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Does anyone use bond ladders?

Including Financial Independence and Retiring Early (FIRE)
Gilgongo
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Does anyone use bond ladders?

#410203

Postby Gilgongo » May 8th, 2021, 9:17 am

Most "bucket" approaches recommend a bond ladder with maturing bonds doing the spending cash replenishment, and stocks being sold to replace the maturing bond (as I understand it).

But with interest rates expected to rise long-term, are bond ladders a good idea? I like the principle of smoothing out market volatility in draw-down, so would a decent compromise be having, say, 30-40% of the portfolio in a bonds/gilts EFT instead? So, selling a year's worth from those every year to replenish cash, and keeping them at 30-40% from the sale/proceeds from stocks (the sale of which would be governed by market conditions)?

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Re: Does anyone use bond ladders?

#410253

Postby hiriskpaul » May 8th, 2021, 12:45 pm

You are almost always better off using a series of fixed rate deposit accounts than a short dated bond ladder. At the moment the 5 year gilt yield is about 0.32%, but you can find FSCS protected 5 year bank deposits paying above 1.3%.

An alternative that used to work well was to hold longer dated bonds, such as a seven through 12 year ladder, then each year selling the short dated gilt and buy another long dated one. This strategy does carry more interest rate risk, but compensates with a much greater expected return. The problem at present though is that 12 year gilts are still only yielding around 0.9%, so the risk of holding that as a "safe" asset for 5 years, compared to a 5 year deposit paying 1.3% does not really stack up. Expected return is about the same provided the yield curve does not change significantly. The yield curve almost certainly will change of course, but that change could be to the detriment of bond holders.

The advantage of a gilt ladder compared to a deposit ladder though is that of liquidity. Gilts can be sold instantly, but ending fixed rate deposits early has become virtually impossible (sometimes possible in the case of hardship, severe illness or death). There was a time when you could do this, but suffer from loss of interest, but the banks no longer want to offer fixed term deposits with an early withdrawal option.

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Re: Does anyone use bond ladders?

#410331

Postby 1nvest » May 8th, 2021, 6:24 pm

With a ladder where each bond is held to maturity the ongoing rate of return without marking the gilts to ongoing market prices (as you're holding each to maturity) can be approximated as the average of the current and prior 9 years ten year gilt yields (which assumes that each rung is loaded to equal capital values which in practice is unlikely) - assuming a ten year ladder.

Go back over UK history and those 10 year ladder figures look like ...

3.574 1939
3.444 1940
3.316 1941
3.103 1942
2.999 1943
2.927 1944
2.883 1945
2.873 1946
2.831 1947
2.762 1948
2.714 1949
2.618 1950
2.577 1951
2.629 1952
2.761 1953
2.838 1954
2.889 1955
3.039 1956
3.321 1957
3.608 1958
3.9 1959
4.163 1960
4.483 1961
4.785 1962
4.971 1963
5.129 1964
5.369 1965
5.61 1966
5.785 1967
5.927 1968
6.134 1969
6.504 1970
6.785 1971
6.965 1972
7.221 1973
7.769 1974
8.63 1975
9.293 1976
9.966 1977
10.498 1978
10.959 1979
11.369 1980
11.897 1981
12.579 1982
13.051 1983
13.122 1984
12.814 1985
12.593 1986
12.246 1987
12.001 1988
11.757 1989
11.483 1990
11.272 1991
10.795 1992
10.392 1993
10.012 1994
9.716 1995
9.443 1996
9.211 1997
8.959 1998
8.543 1999
8.032 2000
7.383 2001
6.866 2002
6.451 2003
6.156 2004
5.823 2005
5.436 2006
5.097 2007
4.884 2008
4.79 2009
4.656 2010
4.500 2011
4.329 2012
4.034 2013
3.828 2014
3.606 2015
3.359 2016
3.046 2017
2.678 2018
2.366 2019
2.085 2020
1.748 2021

Note how end of 2021 reward is already known in advance.

That's a lagging type motion. During periods across declining yields so older bonds continue paying higher yields. As rates rise so maturing bonds roll into those higher yields but progressively, over ten years in this case. Having one asset that is 'out of cycle' with others is a form of diversification.

