A bond duration glide path for retirement investing

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vineviz
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A bond duration glide path for retirement investing

Post by vineviz »

It's a basic tenet of financial planning that one way an investor can minimize their interest rate risk is to match the average duration of their bond holdings with their investment horizon. In plain English, long-term investors reduce their interest rate risk by owning long-term bonds whereas short-term investors reduce their interest rate risk by owning short-term bonds.

Many investors struggle with this concept, unfortunately, and partly I think this is due to the concept of duration matching being somewhat abstract and difficult to visualize. Although there are endless nuances that can be modeled, it is nonetheless possible to construct a very reasonable estimate for an investor's investment horizon using a few simplifying assumptions. Luckily, the estimated investment horizon isn't overly sensitive to these assumptions so a fairly general result is pretty easy to obtain.

Because most investors are familiar with the concept of a glide path which illustrates the appropriate ratio of stocks and bonds at different ages (a glide path that is MORE sensitive to the underlying assumptions, by the way), I thought it might be useful to see what a bond duration glide path would look like.

Image

This glide path illustrates a target bond duration over the investor's lifetime. The blue line assumes the use of a typical long-term bond index fund, most of which have weighted average durations of 19 years or less. Some investors may prefer to use a so-called "extended duration" bond fund, which can have an average duration up to 25 years or so, so I've included a separate line in the graph for that fund.

Just like an investor can match the stock/bond glide path by rebalancing between two or more funds (e.g. a stock fund and a bond fund), an investor can match the duration glide path by rebalancing between two or more bond funds (e.g. a long-term bond fund and a short-term bond fund) such that the average duration of the bond funds matches the glide path for a particular time horizon.

The graph essentially uses the investor's remaining life expectancy (with a small modification to account for the typical need to plan for slightly longer life than the actuarial average), a retirement age of approximately 65, and an assumption of flat retirement expenditures in real (inflation adjusted) terms.
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1789
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Re: A bond duration glide path for retirement investing

Post by 1789 »

vineviz,

I am no expert on this. Couple questions.

1) Where does this particular investor start introducing short term bonds?
2) How do you re balance between them? Do you sell long and buy short or you start reinvestng interest from long to short?

On an Example

I am 36 years old with NO bonds. Assume i will implement this and i have 50k now to start with, retirement age 60, and lets be positive and assume i will die at age 80.

What would be an example plan for me?

Thanks
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Re: A bond duration glide path for retirement investing

Post by OffGridder »

I have given some thought to this concept too. So thank you for your post and graph.

My only question is rather than assuming flat expenditures during retirement, shouldn't a weighting based on the anticipated expenditure profile be included in the calculation? For example if you are delaying social security until age 70, your withdrawals from the portfolio will probably be much higher during the pre-SS period. That would give a higher weight to shorter bond duration for that period, offset sonewhat by a longer duration for expenditures after age 70.
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Re: A bond duration glide path for retirement investing

Post by vineviz »

OffGridder wrote: Tue Jun 23, 2020 3:42 pm My only question is rather than assuming flat expenditures during retire, shouldn't a weighting based on the anticipated expenditure profile be included in the calculation? For example if you are delaying social security until age 70, your withdrawals from the portfolio will probably be much higher during the pre-SS period. That would will give a higher weight to shorter bond duration for that period, offset by a longer duration for expenditures after age 70.
I've modeled many different scenarios, including some like the one you've mentioned (e.g. heavy withdrawals up front to cover the "bridge years" from retirement to SS). The impact on the weighted average time to withdrawal (aka time horizon) is pretty small, it turns out. Typically it's less than a year, which I'd say is a small tweak given the size of the elephant in the room (longevity).
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Re: A bond duration glide path for retirement investing

Post by mhc »

If a person only knew when he would die, planning would be so easy.
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Re: A bond duration glide path for retirement investing

Post by fsh71 »

Thanks for this. I do struggle visualizing this. Let's take a not-so-great case scenario:

Investor is currently 40, retiring at 60, and dying at 80. Interest rates are currently 0%. Investor lump-sums 100% of their bond allocation into long-term treasuries today.

Starting today, we end up in a slow-and-steady rising rate environment for the next 40 years, how does the investor come out ahead by duration-matching in this situation?

