Summary
In terms of returns, the short answer to “How much difference is there?” is, if fees and taxes are ignored, not much.
The slightly longer answer is it depends on whether the yield curve is inverted or not and changes in yield. To summarise, for no withdrawals or new money:
Flat yield curve
No change in yield: Fund and ladder are identical
Step decrease in yield: Ladder performs better
Step increase in yield: Fund performs better
Non-inverted yield curve (i.e., yield increases with maturity)
No change in yield: Ladder performs better
Step increase in yield: Ladder performs better
Step decrease in yield: Ladder performs better (whether this is the case depends on the gradient in the yield curve)
Inverted yield curve (i.e, yield decreases with maturity)
No change in yield: Fund performs better
By ‘better’, the difference in annualised returns is no more than 5 bp (for the example I’ve used) and often less.
(edit) I will summarise other results as I include them below
Method
Now for some details
This analysis was prompted by some recent discussion about bond fund and rolling ladders in viewtopic.php?t=437867. Further reading can also be found on the wiki at
https://www.bogleheads.org/wiki/Rolling ... bond_funds and reference therein.
I’ve simulated the returns for a rolling bond ladder and bond fund (operational details below) where the highest maturity is 5 years and the lowest maturity is 0 years. In constructing the simulation I’ve made a number of assumptions.
Bonds
1) 5 years bonds are issued every 6 months (or ‘semester’ to borrow longinvest’s terminology in the thread at viewtopic.php?p=2717165) with a coupon equal to the yield to maturity and, therefore, the issue price is at par. The total number of bonds issued is always the same.
2) No other bonds are issued (i.e., there is never more than one bond available at a given maturity).
3) Coupons are paid every 6 months
4) The yield curve is defined as yield to maturity at 6 month intervals
5) The yield curve prior to the construction of the ladder or fund has been fixed for at least 5 years (which means that, initially, coupons are the same at all maturities).
6) Fractional bonds can be held
Rolling ladder
1) New money (if any), maturing bonds, and coupons are always (re)invested in the highest maturity bond (5 years in the example here).
2) Withdrawals (if any) are always taken from the maturing bond and coupons.
Bond fund
1) New money, (if any), maturing bonds, and coupons are distributed across all maturities such the fund always holds an equal number of bonds at each maturity.
2) Withdrawals (if any), are taken such that the fund is left with an equal number of bonds at each maturity.
To avoid overlong individual posts, I’ll post different scenarios separately. We’ll start with a relatively simple case in the next post and compare the outcomes for rolling ladder and fund.
cheers
StillGoing
In terms of returns, the short answer to “How much difference is there?” is, if fees and taxes are ignored, not much.
The slightly longer answer is it depends on whether the yield curve is inverted or not and changes in yield. To summarise, for no withdrawals or new money:
Flat yield curve
No change in yield: Fund and ladder are identical
Step decrease in yield: Ladder performs better
Step increase in yield: Fund performs better
Non-inverted yield curve (i.e., yield increases with maturity)
No change in yield: Ladder performs better
Step increase in yield: Ladder performs better
Step decrease in yield: Ladder performs better (whether this is the case depends on the gradient in the yield curve)
Inverted yield curve (i.e, yield decreases with maturity)
No change in yield: Fund performs better
By ‘better’, the difference in annualised returns is no more than 5 bp (for the example I’ve used) and often less.
(edit) I will summarise other results as I include them below
Method
Now for some details
This analysis was prompted by some recent discussion about bond fund and rolling ladders in viewtopic.php?t=437867. Further reading can also be found on the wiki at
https://www.bogleheads.org/wiki/Rolling ... bond_funds and reference therein.
I’ve simulated the returns for a rolling bond ladder and bond fund (operational details below) where the highest maturity is 5 years and the lowest maturity is 0 years. In constructing the simulation I’ve made a number of assumptions.
Bonds
1) 5 years bonds are issued every 6 months (or ‘semester’ to borrow longinvest’s terminology in the thread at viewtopic.php?p=2717165) with a coupon equal to the yield to maturity and, therefore, the issue price is at par. The total number of bonds issued is always the same.
2) No other bonds are issued (i.e., there is never more than one bond available at a given maturity).
3) Coupons are paid every 6 months
4) The yield curve is defined as yield to maturity at 6 month intervals
5) The yield curve prior to the construction of the ladder or fund has been fixed for at least 5 years (which means that, initially, coupons are the same at all maturities).
6) Fractional bonds can be held
Rolling ladder
1) New money (if any), maturing bonds, and coupons are always (re)invested in the highest maturity bond (5 years in the example here).
2) Withdrawals (if any) are always taken from the maturing bond and coupons.
Bond fund
1) New money, (if any), maturing bonds, and coupons are distributed across all maturities such the fund always holds an equal number of bonds at each maturity.
2) Withdrawals (if any), are taken such that the fund is left with an equal number of bonds at each maturity.
To avoid overlong individual posts, I’ll post different scenarios separately. We’ll start with a relatively simple case in the next post and compare the outcomes for rolling ladder and fund.
cheers
StillGoing
Statistics: Posted by StillGoing — Mon Sep 02, 2024 1:44 am — Replies 22 — Views 1253