Generally I think this is overly complex. Exact immunization (matching the cash flows of the bond portfolio to the need for cash) is a complex topic which even the professionals don't always get right (because of uncertain timings of need for cash).We have some proceeds coming from real estate and we want to invest it entirely in bonds. We don’t know when or if we will need the money but instead have a probability distribution of outcomes from which we want to build a bond ladder. Here is the distribution of outcomes:
Let X be amount of total bonds to buy (= distribution from real estate sale).In summary, it seems safe to put 1/4 of X in bonds with a duration of 5 or more years. I would also say we have a 87% chance we can put another 1/4 in for 5 or more years. Thus I’m thinking
- 50% chance: We need ~1/2 of X in ~2 years for another real estate purchase.
- 25% chance: we don’t need any of X for next 5 years
- 12.5% chance: we need ~3/4 of X in ~2-3 years
- 12.5% chance: we need only 1/4 of X in ~2 years
We will know a lot more in 1 year and can adjust the bond ladder then as needed (reinvesting shorter or longer as needed).
- 1/4 in <2 year bonds
- 1/4 in 2 year bonds
- 1/4 in bonds 3-5 year duration
- 1/4 in bonds 5+ (7 and 10 year bonds)
Q1: Overall, is this a reasonable approach?
We thought that if we absolutely need the 3-5 year duration bonds we can sell them in 2-3 years when close to maturity; if interest have risen then the typical penalty is only 1% per 100bps change. And, also, we can opt for higher coupon bonds for now...I realize that might be "market timing" with the expectation that interest rates will fall but perhaps all things being equal it is best to opt for the higher coupon bonds for now.
Q2: I'm not that experienced with buying bonds so trying to understand if I should just get an assortment of coupons or just take the highest yield and ignore the coupon amount?
Also, the plan is to use Treasuries only. This gets us close to our desired asset allocation of 70/30 (equities/bonds). We will take the risk on the equity side and just stick to Treasuries and in our case there is no benefit to munis.
Thanks in advance. Have learned a lot here and hoping to get useful suggestions on tools to use or how to think about bond ladders when considering a probability distribution of needs.
I would put 100% in either ST Bond fund or CDs maturing in 1-5 years. Assuming those CDs can be cashed in or sold early. Rule of thumb: duration of the portfolio less than or equal to the timing of the need for cash. You can estimate the latter given your probabilities.
For some taxpayers, municipal bonds are worthy of consideration.
If you are not experienced with owning individual bonds there's a lot to learn. Perhaps the Annette Thau book? Larry Swedroe?
Concepts like clean and dirty pricing. Rule of thumb: the bond price is the clean price (no interest accrual) and the price paid is the dirty price (paying the seller for the accrued interest they will not receive from the next coupon).
Your income will be the coupons - which you will then need to reinvest. The Yield to Maturity number reflects the premium/ discount to par ($100 usually) that is amortised over your holding period of the bond. It's not a bad measure of estimated return from owning the bond. However unless it is a zero coupon bond, it won't be an exact estimate (because interest rates fluctuate).
Statistics: Posted by Valuethinker — Fri Jun 14, 2024 4:55 am — Replies 4 — Views 503