He's buying long-term bonds at historically low interest-rates today, and as rates rise slowly over time, he's selling at a loss and buying new shorter-duration bonds in the higher yield environment. Seems he's effectively locking-in large losses by selling the most interest-rate sensitive bonds, and swapping them for less rate-sensitive bonds that are unlikely to recoup the losses from the longer-duration bonds.
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Re: A bond duration glide path for retirement investing

Post by coffeeblack »

Why can't you just buy intermediate term bonds and get the average of the short and long? Since no one knows where interest rates are going to be, it seems this is a better idea.
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Re: A bond duration glide path for retirement investing

Post by JamesDean44 »

coffeeblack wrote: Tue Jun 23, 2020 4:23 pm Why can't you just buy intermediate term bonds and get the average of the short and long? Since no one knows where interest rates are going to be, it seems this is a better idea.
The OP isn't about timing the market or predicting where rates could go. It is about reducing interest rate risk (and reinvestment risk) by matching duration to investment horizon. Intermediate bond fund duration isn't necessarily going to match the investment horizon.
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Re: A bond duration glide path for retirement investing

Post by coffeeblack »

JamesDean44 wrote: Tue Jun 23, 2020 5:07 pm
coffeeblack wrote: Tue Jun 23, 2020 4:23 pm Why can't you just buy intermediate term bonds and get the average of the short and long? Since no one knows where interest rates are going to be, it seems this is a better idea.
The OP isn't about timing the market or predicting where rates could go. It is about reducing interest rate risk (and reinvestment risk) by matching duration to investment horizon. Intermediate bond fund duration isn't necessarily going to match the investment horizon.
Right. Interest rate risk. As in getting a high or low rate depending on the time they invest over a time horizon. I get it. So since no one knows where interest rates are going to be at any given time period, why not pick one in the middle and avoid the highs and lows for a time horizon? Because no one knows if doing the type of glide path that is proposed for bonds will work. I guess I just don't see the benefit and the guesswork.
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Re: A bond duration glide path for retirement investing

Post by vineviz »

coffeeblack wrote: Tue Jun 23, 2020 5:26 pm Right. Interest rate risk. As in getting a high or low rate depending on the time they invest over a time horizon. I get it. So since no one knows where interest rates are going to be at any given time period, why not pick one in the middle and avoid the highs and lows for a time horizon?
“Picking one in the middle” doesn’t sound interest rate risk: only picking a bond fund that matched your investment horizon does that.
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Re: A bond duration glide path for retirement investing

Post by Zosima »

Vinevix, thank you for the chart and for starting the conversation. So the next question is what fund to use for long-term bonds?

Does one use only Treasuries like many Diehards advocate for (e.g. Vanguard Long-Term Treasury Fund (VUSUX) or iShares 20+ year Treasury ETF (TLT))?

Does one use a long-term investment grade fund similar to what many pension funds and insurance companies use (e.g. Vanguard Long-Term Investment Grade Fund (VWETX) which is a majority "A" rated bonds)?

Or does one use a long-term bond index (e.g. Vanguard Long-Term Bond Index (VBLAX) or iShares Core 10+ Bond ETF (ILTB))?

The results over the last decade are fairly comparable among the approaches.

https://www.portfoliovisualizer.com/bac ... tion5_3=30
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Re: A bond duration glide path for retirement investing

Post by marcopolo »

Makes sense.

Are you aware of any funds that do this rebalancing for you?

I am thinking something like a target date fund that shortens the maturity as it gets closer to your predicted date of demise?
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Re: A bond duration glide path for retirement investing

Post by pascalwager »

I don't question the concept, but the curve itself surprises me. The SS tables show a life-expectancy of ten (10) years for a 77 year-old, but the OP curve shows about five (5) years duration.
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Re: A bond duration glide path for retirement investing

Post by vineviz »

1789 wrote: Tue Jun 23, 2020 3:21 pm 1) Where does this particular investor start introducing short term bonds?
2) How do you re balance between them? Do you sell long and buy short or you start reinvestng interest from long to short?
An investor using the glide path I posted could possibly start introducing short-term bonds at around age 55 to 60. By age 70 the bond allocation could be 50% short-term and 50% long-term (optionally including some intermediate bonds instead)
1789 wrote: Tue Jun 23, 2020 3:21 pm I am 36 years old with NO bonds. Assume i will implement this and i have 50k now to start with, retirement age 60, and lets be positive and assume i will die at age 80.
For one thing, I can't fathom a scenario under which it'd be appropriate to plan to retirement that only lasts until age 80. Retiring at age 60 would likely call for planning to have a retirement of 35+ years, to ensure you don't outlive your wealth.

There are lots of variables in play, but just by way of example:

Age 45: 75% stocks, 25% long-term bonds, 0% short-term bonds
Age 55: 55% stocks, 45% long-term bonds, 0% short-term bonds
Age 65: 40% stocks, 35% long-term bonds, 25% short-term bonds
etc.
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Re: A bond duration glide path for retirement investing

Post by Swivelguy »

pascalwager wrote: Tue Jun 23, 2020 7:03 pm I don't question the concept, but the curve itself surprises me. The SS tables show a life-expectancy of ten (10) years for a 77 year-old, but the OP curve shows about five (5) years duration.
If you will be spending your portfolio at a roughly constant rate over the next 10 years, the average duration to the expenditure is 5 years.
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Re: A bond duration glide path for retirement investing

Post by vineviz »

gjlynch17 wrote: Tue Jun 23, 2020 6:36 pm Vinevix, thank you for the chart and for starting the conversation. So the next question is what fund to use for long-term bonds?