Another reason is to liability match future spending. If I want 10K of inflation adjusted income in ten years time (and perhaps another 10K in 9 years time ...etc.), I could buy a ladder of index linked gilts to provide that. In some cases that may cost less than 10K of present day money to buy - perhaps 8K to buy 10K in ten years time, at other times such as of present it costs more of present day money. Perhaps 12K of present day money to buy 10K of future money.

Others like to instead mark to market, also factor in the ongoing price of the gilts. Yet others might opt for a barbell, hold equal amounts of both a 1 year and 20 year gilt to approximate a 10 year bond bullet.

A nice feature with Gilts is that they're fully guaranteed no matter how much you invest. With high street bank fixed income/term bonds if the bank goes bust then only so much is protected (85K ???) and you have to spread across different providers and hope they don't merge etc. Gilts can also be liquidated at any time.

The general consensus is that when yields are perceived to be high its better to shift towards long dated. When yields are low its better to 'shorten down'. i.e. at current levels perhaps a 3 year ladder might be considered appropriate.

For those with more than enough, perhaps aged 70, no heirs and don't expect to live beyond 95, perhaps with 40K/year of spending, 10K state pension, 10K occupational pension, then loading into a inflation bond ladder spanning those 25 years, 20K/year inflation adjusted maturity value each would cost 500K assuming bonds were priced to 0% real. Historically that might have only cost 400K, nowdays perhaps 600K. If they bought a annuity with that 600K they might be paid a similar return, but not have access to that money, with bonds they could always be sold if needed - perhaps after being told you only had a year left to live and fancied living that to the fullest.

With stocks, you run the historic risk of both prices and dividends halving and halving again, or more. Likely could and more often do do better, but might not.

If £250K or less for bonds, at recent yields perhaps spread across 1, 2 and 3 year fixed term bonds with three different banks (not under the same umbrella). Sell down stocks in good years, draw from bonds during bad years, asymmetric rebalance, only ever from stocks to bonds.

Bond ladders are a great idea if real yields are up at +3% levels. Much less so when down at -2.5% type levels. That said, the events that drove yields down to such low levels does mean that capital values of other assets are perhaps high. If you've accumulated 1M of wealth due to such conditions you might of only had 500K otherwise, in which case if liability matching was the preferred position then even at negative real yields a bond ladder might still be considered as OK by some.

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Re: Does anyone use bond ladders?

#410355

Postby AleisterCrowley » May 8th, 2021, 8:07 pm

is there a 'ready made' bond ladder ETF available?

Gilgongo
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Re: Does anyone use bond ladders?

#410359

Postby Gilgongo » May 8th, 2021, 8:15 pm

Thanks for the replies! I'm not sure I understand all of the issues, but re. "You are almost always better off using a series of fixed rate deposit accounts than a short dated bond ladder" - is my question re. bonds/gilts ETF relevant?

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Re: Does anyone use bond ladders?

#410361

Postby AshleyW » May 8th, 2021, 8:23 pm

The problem at the moment is that a bond ladder will give you no protection against inflation with current yields lower than current and prospective inflation rates. An index-linked ladder is also an expensive option and probably only worthwhile if you think there´s going to be 4%+ inflation over the duration of the bond otherwise a savings bond or conventional gilt would be better.

Neither conventional nor index-linked gilts provide a risk-free option - a conventional gilt ladder will provide poor real returns if inflation and interest rates increase and index-linked will prove to be a bad buy if inflation is less than current market expectations. Maybe you consider the inflation risk to be acceptable compared to having some equity investments as at least nominal capital values aren´t threatened - all depends upon your tolerance of risk.

My preference would be to consider a bond/equity drawdown portfolio. A 2%+ inflation-linked perpetual drawdown should be virtually risk-free and it is almost 100% certain your capital will increase in real terms. If your time horizon is less than 30 years 3% to 3.5% after expenses should be realistic.

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Re: Does anyone use bond ladders?

#410426

Postby xxd09 » May 8th, 2021, 11:42 pm

I used one for a few years but......
I wanted exposure to the world bond markets specifically the US
I got fed up with the work involved
Vanguard brought out a Global Bond Index Fund (VIGBBD) hedged to the Pound and I never looked back
Used it as my only bond for many years
Some corporate bonds admittedly but it has reduced the volatility of my portfolio and returned an average of over 4% increase in NAV pa as a addd bonus
Cheap,simple and easy to understand
xxd09

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Re: Does anyone use bond ladders?

