Fixed Income Investing II

[Echard]

Has anyone else noticed that the yield to maturity shown on brokerages like Vanguard and Fidelity don't take into account the accrued interest you have to pay a seller, and thus over-state the "true" yield you are receiving?

 

[Spock]

Has anyone else noticed that the yield to maturity shown on brokerages like Vanguard and Fidelity don't take into account the accrued interest you have to pay a seller, and thus over-state the "true" yield you are receiving?

You get the accrued interest back at the next coupon payment.

 

[COcheesehead]

Has anyone else noticed that the yield to maturity shown on brokerages like Vanguard and Fidelity don't take into account the accrued interest you have to pay a seller, and thus over-state the "true" yield you are receiving?

The yield is restated on the preview you see before buying. There is an offer yield and a purchase yield. They will be different, but reset upon the first coupon payment.

 

[Echard]

You get the accrued interest back at the next coupon payment.

What you get back is just your normal coupon payment, which was already taken into account in the original YTM calculation, I believe (but not 100% sure). You are still paying the seller for interest while they held the bond, and that is appropriate, of course. These bonds don't trade flat like baby bonds.

The yield is restated on the preview you see before buying. There is an offer yield and a purchase yield. They will be different, but reset upon the first coupon payment.

Ah interesting. I buy almost all bonds on Vanguard and it doesn't re-state the yield with the accrual interest, unless I'm missing something.

And I don't understand the reset comment. I'm realizing I may not fully understand the YTM calculation. Upon a coupon payment and assuming no market change, the price should drop to show the same YTM, right?

For example, Fidelity and Vanguard will show you when you search for bonds, say, a 4.9% yield. But when you purchase that bond, it includes accrued interest, taking your "true" yield to say 4.7%. Then, at coupon payment, the price of the bond should drop to reflect the payment and returns to the same elevated, but ultimately incorrect 4.9% YTM. Is that right?

Bottom line - are you only making 4.7% or 4.9% on your money?

 

[Mulligan]

Congrats!

Yes I agree. It seems like the little upticks we have had in yields since then have just been stairsteps on the way down, to the consternation of some.

Mulligan, you are definitely one of the most experienced guys here. If you wished to share some of your ideas closer to your trade I'm sure many would appreciate it.

If memory serves, we were both on the same wavelength about the yields last fall. Nobody ever knows for sure, they just have to buy when it suites a comfort zone. Sometimes you have to buy when its uncomfortable. Last fall yields were ripping, but senior unsecured bonds were paying more than preferred stock were at the time, so I dove in….But never at the degree I should have looking back…But I rarely over dive at the wrong time either so I guess it balances out some.
The “perfect time” is never obvious when going long, because there will always be hesitation due to the duration exposure. As you mentioned before, bells wont ring to buy. Look at how quickly the 2 year has collapsed in less than a week….60 bps!
And of course going longer duration may not be a need or desire for any particular investor either.

 

[COcheesehead]

What you get back is just your normal coupon payment, which was already taken into account in the original YTM calculation, I believe (but not 100% sure). You are still paying the seller for interest while they held the bond, and that is appropriate, of course. These bonds don't trade flat like baby bonds.



Ah interesting. I buy almost all bonds on Vanguard and it doesn't re-state the yield with the accrual interest, unless I'm missing something.

And I don't understand the reset comment. I'm realizing I may not fully understand the YTM calculation. Upon a coupon payment and assuming no market change, the price should drop to show the same YTM, right?

For example, Fidelity and Vanguard will show you when you search for bonds, say, a 4.9% yield. But when you purchase that bond, it includes accrued interest, taking your "true" yield to say 4.7%. Then, at coupon payment, the price of the bond should drop to reflect the payment and returns to the same elevated, but ultimately incorrect 4.9% YTM. Is that right?

Bottom line - are you only making 4.7% or 4.9% on your money?

Honestly, I just look at the purchase yield on the buy ticket and make my final decision then. Most times it’s so small of a difference.
If you really want to get into the weeds, the YTM assumes reinvestment of the interest. So noodle on that one for a bit.

