Treasury_Bond_Buying_Strategies
00:00:00.000 | Hello everybody, it's Sam from Financial Samurai and in this episode
00:00:03.320 | I want to talk about how to buy Treasury bonds and various buying strategies to consider
00:00:08.120 | Because after I discussed buying Treasury bonds with over a 4% yield
00:00:13.360 | Many people email me asking me how to do it
00:00:16.100 | and also
00:00:16.960 | I spent three hours writing a new post on how to exactly buy Treasury bonds and I came to some
00:00:23.560 | Realizations that I think many of you will appreciate
00:00:25.760 | first of all
00:00:27.840 | Treasury bonds have been zooming higher the 10-year bond yield reached 4%
00:00:32.640 | the morning of September 28, it hasn't been there since
00:00:37.040 | 2007 it's been a while folks and it's interesting because there is not more demand during the Treasury bond
00:00:46.160 | auctions
00:00:46.880 | It's weird to me that 4% doesn't seem attractive because I can see in
00:00:51.960 | 3, 4, 5 years when we look back on today
00:00:55.560 | We might think to ourselves Wow, we could have locked in
00:00:58.440 | 4% risk-free rate of return over a 20-year time period
00:01:02.720 | Hmm, not bad, but nobody knows the future which is why investing is so interesting
00:01:08.960 | So hard and why we need to invest for the long term in a proper asset allocation framework
00:01:14.180 | If you don't know what a Treasury bond is, that's okay
00:01:16.820 | They are risk-free investments if you hold them until maturity
00:01:21.880 | Treasury bonds are issued by the United States federal government the Treasury to finance projects or and day-to-day operations as
00:01:29.200 | Inflation and inflation expectations rise and fall so do Treasury bond yields now
00:01:35.320 | There are two ways to buy Treasury bonds. The first way is through Treasury direct Treasury direct gov
00:01:41.800 | It's a terrible website super cumbersome
00:01:44.820 | Don't lose your password folks because you're gonna spend an hour trying to get someone on hold to reset it
00:01:49.840 | But if you go to Treasury direct gov, you can buy all sorts of bonds
00:01:54.940 | You can buy I bonds
00:01:56.040 | Hopefully y'all bought 10,000 worth at the end of 2021 when I was talking about it and the beginning of 2022
00:02:02.240 | Because these bonds have outperformed the stock market obviously year-to-date and will probably continue to outperform
00:02:08.880 | For the rest of the year now you go to Treasury direct gov and you can click buy direct
00:02:15.220 | Select bonds or bills so Treasury bills are
00:02:19.840 | Bonds that have a one year or less duration Treasury bonds are bonds that have a duration of
00:02:27.400 | Beyond one year, but you can just call them Treasury bonds in general
00:02:31.920 | So Treasury direct sells bonds directly to you at auction at par value
00:02:39.540 | So you're buying the bond at $100 per share
00:02:43.200 | This is very different from the second way to buy Treasury bonds
00:02:46.880 | Which is through your online brokerage account like Fidelity Charles Schwab or E*Trade
00:02:51.620 | These are the giants you pay a nominal fee by receiving a lower bond yield usually about three to five basis points lower
00:02:59.400 | So we're talking instead of let's say getting a four point two five percent yield to maturity
00:03:04.760 | You'll get four point two percent because this is a marketplace
00:03:09.540 | online brokerage accounts provide a marketplace for
00:03:12.940 | Treasury bonds and other bonds that have already been issued and they're just trading up and down depending on the economic
00:03:21.440 | Environment. This is the main difference Treasury direct gov
00:03:24.920 | You're buying directly from the Treasury Department at par value you get the coupon you get the yield to maturity
00:03:32.400 | Whereas when you buy US Treasury bonds on online brokerage accounts their marketplace and these bonds could have been issued years ago
00:03:39.800 | With different coupon payments and different yields if you click the post in the show notes, you'll see a step-by-step
00:03:46.700 | Direction guide on how to buy bonds via Fidelity. I use Fidelity. I've used them for over 20 years
00:03:53.140 | I think they're great
00:03:54.660 | But the quickie here is to log on to your Fidelity account if you have one go to the tab news and research
00:04:00.980 | Click fixed income bonds and CDs and then you'll see a whole bunch of bonds a nice table
00:04:08.460 | organized by US Treasury
00:04:10.860 | corporate bonds municipal bonds
00:04:12.900 | And then you'll see each bond yield by duration and then you just click that link and then you can sort through the marketplace
00:04:20.900 | To see which bonds are most attractive now
00:04:24.700 | This is the point where it can get a little bit confusing because you might click a duration a type of bond and you'll see
00:04:32.540 | Ten of them listed. Well, what's going on there? Well again
00:04:35.580 | Fidelity Vanguard eTrade Charles Schwab. They are marketplaces. So once you click the appropriate
00:04:43.060 | time the maturity
00:04:45.580 | You're gonna see a whole bunch of bonds being sold by individuals or institutions
00:04:50.420 | Most likely and you can pick or choose some you'll see well, why is the coupon?