#410441

Postby JohnW » May 9th, 2021, 6:15 am

Gilgongo wrote:Most "bucket" approaches recommend a bond ladder with maturing bonds doing the spending cash replenishment, and stocks being sold to replace the maturing bond (as I understand it).

First up, we need to specify whether it’s nominal or inflation linked bonds. I think inflation linked are better because they protect you against unexpected inflation, and recall that the three big risks with retirement funding are longevity (running out of money), market risk (poor returns, especially at the wrong time), and inflation. Nominal bonds will be better during periods of deflation but how common are they, and any cash is already giving protection, and it’s perhaps wise to own both nominal and inflation linked bonds (although the nominals won’t be in the ladder, but in the ‘risk portfolio’).
Secondly, what you describe is better thought of, not as a bond ladder (although it is a rolling bond ladder) but as a bucket strategy (where you draw from stable buckets), or just an ordinary old stocks/bonds portfolio that you rebalance by withdrawals.
Thirdly, a safer approach is a non-rolling bond ladder: you buy the bonds, then spend their coupons and redeemed principle over the coming years, nothing is replaced. Safer, but expensive now with yields low.
Fourthly, unpleasant inflation in the near term only (next 3 years perhaps) is less a problem than inflation running for 15 years even if it’s modest inflation. So an inflation linked bond ladder doesn’t need to deal with the next 3 years as seriously (or at all) in the way it should for years 4-15.
Fifthly, yes, interest rates are expected to rise (bad for bond values), but folk have been saying that for a decade now as they’ve kept falling. Beware predictions! But that problem does not exist with a non-rolling bond ladder, because you hold the bonds to maturity (with its guaranteed value), and so falling prices with increasing interest rates have no effect for you. Other than, of course, your money is locked up in bonds you’ve planned to hold to maturity, and are thus losing the chance to buy higher yielding bonds now available. So bond ladders remain a good idea, if they ever were for you.
Sixthly, I don’t think you’re smoothing market volatility with a non-rolling bond ladder. Your assets continue to show market volatility; it’s just that it no longer matters to you because the bond ladder is guaranteed income, and the rest of the portfolio (the at risk part) is not being touched unless you’re replenishing the bond ladder in which case it’s a rolling bond ladder, not a non-rolling ladder.
Seventhly,
hiriskpaul wrote:The advantage of a gilt ladder compared to a deposit ladder though is that of liquidity. Gilts can be sold instantly,

Well, you don’t need liquidity with a non-rolling ladder. Secondly, if you have to sell during rising interest rate times you’ll lose capital. Yuk.
1nvest wrote:Bond ladders are a great idea if real yields are up at +3% levels. Much less so when down at -2.5% type levels.


Indeed, but they still give you a guaranteed, known, predictable, no risk income, No other way to get that, so of course the cost will be high.


Don’t think there's any 'ready made' bond ladder ETF available.
AshleyW wrote:The problem at the moment is that a bond ladder will give you no protection against inflation with current yields lower than current and prospective inflation rates.


Disagree. A non-rolling ladder gives perfect inflation protection; it's just that the real yield on those bonds is negative, so you’ll pay more than you get back. You lose purchasing power, but not because of inflation, it’s because yields are negative.
AshleyW wrote:Neither conventional nor index-linked gilts provide a risk-free option - a conventional gilt ladder will provide poor real returns if inflation and interest rates increase and index-linked will prove to be a bad buy if inflation is less than current market expectations.


Yes, but at the risk of doing something unforgivable like making predictions, you need to ponder which is more likely (inflation or deflation), and which will do more damage to you. Linkers have a floor value I think: no matter how bad the deflation, their value stops dropping when the price gets to that floor; there’s some protection against the loses raging deflation can do to linkers.

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Re: Does anyone use bond ladders?

#410471

Postby dealtn » May 9th, 2021, 9:52 am

JohnW wrote:Fifthly, yes, interest rates are expected to rise (bad for bond values),


If rates are expected to rise, that is already in the price. Only rises higher than expected will be bad for bond values, and conversely lower than expected rises will be good.

