, 05:25 AM   #39
 
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Re: Quest for yield verus safety

Ted,

Do you know of any good books on strategies for investing in TIPS?
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Re: Quest for yield verus safety
Old 11-10-2003, 05:52 PM   #40
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Re: Quest for yield verus safety

Nope. Zvi Bodie's Worry Free Investing has caught Bernstein's attention - check Efficient Frontier website - fall 2003.
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