 

[COcheesehead]

The yield to maturity (YTM) is an estimated rate of return. It assumes that the buyer of the bond will hold it until its maturity date, and will reinvest each interest payment at the same interest rate. Thus, yield to maturity includes the coupon rate within its calculation. YTM is also known as the redemption yield.

 

[Echard]

The yield to maturity (YTM) is an estimated rate of return. It assumes that the buyer of the bond will hold it until its maturity date, and will reinvest each interest payment at the same interest rate. Thus, yield to maturity includes the coupon rate within its calculation. YTM is also known as the redemption yield.

I had never noticed a significant difference before between the dirty yields and clean yields, I guess because I had not bought a bond with significant accrued interest and high coupon rates. Something to keep in the back of our minds as we compare the yields of bonds with comparable credit ratings and other characteristics. But, like you said probably the max yield impact is probably not too high. I found .2% on the one I bought yesterday.

 

[COcheesehead]

I had never noticed a significant difference before between the dirty yields and clean yields, I guess because I had not bought a bond with significant accrued interest and high coupon rates. Something to keep in the back of our minds as we compare the yields of bonds with comparable credit ratings and other characteristics. But, like you said probably the max yield impact is probably not too high. I found .2% on the one I bought yesterday.

I agree, it’s really just a nit.

 

[ShokWaveRider]

I think I may jump into one of Schwab's 5.5% Callable CDs.

 

[COcheesehead]

I sold all my speculative bonds yesterday on the pop - lower rates - over the last few days. I am now back to having all my bonds be for income. I made some fun money, low thousands on all of them. Now back to collecting boring interest to pay the retirement bills.

 

[Echard]

what are people's thoughts on how much money to put in year of their bond ladders. For a ten year ladder, do you put 10% of your total funds in each, or do you put more in each of the successive maturity dates? As I mentioned before my current bond ladder looks more like a slide since the yield curve is inverted, but given inflation annually of 2-4%, theoretically you should be putting more money in each year of the ladder.

 

[Montecfo]

I think the answer is a dynamic one, depending on dollars to invest in bonds and number of years.

So if you have 400K to invest and want and 8 year ladder it is 50K per year.

 

[pb4uski]

what are people's thoughts on how much money to put in year of their bond ladders. For a ten year ladder, do you put 10% of your total funds in each, or do you put more in each of the successive maturity dates? As I mentioned before my current bond ladder looks more like a slide since the yield curve is inverted, but given inflation annually of 2-4%, theoretically you should be putting more money in each year of the ladder.

My approach to this is evolving and I'm trying to decide on how to play the inverted yield curve without leaving too much yield on the table and what weighted average maturity I want to target.

Right now my weighted average maturity is 2.5 years, with 14% in 2023, 25% in 2024 and 26% in 2025as these issues matury I can reinvest to extend the ladder. OTOH, I have some deminimus perpetual preferreds (4%) and 5% maturing in 2037 (a 6.375% agency callable that I fully expect will be called sometime but if it doesn't get called I won't be disappointed).

If I look at Vanguard's Short Term bond fund their weighted average maturity is around 3 years and Intermediate Term are around 7 years. Over the long term, 3 years seems too short, but at the same time 7 years seems a bit long, so at least for now, I'm thinking of drifting to a weighted average maturity of about 5 years over some period of time. That would ideally mean 10 roughly equal annual rungs.

 

[Echard]

My approach to this is evolving and I'm trying to decide on how to play the inverted yield curve without leaving too much yield on the table and what weighted average maturity I want to target.

Right now my weighted average maturity is 2.5 years, with 14% in 2023, 25% in 2024 and 26% in 2025as these issues matury I can reinvest to extend the ladder. OTOH, I have some deminimus perpetual preferreds (4%) and 5% maturing in 2037 (a 6.375% agency callable that I fully expect will be called sometime but if it doesn't get called I won't be disappointed).