Does one use only Treasuries like many Diehards advocate for (e.g. Vanguard Long-Term Treasury Fund (VUSUX) or iShares 20+ year Treasury ETF (TLT))?

Does one use a long-term investment grade fund similar to what many pension funds and insurance companies use (e.g. Vanguard Long-Term Investment Grade Fund (VWETX) which is a majority "A" rated bonds)?

Or does one use a long-term bond index (e.g. Vanguard Long-Term Bond Index (VBLAX) or iShares Core 10+ Bond ETF (ILTB))?

The results over the last decade are fairly comparable among the approaches.
I prefer the use of Treasuries (either nominal or TIPS) with a slightly higher equity allocation to balance out expected return.

But mix of corporate bonds and Treasuries should be fine too. I think ILTB is an interesting fund, because it includes both high yield and USD-denomicanted foreign bonds for investors who need/want the yields associated with the credit risk of those. And of coures many Bogleheads discuss using Series I and/or Series EE savings bonds.

The iShares Inflation Hedged Corporate Bond ETF (LQDI) is intriguing also, perhaps coupled with PIMCO 15+ Year US TIPS ETF (LTPZ) for a DIY inflation-indexed pseudo-version of ILTB.
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Re: A bond duration glide path for retirement investing

Post by vineviz »

marcopolo wrote: Tue Jun 23, 2020 6:57 pm Makes sense.

Are you aware of any funds that do this rebalancing for you?

I am thinking something like a target date fund that shortens the maturity as it gets closer to your predicted date of demise?
The TDF series that get closest to the ideal setup IMHO are Dimensional Fund Advisors (DFA) and State Street (SSGA), but neither is widely available to retail investors.
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Re: A bond duration glide path for retirement investing

Post by pascalwager »

Swivelguy wrote: Tue Jun 23, 2020 7:19 pm
pascalwager wrote: Tue Jun 23, 2020 7:03 pm I don't question the concept, but the curve itself surprises me. The SS tables show a life-expectancy of ten (10) years for a 77 year-old, but the OP curve shows about five (5) years duration.
If you will be spending your portfolio at a roughly constant rate over the next 10 years, the average duration to the expenditure is 5 years.
You may not make it to 87, or you may live longer, so a ten-year duration makes more sense to me as an average.
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Re: A bond duration glide path for retirement investing

Post by 1789 »

vineviz wrote: Tue Jun 23, 2020 7:16 pm
1789 wrote: Tue Jun 23, 2020 3:21 pm 1) Where does this particular investor start introducing short term bonds?
2) How do you re balance between them? Do you sell long and buy short or you start reinvestng interest from long to short?
An investor using the glide path I posted could possibly start introducing short-term bonds at around age 55 to 60. By age 70 the bond allocation could be 50% short-term and 50% long-term (optionally including some intermediate bonds instead)
1789 wrote: Tue Jun 23, 2020 3:21 pm I am 36 years old with NO bonds. Assume i will implement this and i have 50k now to start with, retirement age 60, and lets be positive and assume i will die at age 80.
For one thing, I can't fathom a scenario under which it'd be appropriate to plan to retirement that only lasts until age 80. Retiring at age 60 would likely call for planning to have a retirement of 35+ years, to ensure you don't outlive your wealth.

There are lots of variables in play, but just by way of example:

Age 45: 75% stocks, 25% long-term bonds, 0% short-term bonds
Age 55: 55% stocks, 45% long-term bonds, 0% short-term bonds
Age 65: 40% stocks, 35% long-term bonds, 25% short-term bonds
etc.
vineviz,

Thank you for providing an example AA. This idea is interesting, thou i’m not knowledgable enough to see the downsides of this.
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Re: A bond duration glide path for retirement investing

Post by Horton »

vineviz wrote: Tue Jun 23, 2020 7:28 pm
marcopolo wrote: Tue Jun 23, 2020 6:57 pm Makes sense.

Are you aware of any funds that do this rebalancing for you?