JohnW wrote:Linkers have a floor value I think: no matter how bad the deflation, their value stops dropping when the price gets to that floor; there’s some protection against the loses raging deflation can do to linkers.


No floor that I am aware of.

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Re: Does anyone use bond ladders?

#410502

Postby NotSure » May 9th, 2021, 11:35 am

1nvest wrote:.....Bond ladders are a great idea if real yields are up at +3% levels. Much less so when down at -2.5% type levels. That said, the events that drove yields down to such low levels does mean that capital values of other assets are perhaps high. If you've accumulated 1M of wealth due to such conditions you might of only had 500K otherwise, in which case if liability matching was the preferred position then even at negative real yields a bond ladder might still be considered as OK by some.


The above (my emphasis) is a very good point in my humble opinion. Cake and all that. The very thing that has made bonds so expensive (and yields so unattractive) is strongly related to the fact that so much money has been made elsewhere (shares, property), namely massive central bank intervention. If this stimulus continues, yields could reduce further, increasing the value of bonds. If it is withdrawn, while bonds will fall, the 1M may very rapidly become 500K again.

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Re: Does anyone use bond ladders?

#410546

Postby dealtn » May 9th, 2021, 1:53 pm

NotSure wrote: If it is withdrawn, while bonds will fall, the 1M may very rapidly become 500K again.


Or it may not. It depends on whether the intervention acts as a "flow" or a "stock" in its effects on asset prices.

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Re: Does anyone use bond ladders?

#410584

Postby NotSure » May 9th, 2021, 5:25 pm

dealtn wrote:
NotSure wrote: If it is withdrawn, while bonds will fall, the 1M may very rapidly become 500K again.


Or it may not. It depends on whether the intervention acts as a "flow" or a "stock" in its effects on asset prices.


While I am in full agreement that "it may not", I confess I lack the financial literacy to fully understand your comment. As I understand it, "the intervention" as a verb seems to generate large inflows, in particular for bonds, driving up prices and depressing yields. "The intervention" as a noun, seems like a "stock". Don't fight the Fed and all that? But the flow into bonds means there are no risk-free returns, hence it encourages flows into shares and property.

I guess my point was, if one has made large gains in shares due to intervention, it's a bit hopeful that one can then roll these into bonds with positive yields. So as 1nvest suggested, the poor bond returns, with limited downside at least, are just a price you pay for the current policies and the size of your share portfolio - so not as bad as they look.

Put it this way - it will not happen - but imagine the central banks suddenly decided to rapidly taper QE and then raise interest rates. I believe in this extreme 'thought experiment', bonds would fall, but shares would crash, so having an allocation to bonds would allow rebalancing while shares are 'cheap'.

The whole area of asset allocation is of great interest to me personally - I'm accumulating, but reaching the age where I may need to start thinking about consolidation - the time is approaching where a big correction could impact my retirement plans, if I'm 'all in' on equities (and I'm pretty close to that). But bonds just look like a terrible 'bet' at the moment, but taken in the round, maybe not as bad as they look at first glance. Hence my appreciation of TLF!

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Re: Does anyone use bond ladders?

#410587

Postby scrumpyjack » May 9th, 2021, 5:45 pm

If I wished to hold some cash assets in case of rising interest rates, falling equities, rising inflation (and I do hold a large amount of cash to cover many years of living costs), I would not want to limit my thoughts simply to sterling bonds, cash, ILGs etc. Another alternative would be to park cash in a stronger currency more likely to withstand rising inflation (whether cash or bonds in that currency). Historically swiss francs have been a pretty reliable store of value and if significant inflation increases arise in GBP and USD, Swiss francs would be a good safe haven, IMO.

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Re: Does anyone use bond ladders?

#410590

Postby dealtn » May 9th, 2021, 5:54 pm

NotSure wrote:
dealtn wrote:
NotSure wrote: If it is withdrawn, while bonds will fall, the 1M may very rapidly become 500K again.


Or it may not. It depends on whether the intervention acts as a "flow" or a "stock" in its effects on asset prices.