00:04:55.480 | 1.625%
00:04:58.020 | Well, another coupon is only
00:05:00.460 | 0.25%
00:05:02.060 | Well, the reason why is because at the time of issuance of these bonds directly from the government
00:05:08.100 | Those were the coupon payments, right?
00:05:10.180 | so what you want to look at is the yield and if you're looking for let's say a
00:05:14.620 | Two-year Treasury bond. Well, it's around four point three percent right now
00:05:19.460 | So if you click the link, you'll see a whole bunch of bonds being offered at around between let's say four point two
00:05:25.820 | seven five percent to four point three two five percent
00:05:29.500 | So you'll notice when you click through the individual bonds
00:05:33.180 | They were all issued at different dates. So different dates different time periods different coupon rates
00:05:40.940 | But they will all be expiring in two years time
00:05:45.760 | So in this case 2023 around September or October
00:05:50.740 | And so you got to sort through that and so if you've been wondering why the coupon payment is so different. It's because
00:05:57.480 | Different dates and so you will notice that you can buy these Treasury bonds at a discount to par value
00:06:05.240 | And if you hold them to maturity, you're gonna get that semi annual coupon payment usually and you'll get a hundred dollars per share
00:06:13.420 | So if you bought let's say it at ninety seven dollars and twenty cents and it
00:06:18.440 | Expires not expires and matures in one year
00:06:21.840 | You'll get a hundred dollars back plus the coupon payment for a yield of about four point three percent
00:06:28.120 | Hope this makes sense. If not read the post listen to this example again
00:06:33.220 | Bonds are confusing because the price movements are inverse bond
00:06:39.040 | Prices go down yields go up and vice versa now if you want to take more risk
00:06:43.400 | You can purchase longer duration CDs Treasury bonds or municipal bonds
00:06:48.480 | The risk here lies in liquidity risk and real interest rate risk not principal risk
00:06:54.360 | Because you plan to hold it to maturity
00:06:56.680 | if you don't hold the bond to maturity you can end up on this marketplace because
00:07:01.440 | You know you needed the liquidity and so you sell at a discount to par
00:07:05.840 | For example, let's say you purchase a 20-year municipal bond, but need the money before 20 years
00:07:11.320 | You will likely have to sell at a discount
00:07:14.120 | Now if you lock in a 10-year Treasury bond at let's say three point nine two percent
00:07:19.360 | But inflation continues to increase then you've locked in a sub optimal yield. Why is it sub optimal?
00:07:25.840 | well, it's because you could have waited and
00:07:27.840 | Purchased a different or new 10-year Treasury bond that had a higher yield
00:07:33.920 | now finally if you want to take even more risk, you can purchase corporate bonds all the way down to be a and
00:07:40.480 | BBB rated corporate bonds now corporate bonds are higher risk because corporates have a higher default and
00:07:48.120 | Bankruptcy rate than municipalities and the federal government, right?
00:07:52.320 | We see corporations come and go all the time in the history of time
00:07:56.680 | But the United States government has stayed sovereign. It's stayed here for hundreds of years now
00:08:02.400 | Okay, so three reasons why you might want to buy US Treasury bonds one
00:08:07.120 | You want a risk-free investment with a higher yield if US Treasury bond yields are higher than yields for savings accounts and CDs
00:08:14.640 | Then buying a Treasury bond with the same duration makes sense
00:08:18.200 | US Treasury bond income is also not taxed at the state level
00:08:21.640 | So if you live in high income tax states such as California like I do New Jersey, Connecticut and Hawaii
00:08:28.880 | US Treasury bonds offer relatively higher returns
00:08:32.200 | - the risk-free yield is attractive relative to your inflation
00:08:36.480 | Forecasts and also stock return forecasts
00:08:40.000 | For example, you could buy a five-year Treasury bond today yielding about four point one eight percent
00:08:46.080 | If you believe inflation will decline from let's say eight percent now to two percent in one year
00:08:51.160 | You will earn a two point one eight percent real yield for four more years
00:08:55.360 | If you hold to maturity in addition, you could sell the five-year Treasury bond for a profit since it will likely
00:09:01.680 | increase in value
00:09:04.080 | How much the principal value of the Treasury bond increases will depend on inflation expectations
00:09:08.400 | however
00:09:09.520 | The Treasury bond could also increase in value to the point where the yield is at parity to the two percent
00:09:15.840 | inflation rate at the time in other words while holding this bond you could earn that coupon payment and
00:09:22.600 | Earn a greater return because the principal value has appreciated by more than the yield
00:09:28.080 | Let's say it might have appreciated by like eight percent eight percent plus and say the one
00:09:33.400 | Percent coupon payment that's a nine percent return
00:09:36.400 | This is thinking like a bond trader acting like a bond trader and my final