I am thinking something like a target date fund that shortens the maturity as it gets closer to your predicted date of demise?
The TDF series that get closest to the ideal setup IMHO are Dimensional Fund Advisors (DFA) and State Street (SSGA), but neither is widely available to retail investors.
This is unfortunate because a TDF is the best way to execute this strategy for 99.9% of people. I’ve come to the conclusion, after many discussions on this topic, that the vast majority of DIY investors won’t be able to execute and stick with this strategy for the long term.
My IPS - use target date funds (except in taxable)
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Re: A bond duration glide path for retirement investing

Post by venkman »

For someone in retirement, couldn't reinvestment risk be more important than interest rate risk (particularly if they were hoping not to spend down their portfolio)? If you're depending on the income, variability of principal is preferable to variability of income.

e.g. An 80-year-old in 2018 might have wanted to lock in a yield of 3%+ on 30-year Treasuries, even though they were unlikely to live 30 more years, if they were spending the income. 5-year Treasuries at the time peaked around 3%--pretty close to the 30-year with much less interest rate risk--but they're likely to pay far less when 2023 rolls around.
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Re: A bond duration glide path for retirement investing

Post by Ben Mathew »

pascalwager wrote: Tue Jun 23, 2020 7:47 pm
Swivelguy wrote: Tue Jun 23, 2020 7:19 pm
pascalwager wrote: Tue Jun 23, 2020 7:03 pm I don't question the concept, but the curve itself surprises me. The SS tables show a life-expectancy of ten (10) years for a 77 year-old, but the OP curve shows about five (5) years duration.
If you will be spending your portfolio at a roughly constant rate over the next 10 years, the average duration to the expenditure is 5 years.
You may not make it to 87, or you may live longer, so a ten-year duration makes more sense to me as an average.
You need to consume 1 year from now, 2 years from now, and so on. So you would need 1 year bonds, 2 year bonds, etc.. That brings the average duration across all your bonds closer to the middle of expected years left rather than towards the end of expected years left.
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Re: A bond duration glide path for retirement investing

Post by Ben Mathew »

venkman wrote: Tue Jun 23, 2020 10:13 pm For someone in retirement, couldn't reinvestment risk be more important than interest rate risk (particularly if they were hoping not to spend down their portfolio)? If you're depending on the income, variability of principal is preferable to variability of income.
For people with a strong bequest motive, living off bond income could make sense. They are investing for their heirs, and their horizon is longer than expected years left of their own lifetime. So they might want to get long term bonds even when they are old because that fixes what their heirs will get decades down the line. Stocks might make even more sense than long term bonds, especially if the heirs are young.

For people without a strong bequest motive, living off the income of bonds will leave a lot of money unspent when they die.
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Re: A bond duration glide path for retirement investing

Post by klaus14 »

vineviz wrote: Tue Jun 23, 2020 7:16 pm
1789 wrote: Tue Jun 23, 2020 3:21 pm 1) Where does this particular investor start introducing short term bonds?
2) How do you re balance between them? Do you sell long and buy short or you start reinvestng interest from long to short?
An investor using the glide path I posted could possibly start introducing short-term bonds at around age 55 to 60. By age 70 the bond allocation could be 50% short-term and 50% long-term (optionally including some intermediate bonds instead)
1789 wrote: Tue Jun 23, 2020 3:21 pm I am 36 years old with NO bonds. Assume i will implement this and i have 50k now to start with, retirement age 60, and lets be positive and assume i will die at age 80.
For one thing, I can't fathom a scenario under which it'd be appropriate to plan to retirement that only lasts until age 80. Retiring at age 60 would likely call for planning to have a retirement of 35+ years, to ensure you don't outlive your wealth.

There are lots of variables in play, but just by way of example:

Age 45: 75% stocks, 25% long-term bonds, 0% short-term bonds
Age 55: 55% stocks, 45% long-term bonds, 0% short-term bonds
Age 65: 40% stocks, 35% long-term bonds, 25% short-term bonds
etc.
I guess one assumption here is increasing bond amount till retirement. So you don't sell the LT bond fund you bought when you were 30, till sometime in retirement. Then, this framework obviously makes sense, you expect to collect more interest with LT bonds.

However, this is not how most peoples portfolios work. People use bonds as a ballast. That is: they are the low volatility component of the portfolio. They rebalance from bonds when stocks crash.

When you exclusively use LT, you lose this safety. There can be periods where both stocks and bonds do bad. Then you would wish holding at least some shorter term bonds.

So how about this rule of thumb:
If you don't expect to sell the bond you are purchasing for N years, then you should buy a bond with N years duration.

This rule would allow for some amount of ST bonds for potential rebalancing during a crash, at any age.
So for 75/25, to power 1/3 stock crash rebalancing, you should hold 6.25% in ST which leaves 18.75% for LT.