While I am in full agreement that "it may not", I confess I lack the financial literacy to fully understand your comment. As I understand it, "the intervention" as a verb seems to generate large inflows, in particular for bonds, driving up prices and depressing yields. "The intervention" as a noun, seems like a "stock". Don't fight the Fed and all that? But the flow into bonds means there are no risk-free returns, hence it encourages flows into shares and property.

I guess my point was, if one has made large gains in shares due to intervention, it's a bit hopeful that one can then roll these into bonds with positive yields. So as 1nvest suggested, the poor bond returns, with limited downside at least, are just a price you pay for the current policies and the size of your share portfolio - so not as bad as they look.

Put it this way - it will not happen - but imagine the central banks suddenly decided to rapidly taper QE and then raise interest rates. I believe in this extreme 'thought experiment', bonds would fall, but shares would crash, so having an allocation to bonds would allow rebalancing while shares are 'cheap'.

The whole area of asset allocation is of great interest to me personally - I'm accumulating, but reaching the age where I may need to start thinking about consolidation - the time is approaching where a big correction could impact my retirement plans, if I'm 'all in' on equities (and I'm pretty close to that). But bonds just look like a terrible 'bet' at the moment, but taken in the round, maybe not as bad as they look at first glance. Hence my appreciation of TLF!


"flow" and "stock" in this context are different support concepts, and the economists don't agree on which applies here.

If the problem requires intervention such that support is required by authorities who put £xbn into the economy and that fixes it (a stock of £xbn is required) that is one thing. The support can stop. Eventually when conditions are allowed that £xbn can be removed again. If the problem is such that £ybn is required, and continues to be needed regularly/annually as the lack of monetary demand hasn't reversed (a missing "flow" problem) then even stopping, let alone unwinding is a problem.

So depending on which is right, stopping QE might be a problem, or it might not. Deflation, or recession, might occur (or not). If it's a stock type problem then stopping QE shouldn't cause asset prices to reverse (indeed they might even rise as the signal QE was no longer needed might be taken as confidence the economy is fine and fixed).

Reversing QE is the next stage after that, which could be many years after QE stopped, and could be done gradually and naturally as bonds mature (and replacement purchases aren't undertaken).

My personal view is stopping QE won't lead to a sell off in general asset prices, although I think it will lead to a fall in gilt prices.

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Re: Does anyone use bond ladders?

#410599

Postby 1nvest » May 9th, 2021, 6:51 pm

scrumpyjack wrote:Historically swiss francs have been a pretty reliable store of value and if significant inflation increases arise in GBP and USD, Swiss francs would be a good safe haven, IMO.

The Swiss Franc still remained pegged to gold up to 1999, the UK ended that coupling in 1931, the US in 1971 ... both primarily as a means to devalue the currency i.e. partial default, without being branded as having defaulted. So for 1972 to 1999 and yes the Swss Franc might have been perceived as a safe haven, however for instance over the last decade the CHF/USD pretty much started and ended at 1.11 levels.

Basically being pegged to gold and a relative rising/strong currency was hurting their economy, so they opted to decouple and devalue/better-align with others. As such CHF is perhaps no longer any better than US$. Perhaps worse so after costs/taxes. When a currency remains consistently pegged to gold at a fixed rate then it will naturally tend to be a good hedge relative to others that can just deflate their currency.

Image

Another nice aspect when a currency is pegged to gold is that you can instead hold cash, deposited and earning interest, which if via a loan to the state (Treasury bonds/Gilts) is like the state paying you for it to securely store your gold. And if the interest is used to also convert back to gold sees a form of gold dividend, where you end up with more ounces of gold than before.

In some cases foreign currencies can be as good as gold. Using Icelands 2009 crisis as a example their Krona collapsed in value and gold was a savour, however priced in Euros and gold remained much the same price - so they would have been as equally saved had they held gold or Euro's. A factor however is what the foreign currency is invested in, if Euros invested in stocks for instance saw stock values drop (as was the case in 2009) then the gain from currency might be lost by stocks (or bonds, or whatever).