00:09:40.740 | Favorite reason for why you want to buy US Treasury bonds today
00:09:44.200 | Or maybe any point in the future is if you have a low mortgage rate and you like the idea of living for free
00:09:50.440 | Who doesn't love living for free or getting something for free even ultra rich people have a difficult time passing on a free lunch
00:09:57.400 | So if you want to connect with someone offer them a free lunch offer them coffee drinks, whatever it is
00:10:03.760 | Heck this podcast is free and financial samurai commas free and the newsletter is free
00:10:09.540 | You might as well subscribe and listen to it. There's no downside, especially since I have over 25 experience
00:10:15.920 | Working in finance and writing about finance now back to the low mortgage rate and living for free
00:10:22.440 | The majority of mortgage holders have a mortgage rate below the yield of a one-year Treasury bond or longer duration in other words
00:10:30.440 | The mortgage rates majority people have are below 4%
00:10:33.920 | Therefore mortgage holders can simply buy US Treasury bonds to live for free for the next 30 years
00:10:41.480 | For example, you could buy a 30-year Treasury bond right now at about 3.8 percent yield for the last two years
00:10:47.320 | Most mortgage borrowers were able to refinance to a 30-year fixed rate of 3% or less
00:10:52.780 | Everybody who comments on my mortgage related posts say they got 30-year fixed rate mortgages for 2.75 percent or less
00:11:00.120 | Therefore not only could you live for free for the next 30 years, but you could also live for free and earn risk-free income
00:11:07.840 | Now the only catch is that to truly live for free you need to buy an equal amount of Treasury bonds to your mortgage amount
00:11:14.600 | But even if you can't which most of us can't every dollar you do spend buying higher yielding Treasury bonds is an arbitrage
00:11:22.320 | That lowers your true living costs. I want to end this episode by discussing Treasury bond buying strategies
00:11:29.720 | In a nutshell in a rising interest rate environment
00:11:33.840 | Buying shorter duration Treasury bills is the optimal strategy and in a declining interest rate environment
00:11:41.200 | Buying longer duration Treasury bonds is the optimal strategy
00:11:45.200 | Now, why is that? Well in a rising interest rate environment
00:11:48.800 | Rates are continuing to go up. So you want to take advantage of the wave up you buy three month Treasury
00:11:57.200 | Bills or maybe nine month Treasury bills because when you get your money back you can reinvest in an hopefully even higher rate
00:12:05.040 | Now in a declining interest rate environment or a potentially declining interest rate environment
00:12:10.200 | You want to go a little bit longer on the yield curve?
00:12:12.760 | maybe you get a one-year two-year or three-year Treasury bond with a higher yield and that way you can lock in that higher rate so as
00:12:22.760 | Inflation and interest rates decline over the years. You'll be sitting pretty your bond will increase in value and your real
00:12:29.380 | Yield will also grow so before you buy a Treasury bond
00:12:34.120 | You should have a buying strategy based on your liquidity needs
00:12:37.440 | financial goals
00:12:39.680 | Existing net worth asset allocation and your inflation forecast
00:12:43.560 | So we just talked about inflation forecast, which it's not really that easy to figure out
00:12:48.600 | But we need an opinion before we buy a Treasury bill or Treasury bond at a certain duration for the lowest risk
00:12:56.720 | easiest
00:12:58.680 | No-brainer strategy to buying Treasury bonds is to buy the shortest duration Treasury bond available this way
00:13:05.120 | You have minimal liquidity risk and you can always buy more short-term Treasury bills at their latest rates
00:13:11.600 | So in other words, you can just keep on buying three month Treasury bills
00:13:15.240 | You're gonna get a lower yield but after three months you can just buy again and you can keep on rolling that and you'll have
00:13:22.440 | No real liquidity risk, especially after three months if you're buying
00:13:25.800 | Three month bills every month. The thing is eventually greed starts taking over. We're thinking to ourselves
00:13:32.920 | Well, why buy a three-month Treasury bill with a three point five one percent yield when I could get four point four five percent
00:13:40.200 | On a three-year Treasury bond. It's a pretty big difference
00:13:43.880 | especially if you have a significant amount of cash if you are unsure about the future macroeconomic environment as
00:13:51.000 | Most of us are you can simply hedge by buying a variety of Treasury bond durations
00:13:56.800 | Let's say you have two hundred fifty thousand in cash with enough cash flow every month to cover your monthly living expenses by at least 2x
00:14:04.680 | So with a 70% conviction level as I discuss in my book buy this not that
00:14:10.240 | You believe inflation has peaked in one year's time. You believe headline inflation will drop from 8% today to 3.5%
00:14:18.080 | You also want to upgrade your home in three years
00:14:21.400 | Here's what you could buy out of the 250,000 you have a hundred thousand worth of three-year Treasury bonds
