fixed income allocation and duration calculation

[trallium]

Hi,

I'm probably going to do a viewtopic.php?t=6212 post at some point -- but if this format is acceptable I have a couple of questions about my fixed income asset allocation.

Code: Select all

------------+---------------------------------+-----+---------+--------
name        |benchmark                       duration    %     duration * % 
------------+---------------------------------+-----+---------+--------
Bond Fund   |Bloomberg US Aggregate Bond Index|6.71 |  48.77% | 3.272759
Savings Fund|2 Year Treasury Income Return    |2.37 |  23.81% | 0.564226
Short TIPS  |Bloomberg 1-3 Year US TIPS Index |1.19 |  16.40% | 0.195129
TIPS Fund   |Bloomberg US TIPS Index          |7.74 |  11.02% | 0.853046
------------+---------------------------------+-----+---------+--------
                                             effective duration 4.885159
------------+---------------------------------+-----+---------+--------

Does my naive calculation of my effective duration make sense? (I think this is a weighed average)

Is interest rate risk the same for TIPS vs not? (assuming a TIPS fund or a normal Bond fund of comparable durations, would an interest rate change affect the NAV to the same degree.)

This is about 40% of my portfolio and I'm about to retire this year with a COLA pension that covers about half my expenses. Does this allocation seem reasonable? These are the only options in my plan (0.01% expense ratio except for savings fund which is 0.03%) but I do have a Brokeragelink option.

[Hector]

I would use broker link option and get my desired allocation. I do that with bonds in my 401k.

[Beensabu]

Does my naive calculation of my effective duration make sense? (I think this is a weighed average)

Yes.

Does this allocation seem reasonable?

Yes.

Is interest rate risk the same for TIPS vs not?

Pretty much.

[trallium]

Thanks for the feedback Beensabu.

If all of that is true; seems like I could get the same market exposure with just two funds -- say the Bond Fund and the short term TIPS (to lower the duration and add some more inflation protection).

Thanks for the feedback Hector. I don't think I want to mess around with individual bonds. My bonds to stocks ratio is where I want it. As far as the allocation inside of bonds; it seems like duration / tips-or-not / credit quality / dollar-denominated-or-not are the main dimensions. I think I want a slightly lower duration if I'm expecting that probably we are in a environment where rates might raise; some inflation protection sounds nice; but if I diversify into more credit risk then the bonds will act more like stocks. w/r/t US or international -- I'm mostly in total world market so I'm not sure I want any international or currency exposure in my bonds. Otherwise there don't seem like many nobs to tweak unless I start getting into alternative and/or non-liquid products.

Thanks again!

[hudson]

trallium,
You've probably already read this discussion? viewtopic.php?t=318412

another discussion that goes into duration matching: viewtopic.php?t=287627

[vineviz]

Is interest rate risk the same for TIPS vs not? (assuming a TIPS fund or a normal Bond fund of comparable durations, would an interest rate change affect the NAV to the same degree.)

Technically (and this is getting deep in the weeds) TIPS have two different durations: they have a real interest rate duration and an inflation duration. The inflation duration is rarely calculated or displayed, but it exists. Don't try to calculate it, but understand that it exists. As a result, the nominal duration calculations above only partly capture the inflation duration component of the TIPS.

What's the tl;dr upshot?

All else equal, you should prefer the combination of a intermediate-term TIPS fund + a short-term nominal bond fund over a combination of a short-term TIPS fund + an intermediate-term nominal bond fund when the average nominal durations are equal.

In your case, I'd prefer the [TIPS fund + Savings Fund] over [Bond fund + Short TIPS].

[trallium]

thanks hudson and vineviz.

I had seen the gluidepath article, but it never clicked for me before it was like the gluidepath a target date fund might use for the stock to bond ratio (but it says it right at the top); but only for the ratio of the bond types (first time I saw it, I don't think I understood how to adjust duration). As it happens, I spent some time yesterday looking at the fixed income allocation of the target date funds we have at work, and I notice that they sort of do the same thing (20 Treasuries in the far out dates, much shorter duration in the income fund). They also have some fixed income funds (20 year / High Yield / commodities) for the target date funds that we don't have access to in the savings.

thanks for the dive into the weeds, very interesting.

In my case, I have a 457b that I will start spending this year, and a 403 I can't spend for 10 years but I'll be doing Roth conversions from it. I've sort of tried to do a duration placement; only longer term funds in the 403, the shorter term funds are in the 457. Maybe I'm overoptimistic, but I'm planning for a 50 year retirement (to age 100) and was considering adding some long term treasuries via brokerage link to the 403b.

[grabiner]

While durations can be averaged, the average becomes less meaningful when the bonds are less similar.

It is true that, if the yields of all the bonds in your portfolio rise by 1%, your portfolio will lose 4.89% of its value. However, it is not as likely that TIPS and nominal bond yields will change by the same amount at the same time, so this is not a good measure of your portfolio risk. There is a similar issue with short-term and long-term bonds; it is more likely that short-term yields will rise 3% and long-term yields will rise 1% than that both will rise 2% at the same time.

[hudson]

thanks hudson and vineviz.
but I'm planning for a 50 year retirement (to age 100) and was considering adding some long term treasuries via brokerage link to the 403b.

Retiring soon to a 50 year retirement: wow!
What would one do for fixed income for 50 years?
I think planning to 100 is good.
TIPS only run for 30 years.
If I was going for 50 years, I'd be TIPS heavy.