Much of bond interest is just the compensation for the decline of the currency, that may also see that interest being taxed. You're also lending to someone who can revise interest rates, print more money, change taxation rates or the rules in their favour. Accordingly as a alternative some prefer other choices, perhaps a equal split of a UK home priced in Pounds, US stocks priced in US$, gold (global currency and a commodity), to better hedge via diversification across currencies and assets. Only converting to cash as a convenient means of exchange as/when necessary and perhaps picking the relative strongest of the currencies to do so (a new car might be valued at being perhaps 30 ounces of gold or 300 US stock shares ... and pick whichever you consider is the better for you at that time).

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Re: Does anyone use bond ladders?

#410602

Postby scrumpyjack » May 9th, 2021, 6:57 pm

I can remember when there were 13 sw francs to the pound and an uncle of mine recalled skiing there before the first war and it was well over 20 to the pound!

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Re: Does anyone use bond ladders?

#410603

Postby 1nvest » May 9th, 2021, 6:58 pm

dealtn wrote:My personal view is stopping QE won't lead to a sell off in general asset prices, although I think it will lead to a fall in gilt prices.

The State printing money to buy its own bonds/Gilts has a major buyer in the market that pushes prices higher/yields down. Once yields are down and kept down perhaps via additional printing/buying then inflation is not only more likely in having devalued the currency, but will inflationary erode the debt. In the 70's we saw taxation also raised without QE, so for instance 15% inflation, 40% basic rate taxation, 15% interest rates = -6%/year net loss for investors. Post WW2 it was more a case of QE to keep interest rates low, whilst inflation entered double digits, perhaps 3% interest, 12% inflation = -9%/year loss for investors. Repeated over a handful of years and such losses can compound out to substantial losses, more so if a income is also being drawn.

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Re: Does anyone use bond ladders?

#410607

Postby dealtn » May 9th, 2021, 7:13 pm

1nvest wrote:
dealtn wrote:My personal view is stopping QE won't lead to a sell off in general asset prices, although I think it will lead to a fall in gilt prices.

The State printing money to buy its own bonds/Gilts has a major buyer in the market that pushes prices higher/yields down. Once yields are down and kept down perhaps via additional printing/buying then inflation is not only more likely in having devalued the currency, but will inflationary erode the debt. In the 70's we saw taxation also raised without QE, so for instance 15% inflation, 40% basic rate taxation, 15% interest rates = -6%/year net loss for investors. Post WW2 it was more a case of QE to keep interest rates low, whilst inflation entered double digits, perhaps 3% interest, 12% inflation = -9%/year loss for investors. Repeated over a handful of years and such losses can compound out to substantial losses, more so if a income is also being drawn.


What post WW2 QE?

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Re: Does anyone use bond ladders?

#410619

Postby NotSure » May 9th, 2021, 7:44 pm

dealtn wrote:My personal view is stopping QE won't lead to a sell off in general asset prices, although I think it will lead to a fall in gilt prices.


Well, the 'taper tantrum' of 2013 did indeed hit gilt prices yet had a muted effect on shares - virtually in the noise. However, measures like P/E have doubled since then, so I fear the effect may be less benign this time around.

However, from what I read, the next 'taper tantrum' has already been priced into growth stocks - the dip a couple of months ago - so let's hope you are correct!

I've decided to split the difference - I have about half the amount of bonds 'classical' portfolio theories suggest, so I'll probably lose either way :)

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Re: Does anyone use bond ladders?

#410621

Postby AshleyW » May 9th, 2021, 8:08 pm

JohnW wrote
: A non-rolling ladder gives perfect inflation protection; it's just that the real yield on those bonds is negative, so you’ll pay more than you get back. You lose purchasing power, but not because of inflation, it’s because yields are negative.


It gives perfect protection to its underlying inflation-linked value - but not to the price you are paying. If a 10 year IL sells at a 14% or so premium you invest £100 and get £86 inflation-linked back at maturity. That´s not what I call perfect inflation protection

JohnW wrote:
no matter how bad the deflation, their value stops dropping when the price gets to that floor; there’s some protection against the losses raging deflation can do to linkers.
.

The problem is no one purchases at par. So a 15-year index linker will cost £150 or so and therefore could fall to £100 during a period of sustained deflation - not very likely but illustrates the fact that neither index linkers nor conventional gilts can protect you 100% against inflation and deflation.

Only a diversified portfolio with negatively correlated assets and assets which behave differently during the 4 typical economic environments can give you a high probability of success.


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