00:14:28.880 | Yielding four point four percent because you have strong monthly cash flow
00:14:33.120 | You don't need the 250,000 you match 40% of your cash hoard with your liquidity needs to get the highest
00:14:40.080 | Yield possible at the time
00:14:42.080 | Then you buy 50,000 worth of two-year Treasury bonds yielding four point three one percent that zero point seven percent spread is
00:14:49.920 | Insignificant you're not gonna even notice it
00:14:53.960 | So you buy two years instead of three years because just in case you find an upgrade home in two years
00:15:01.640 | You want that liquidity so you can go buy it
00:15:04.520 | Then you buy 50,000 worth of nine-month Treasury bills yielding four point one three percent
00:15:09.840 | Psychologically you like the idea of still getting a four percent plus yield while looking up your money for only nine months
00:15:17.040 | Given there's still a chance. Let's say 30%
00:15:19.840 | Inflation could stay elevated for longer. You want your money back sooner this way
00:15:25.960 | You can reinvest in a potentially higher yielding Treasury bill or bond in nine months
00:15:30.920 | And then finally you buy 50,000 worth of three-month Treasury bills yielding three point five three percent
00:15:37.840 | Although you're not getting a more attractive four percent yield you get greater peace of mind knowing you get your money back after only three
00:15:45.200 | months just in case rates continue to rise
00:15:47.800 | You can reinvest at a higher rate anything can happen during this most uncertain time
00:15:53.160 | We all know this so it's always nice to stay liquid in conclusion the year
00:15:59.000 | 2022 will unfortunately go down as one of the worst years ever for the bond market as a result
00:16:06.600 | Buying Treasury bonds now actually looks very enticing. Hopefully not many of us were buying bonds in
00:16:12.440 | 2020 or 2021
00:16:15.640 | Because the yields were pitiful in 2020. We're talking about zero point six percent on the 10-year bond yield
00:16:22.920 | So why would you bother buying that?
00:16:25.680 | receiving only such a low yield and
00:16:28.920 | Facing a risk that bonds could sell off if interest rates rise and that's what we've all seen
00:16:34.640 | And is this revisionist history is this you know, looking back 2020 and saying oh, well, of course
00:16:40.520 | We should have done that or could have done that
00:16:42.600 | Not really because we've been talking about this for years how bomb didn't seem attractive one or two years ago
00:16:49.680 | But it's all about thinking about what next what now in my humble opinion
00:16:56.080 | Buying any Treasury bill or bond with a yield greater than four percent is attractive
00:17:01.920 | I would go up to three-year duration where you can get around four point four percent
00:17:06.600 | Because that's 15 plus year highs and if inflation does roll over over the next one to two years
00:17:13.600 | You're gonna be sitting pretty with a three-year Treasury bond yielding four point four percent
00:17:18.320 | And here's an argument for why you might want to buy even longer
00:17:21.840 | Duration Treasury bonds in five years ten years twenty years also yielding over four percent
00:17:29.120 | Because of future expected returns we know in a previous episode and in a previous post how I discussed
00:17:35.840 | Mmm lower future expected returns from Vanguard and other houses. For example
00:17:40.680 | Vanguard expects four point oh two percent annual returns for stocks over the next ten years
00:17:47.160 | Bonds expectation is one point three one percent per year over the next ten years
00:17:53.760 | That seems pretty low. But if those are real if they turn out to be real then locking in a risk-free
00:18:01.440 | Ten-year Treasury bond yielding four percent is a no-brainer
00:18:05.640 | Now unfortunately, nobody knows the future so Vanguard could be totally wrong. So could many other investment houses?
00:18:13.800 | But what I do know is that getting a four percent plus risk-free rate of return without having to pay state taxes is attractive
00:18:21.040 | I love the concept of living for free and if the Fed insists on crushing the economy
00:18:26.720 | We might as well take advantage and earn a higher risk-free rate return on our cash
00:18:33.400 | The biggest hurdle we have to overcome is probably greed and slashing hope, you know
00:18:39.920 | We have greed and we have hope that ten percent historical return averages for stocks could return again
00:18:47.020 | Yeah, they very well could so to be able to buy bonds means to be able to be okay with having lower return rates
00:18:54.900 | And it depends on where you are in the journey if you are retired you're looking at principal protection capital preservation
00:19:02.200 | Then all the more reason to buy
00:19:05.280 | US Treasury bonds with a yield of over four percent if you're still young in your 20s and your 30s and you're trying to take
00:19:11.520 | More risk and build your capital nut then locking your money away risk-free for four percent plus
00:19:17.820 | May not be that attractive. Alright, that's it folks
00:19:21.220 | I hope you enjoyed this episode and if you'd like to support my work
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