If I look at Vanguard's Short Term bond fund their weighted average maturity is around 3 years and Intermediate Term are around 7 years. Over the long term, 3 years seems too short, but at the same time 7 years seems a bit long, so at least for now, I'm thinking of drifting to a weighted average maturity of about 5 years over some period of time. That would ideally mean 10 roughly equal annual rungs.

Ya, I've been trying to develop a spreadsheet tool and/or philosophy around how to apply funds in each year. So far, I've just been chasing yields of 5%+ anywhere from 1-10 years, with a heavy majority in years 1-5.

One of the interesting outputs from the spreadsheet I built is that if you want a certain level of income to be covered for say, 10 years, then you really need to think about inflation during those ten years and probably need to lock-in more rates further out if possible. Of course an inverted yield curve makes that even more risky. But locking in is important, because in the event the entire curve drops and say flattens, then you won't kick off enough funds during reinvestment periods, unless you are already way overfunding years 1-9, and the early years substantially.

 

[COcheesehead]

Ya, I've been trying to develop a spreadsheet tool and/or philosophy around how to apply funds in each year. So far, I've just been chasing yields of 5%+ anywhere from 1-10 years, with a heavy majority in years 1-5.

One of the interesting outputs from the spreadsheet I built is that if you want a certain level of income to be covered for say, 10 years, then you really need to think about inflation during those ten years and probably need to lock-in more rates further out if possible. Of course an inverted yield curve makes that even more risky. But locking in is important, because in the event the entire curve drops and say flattens, then you won't kick off enough funds during reinvestment periods, unless you are already way overfunding years 1-9, and the early years substantially.

Here is my simple minded approach to having enough for 10 years - inflation protected - which was my actual goal - get us to SS at 70. I simply overfund the ladder. So if I need $135,000 a year in today’s dollars to be comfortable - I actually fund the ladder to throw off $195,000. I throw the excess into equities or just back into bonds.
I’ve said on here, probably too many times, that yield percentage to me is secondary to cashflow. I can’t spend yield, but the grocery store accepts cashflow. So if my ladder is yielding 5% vs a more efficient/effective plan of 5.5%. I really don’t care. Just because something can be optimized doesn’t mean it has to be.

 

[Echard]

Here is my simple minded approach to having enough for 10 years - inflation protected - which was my actual goal - get us to SS at 70. I simply overfund the ladder. So if I need $135,000 a year in today’s dollars to be comfortable - I actually fund the ladder to throw off $195,000. I throw the excess into equities or just back into bonds.
I’ve said on here, probably too many times, that yield percentage to me is secondary to cashflow. I can’t spend yield, but the grocery store accepts cashflow. So if my ladder is yielding 5% vs a more efficient/effective plan of 5.5%. I really don’t care. Just because something can be optimized doesn’t mean it has to be.

This makes total sense. I just started to try and figure all of this out in the last few months and your thinking on the topic is way ahead of mine.

I assume you just built a relatively flat ladder across the 10 years, since you overfunded in the first place?

 

[COcheesehead]

This makes total sense. I just started to try and figure all of this out in the last few months and your thinking on the topic is way ahead of mine.

I assume you just built a relatively flat ladder across the 10 years, since you overfunded in the first place?

Flat was the goal, but the reality is I have a bump in 2032, our year of turning 70 and based on originally not wanting to go past that date. It doesn’t really matter and I have begun to extend past 2032 based on some deals I found.
I’ll have a big party in 2032 and everyone on this thread is invited.

 

[DuluthGA]

I can’t spend yield, but the grocery store accepts cashflow. So if my ladder is yielding 5% vs a more efficient/effective plan of 5.5%. I really don’t care. Just because something can be optimized doesn’t mean it has to be.

Totally agree. People would ask me how much net worth i needed to retire and were shocked when I said it didn’t matter. It’s all about how much cash flow I had each year. As I would tell my staff in the old days “Kroger / Publix doesn’t care if you have it budgeted or not. They only care about the cash.”

My ladder is 6 years to get me to 70 when SS kicks in.