People may have other reasons to sell too, like emergencies. Emergencies and rebalancing are expected to happen. So i think it's prudent to allocate some portion of bonds in low duration - low volatility.
My investment algorithm: https://www.bogleheads.org/forum/viewtopic.php?f=10&t=351899&p=6112869#p6112869
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Re: A bond duration glide path for retirement investing

Post by GoneOnTilt »

coffeeblack wrote: Tue Jun 23, 2020 4:23 pm Why can't you just buy intermediate term bonds and get the average of the short and long? Since no one knows where interest rates are going to be, it seems this is a better idea.
+1. The only other thing I do is hold a couple of years cash and short-term bonds for money I might need in the near future. The rest is in imtermediate term bond funds.

I try to keep it simple.
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Re: A bond duration glide path for retirement investing

Post by vineviz »

venkman wrote: Tue Jun 23, 2020 10:13 pm For someone in retirement, couldn't reinvestment risk be more important than interest rate risk (particularly if they were hoping not to spend down their portfolio)? If you're depending on the income, variability of principal is preferable to variability of income.
One of the features of finding the balance of reinvestment risk with price risk (which comes from matching duration to your investment horizon) is precisely that it reduces variability of income.

For sure it is true that an investor who is buying individual bonds with no intention of ever spending the principal (i.e. relying entirely on coupon payments) probably isn't going to want to use a duration glide path. On the other hand, their retirement is so secure that they can probably do whatever they want.
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Re: A bond duration glide path for retirement investing

Post by vineviz »

Horton wrote: Tue Jun 23, 2020 9:32 pm This is unfortunate because a TDF is the best way to execute this strategy for 99.9% of people. I’ve come to the conclusion, after many discussions on this topic, that the vast majority of DIY investors won’t be able to execute and stick with this strategy for the long term.
I agree, and I strongly encourage folks to use TDFs. Although I think most of them could make some design improvements, I wouldn't want folks to avoid their use merely because of this thread.
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Re: A bond duration glide path for retirement investing

Post by vineviz »

klaus14 wrote: Wed Jun 24, 2020 3:23 am I guess one assumption here is increasing bond amount till retirement. So you don't sell the LT bond fund you bought when you were 30, till sometime in retirement. Then, this framework obviously makes sense, you expect to collect more interest with LT bonds.

However, this is not how most peoples portfolios work. People use bonds as a ballast. That is: they are the low volatility component of the portfolio. They rebalance from bonds when stocks crash.

When you exclusively use LT, you lose this safety. There can be periods where both stocks and bonds do bad. Then you would wish holding at least some shorter term bonds.
Not necessarily.

The approach I outlined certainly wouldn't preclude rebalancing from bonds to stocks (which could involve selling the LT bond fund and buying equities after a market crash).

The bonds are still being used as "ballast", so to speak, it's just that they are doing so in a way that makes sense. By that I mean, instead of treating bonds as a "low volatility component of the portfolio" (which is irrational) this approach keeps the focus where it belongs: on the entire portfolio's ability to provide reliable retirement income.

On the other hand, you raise a point that I think is important. Most investors aren't entirely rational, and some investors can't (or don't want to) own a portfolio that is volatile even when such a portfolio is economically optimal. Using only long-term bonds and stocks, there's a limit to how low the overall portfolio volatility can go.

An investor with a long-term investment horizon but who nevertheless has such a strong risk-aversion that they need a portfolio which contains less than 50% stocks probably does need to include some short-term bonds, despite the additional interest rate risk that brings on.
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Re: A bond duration glide path for retirement investing

Post by rlangford »

vineviz wrote: Tue Jun 23, 2020 3:48 pm
OffGridder wrote: Tue Jun 23, 2020 3:42 pm My only question is rather than assuming flat expenditures during retire, shouldn't a weighting based on the anticipated expenditure profile be included in the calculation? For example if you are delaying social security until age 70, your withdrawals from the portfolio will probably be much higher during the pre-SS period. That would will give a higher weight to shorter bond duration for that period, offset by a longer duration for expenditures after age 70.
I've modeled many different scenarios, including some like the one you've mentioned (e.g. heavy withdrawals up front to cover the "bridge years" from retirement to SS). The impact on the weighted average time to withdrawal (aka time horizon) is pretty small, it turns out. Typically it's less than a year, which I'd say is a small tweak given the size of the elephant in the room (longevity).
vineviz,
I like your discussion of this subject. I personally use individual T bonds and TIPS in a partial LMP. Did you calculate the duration of those expenditures in retirement using the standard duration calculation for a bond? Thanks.
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Re: A bond duration glide path for retirement investing

Post by pascalwager »