 

[pb4uski]

Here is my simple minded approach to having enough for 10 years - inflation protected - which was my actual goal - get us to SS at 70. I simply overfund the ladder. So if I need $135,000 a year in today’s dollars to be comfortable - I actually fund the ladder to throw off $195,000. I throw the excess into equities or just back into bonds.
I’ve said on here, probably too many times, that yield percentage to me is secondary to cashflow. I can’t spend yield, but the grocery store accepts cashflow. So if my ladder is yielding 5% vs a more efficient/effective plan of 5.5%. I really don’t care. Just because something can be optimized doesn’t mean it has to be.

Another option would be buy TIPs that mature uniformly over the next 10 years of $135,000 in today's dollars.

 

[Mulligan]

Flat was the goal, but the reality is I have a bump in 2032, our year of turning 70 and based on originally not wanting to go past that date. It doesn’t really matter and I have begun to extend past 2032 based on some deals I found.
I’ll have a big party in 2032 and everyone on this thread is invited.

I went beyond 2032 today, with a smaller add on purchase of the 2033 Commonwealth Edison (ComEd) Illinois’s largest utility. Issued in 2003 as a 6.35%
par subordinate trust debt issue. Got it a smidge over par. Bought more last fall after bond rout. I think 2035 is the furthest out bond debt I have that being an Empire District Electric senior unsecured issue.

 

[Montecfo]

I went beyond 2032 today, with a smaller add on purchase of the 2033 Commonwealth Edison (ComEd) Illinois’s largest utility. Issued in 2003 as a 6.35%
par subordinate trust debt issue. Got it a smidge over par. Bought more last fall after bond rout. I think 2035 is the furthest out bond debt I have that being an Empire District Electric senior unsecured issue.

Excellent Mulligan. Where did you find?

 

[Mulligan]

Excellent Mulligan. Where did you find?

I stumbled onto it last fall through FINRA. Its a $200 million issuance if memory serves. Being it was issued in 2003 and its size by todays standard is small, its not traded that frequently. But I noticed a few days ago an over $300,000 value block became for sale. Its Cusip is 20035AAA2. The bond is called ComEd FING III. It was issued via a trust because the tax laws were different then. Its guaranteed by ComEd. ComEd is a subsidiary of Exelon. ComEd’s Moodys credit ratings are A1 for senior secured then slots down to Baa2 for the lowest debt cap stack of subordinated which is this issue. S&P slots everything one peg lower while Fitch falls in line with Moodys.

https://www.finra.org/finra-data/fixed-income/bond?cusip=20035AAA2&bondType=CA

 

[imbatman]

Quite a drop from A2 to Baa2, has a make whole call which will never happen, not sure this would ever come through in my screens so thanks for sharing, always interesting to hear what others find.

 

[Mulligan]

Quite a drop from A2 to Baa2, has a make whole call which will never happen, not sure this would ever come through in my screens so thanks for sharing, always interesting to hear what others find.

The ratings are just normal “slottings”. I doubt you find any A rated subordinated debt. That is the nature of “cap stacks”. Short version, a corporation can issue senior secured, senior unsecured, subordinated, and junior subordinated. Preferreds land on other side of ledger into equity though are often treated as “debt like”.
They generally drop 2 slots per cap stack lowering. That is how rating agencies do it. So if you have a BBB senior unsecured, you pretty much know, if they issued subordinated debt its going to slot BB+. etc. etc. Many times companies will issue subordinated debt because rating agencies will give it 50% “equity credit” for the debt. Conversely preferreds often are given 50% “debt credit”. One gets higher yield here, but the trade off is, if company goes bankrupt you will almost always have your nose pressing against the window on the outside looking in…Along with the preferred and common stock holders.
Added clarity, rating agencies tend to lump preferreds, and subordinated debt together. Thus their 50% debt or equity “credit” given to them. Sometimes they slot a subordinated issue a tick higher. And Fitch sometimes slots a non cumulative preferred a tick lower than a preferred.