Ben Mathew wrote: Tue Jun 23, 2020 10:39 pm
pascalwager wrote: Tue Jun 23, 2020 7:47 pm
Swivelguy wrote: Tue Jun 23, 2020 7:19 pm
pascalwager wrote: Tue Jun 23, 2020 7:03 pm I don't question the concept, but the curve itself surprises me. The SS tables show a life-expectancy of ten (10) years for a 77 year-old, but the OP curve shows about five (5) years duration.
If you will be spending your portfolio at a roughly constant rate over the next 10 years, the average duration to the expenditure is 5 years.
You may not make it to 87, or you may live longer, so a ten-year duration makes more sense to me as an average.
You need to consume 1 year from now, 2 years from now, and so on. So you would need 1 year bonds, 2 year bonds, etc.. That brings the average duration across all your bonds closer to the middle of expected years left rather than towards the end of expected years left.
Okay, thanks, probably makes sense. I'm only one duration-year above the curve for my age, but previously thought I was three years below. Also, I'm atypical in my use of the portfolio and heir situation. So, I've got some rethinking to do.
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Re: A bond duration glide path for retirement investing

Post by vineviz »

rlangford wrote: Wed Jun 24, 2020 6:45 am I personally use individual T bonds and TIPS in a partial LMP. Did you calculate the duration of those expenditures in retirement using the standard duration calculation for a bond?
Effectively, yes. In practice, if you keep the expenses in real terms and compute a weighted average time for the expenses this is essentially what you're accomplishing.
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Re: A bond duration glide path for retirement investing

Post by nedsaid »

There are a number of ways of reducing risk as we get older, it is a topic with some interesting concepts. The biggest one is reducing the ratio of stocks to bonds within a portfolio as one ages. Another one is increasing the market cap of your stocks as you age, sort of an age in mega-caps sort of thing. Vineviz brings up shortening duration in your bonds. Another one would be an increasing percentage of US stocks compared to International stocks.

Rhetorically speaking, as I approach my 61st birthday, I am not wanting the portfolio equivalent of a walker or a wheelchair. I still like stocks. I still like a mix of more conservative investments along with a smaller portion of aggressive investments. This kind of discussion makes me feel like I can't drive a sporty car anymore but need boring, boxy, safe cars like a Volvo. Like the guy in the movie said, boxy but good. I want the same investments that I always have had but the more aggressive in smaller portions and the more conservative investments in a larger portion. But even then, more conservative to a point. Dadgummit, I don't want no advisor tellin' me I cain't have no Emergin' Markets stocks no more.
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Re: A bond duration glide path for retirement investing

Post by vineviz »

pascalwager wrote: Wed Jun 24, 2020 7:01 am
Ben Mathew wrote: Tue Jun 23, 2020 10:39 pm
pascalwager wrote: Tue Jun 23, 2020 7:47 pm
Swivelguy wrote: Tue Jun 23, 2020 7:19 pm
pascalwager wrote: Tue Jun 23, 2020 7:03 pm I don't question the concept, but the curve itself surprises me. The SS tables show a life-expectancy of ten (10) years for a 77 year-old, but the OP curve shows about five (5) years duration.
If you will be spending your portfolio at a roughly constant rate over the next 10 years, the average duration to the expenditure is 5 years.
You may not make it to 87, or you may live longer, so a ten-year duration makes more sense to me as an average.
You need to consume 1 year from now, 2 years from now, and so on. So you would need 1 year bonds, 2 year bonds, etc.. That brings the average duration across all your bonds closer to the middle of expected years left rather than towards the end of expected years left.
Okay, thanks, probably makes sense. I'm only one duration-year above the curve for my age, but previously thought I was three years below. Also, I'm atypical in my use of the portfolio and heir situation. So, I've got some rethinking to do.
I wouldn't obsess over small differences, honestly.

For one thing, I applied some smoothing to the graph I posted and was also using a mortality table slightly different than the one used by SSA.gov.

More importantly, unless you've got strong longevity insurance (i.e. a deferred income annuity) in place you're almost certainly going to want to plan for a retirement longer than your remaining life expectancy. The challenge is that your calculated (estimated, really) remaining investment time horizon becomes increasingly dependent on a subjective evaluation (i.e. what probability of outliving your wealth are you comfortable with) as you move into your 80s and early 90s.

Personally, I'm with you in your original evaluation: something close to a 8 to 10-year duration is about what I'd say is prudent for a 77-year old investor, because that investor has a non-trivial (i.e. 10% or better) chance of living to at least age 95. In other words, "remaining life expectancy" is a pretty good ballpark estimate of "remaining investment horizon".
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Re: A bond duration glide path for retirement investing

Post by vineviz »

nedsaid wrote: Wed Jun 24, 2020 7:48 am Another one would be an increasing percentage of US stocks compared to International stocks.
I can't tell you how much I don't want to drag international investing into this thread . . . .
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Re: A bond duration glide path for retirement investing

Post by nedsaid »

vineviz wrote: Wed Jun 24, 2020 7:56 am
nedsaid wrote: Wed Jun 24, 2020 7:48 am Another one would be an increasing percentage of US stocks compared to International stocks.
I can't tell you how much I don't want to drag international investing into this thread . . . .
I am just pointing out that there are a number of ways of looking at reducing risk as you get older. Of all the methods of reducing risk, reducing bond duration is probably the least discussed. Not an attempt to derail anything.
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Re: A bond duration glide path for retirement investing

Post by nedsaid »

Another aspect of this, is to get any kind of return in bonds, you can't just stay in US Treasuries anymore. As of today, the U.S. Treasury 10 year yields just 0.72%. If you go out two years, you are stuck with 0.18%. You almost need a microscope to see these yields. I suspect what folks will do is substitute Government Agency Bonds like GNMAs for US Treasuries, they will mix in more corporate bonds to stretch for yield. I suppose folks will be looking to anything that gives them a yield above inflation. The historically low rates of interest rates put a big kink in the strategy of reducing bond duration as you get older. We are being forced to accept higher market volatility in our bond portfolios.
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Re: A bond duration glide path for retirement investing

Post by Nowizard »

Is this accurate? Glide path would indicate somewhere around ten years for a 75 year old person. As someone 78, that would be somewhat less. Total Bond Index has an average duration of 6.4 years. Seems like the post makes it simple if accepted for people in that age bracket.

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Re: A bond duration glide path for retirement investing

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Intellectually your argument is correct to me. But emotionally I have trouble not believing that I am smarter than the market and interest rates just have to go up. I have convinced myself of the foolishness of such logic in stocks. I just have trouble thinking about locking in long duration bonds currently. I am likely wrong but I probably need someone to hit me with a large object to convince me.
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Re: A bond duration glide path for retirement investing

Post by Doc »

mhc wrote: Tue Jun 23, 2020 3:59 pm If a person only knew when he would die, planning would be so easy.
That's easy to do by using a 457 plan. :D
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Re: A bond duration glide path for retirement investing

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qwertyjazz wrote: Wed Jun 24, 2020 9:37 am Intellectually your argument is correct to me. But emotionally I have trouble not believing that I am smarter than the market and interest rates just have to go up. I have convinced myself of the foolishness of such logic in stocks. I just have trouble thinking about locking in long duration bonds currently. I am likely wrong but I probably need someone to hit me with a large object to convince me.
Choosing a bond duration to match your investment horizon is, in actuality, the “I’m not smarter than the market” approach precisely because it eliminates interest rate risk.

Actively taking on interest rate risk (by choosing shorter duration bonds than your investment horizon,for example) is the speculative bet.

Just like the stock/bond glide path is a tool for avoiding market timing, so too is the bond duration glide path.
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Re: A bond duration glide path for retirement investing

Post by coffeeblack »

bck63 wrote: Wed Jun 24, 2020 4:25 am
coffeeblack wrote: Tue Jun 23, 2020 4:23 pm Why can't you just buy intermediate term bonds and get the average of the short and long? Since no one knows where interest rates are going to be, it seems this is a better idea.
+1. The only other thing I do is hold a couple of years cash and short-term bonds for money I might need in the near future. The rest is in intermediate term bond funds.

I try to keep it simple.
+1, Another way to do it is to just buy equal amounts of bonds in all three, long, intermediate and short term. That would make things more complicated. I like to keep it simple as well so I basically do as you do. I keep some cash and the rest is intermediate bonds and stocks in a proper AA I can tolerate. If you want a more diversified bond portfolio you can buy vanguard total bond market.
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Re: A bond duration glide path for retirement investing

Post by rlangford »

vineviz wrote: Wed Jun 24, 2020 10:15 am
qwertyjazz wrote: Wed Jun 24, 2020 9:37 am Intellectually your argument is correct to me. But emotionally I have trouble not believing that I am smarter than the market and interest rates just have to go up. I have convinced myself of the foolishness of such logic in stocks. I just have trouble thinking about locking in long duration bonds currently. I am likely wrong but I probably need someone to hit me with a large object to convince me.
Choosing a bond duration to match your investment horizon is, in actuality, the “I’m not smarter than the market” approach precisely because it eliminates interest rate risk.

Actively taking on interest rate risk (by choosing shorter duration bonds than your investment horizon,for example) is the speculative bet.

Just like the stock/bond glide path is a tool for avoiding market timing, so too is the bond duration glide path.
If I have a partial Liability Matching Portfolio (LMP) of T Bonds and TIPS for the next 10 years that match my basic expenditures before I plan to collect Social Security, would you recommend then that I pick a fund for the remainder of the bond allocation that matches the remaining years of life expectancy. So in effect I would probably just need a long term bond fund and a long term tips fund until I decide if I want to increase my LMP? Thanks.
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Re: A bond duration glide path for retirement investing

Post by vineviz »

rlangford wrote: Wed Jun 24, 2020 10:52 am If I have a partial Liability Matching Portfolio (LMP) of T Bonds and TIPS for the next 10 years that match my basic expenditures before I plan to collect Social Security, would you recommend then that I pick a fund for the remainder of the bond allocation that matches the remaining years of life expectancy. So in effect I would probably just need a long term bond fund and a long term tips fund until I decide if I want to increase my LMP? Thanks.
That's right: you want the duration of the bond fund to correspond with the liabilities you intend to match with the LMP later on, not to correspond with the date on which you will create the new LMP portion.
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Re: A bond duration glide path for retirement investing

Post by vineviz »

Someone suggested that it might be helpful to show how an investor might use the duration glide path with a little more specificity, so I constructed this example glide path using an assortment of bond funds and a generic stock allocation.

Image

Don't fixate on the particular bond funds I chose, or even the number of funds. The duration glide path can easily be managed using just two bond funds at a time: the only effort required is to periodically adjust the ratio of the longer-term fund and the shorter-term fund(s) to keep the weighted average duration close your target.
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Re: A bond duration glide path for retirement investing

Post by klaus14 »

vineviz wrote: Wed Jun 24, 2020 2:37 pm Someone suggested that it might be helpful to show how an investor might use the duration glide path with a little more specificity, so I constructed this example glide path using an assortment of bond funds and a generic stock allocation.

Image

Don't fixate on the particular bond funds I chose, or even the number of funds. The duration glide path can easily be managed using just two bond funds at a time: the only effort required is to periodically adjust the ratio of the longer-term fund and the shorter-term fund(s) to keep the weighted average duration close your target.
Can you explain why you picked LQDI?
My guess is you are achieving two things with one fund: - inflation protection, - credit risk premium.
My investment algorithm: https://www.bogleheads.org/forum/viewtopic.php?f=10&t=351899&p=6112869#p6112869
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Re: A bond duration glide path for retirement investing

Post by vineviz »

klaus14 wrote: Wed Jun 24, 2020 3:11 pm
Can you explain why you picked LQDI?
My guess is you are achieving two things with one fund: - inflation protection, - credit risk premium.
Yep, that was my thought. I wanted to illustrate how someone might include explicit TIPS-like inflation protection in a duration-appropriate way while maintaining TBM-ish yields.


But any number of fund combinations could work: ILTB/SCHB/BSV, EDV/BND/VTIP, LTPZ/IUSB/SHY, etc
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Re: A bond duration glide path for retirement investing

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Can someone explain to me why it is interest rate risk that should be singled out as important enough to drive the selection of bond duration?
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Re: A bond duration glide path for retirement investing

Post by GoneOnTilt »

coffeeblack wrote: Wed Jun 24, 2020 10:29 am
bck63 wrote: Wed Jun 24, 2020 4:25 am
coffeeblack wrote: Tue Jun 23, 2020 4:23 pm Why can't you just buy intermediate term bonds and get the average of the short and long? Since no one knows where interest rates are going to be, it seems this is a better idea.
+1. The only other thing I do is hold a couple of years cash and short-term bonds for money I might need in the near future. The rest is in intermediate term bond funds.

I try to keep it simple.
+1, Another way to do it is to just buy equal amounts of bonds in all three, long, intermediate and short term. That would make things more complicated. I like to keep it simple as well so I basically do as you do. I keep some cash and the rest is intermediate bonds and stocks in a proper AA I can tolerate. If you want a more diversified bond portfolio you can buy vanguard total bond market.
Agreed. I should have clarified. I own total bond market funds at Vanguard and Fidelity, both of which have intermediate durations.
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Re: A bond duration glide path for retirement investing

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sls239 wrote: Wed Jun 24, 2020 4:16 pm Can someone explain to me why it is interest rate risk that should be singled out as important enough to drive the selection of bond duration?
Duration is, by its very definition, a measure of interest rate sensitivity.

Interest rate risk is the only bond risk that duration can help manage, and it is the only way to manage interest rate risk.

There are certainly important risks besides interest rate risk (inflation risk, credit risk, currency risk, etc.), and investors should absolutely pay attention to those as well.
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Re: A bond duration glide path for retirement investing

Post by sls239 »

Well doesn't credit risk have a duration component? I mean isn't it inherently more difficult to evaluate credit risk on a longer duration bond?
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