A bond duration glide path for retirement investing

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BrooklynInvest
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Re: A bond duration glide path for retirement investing

Post by BrooklynInvest »

spdoublebass wrote: Thu Aug 04, 2022 11:37 am
BrooklynInvest wrote: Thu Aug 04, 2022 11:06 am Someone please correct me -

Let's pretend I'm 60, just retired and I expect to live to 90 (glossing over the obvious problem for now.) The midpoint is 15 years. This "duration matching" thing implies I should have zero rate risk in my bonds when I'm 75? Why?

Assuming I maintained a 60-40 allocation in my portfolio, at 75 I'm now 60% stocks and 40 cash. I've got 15 years of 40% of my money doing roughly nothing for me before I kick the bucket. How is this beneficial? I'm still 60% in stocks so my portfolio still has volatility. I've just removed interest rate risk and, importantly, almost all of the bond income for some reason. My equity beta is still .6, I may have international exposure and currency risk etc. etc.

I can see this methodology in rare instances when, say, I'm a corporation with a balloon payment on something on a specific date AND the volatility of my fixed income portfolio needs to track to zero as that date looms, but as a tool for individual retirement, massively overweighting cash to remove one specific risk among many seems odd to me.
At 75 you'd then have a 7.5 year duration. I'm not following what you are saying.
I'm using the midpoint of my retirement years as my investment horizon - the point at which my duration becomes zero, no? I realize at best it's a fudge. Or is it a different point? But my question really is why am I removing rate risk while maintaining other portfolio risks?
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BrooklynInvest
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Re: A bond duration glide path for retirement investing

Post by BrooklynInvest »

hudson wrote: Thu Aug 04, 2022 11:41 am
BrooklynInvest wrote: Thu Aug 04, 2022 11:06 am Someone please correct me -

Let's pretend I'm 60, just retired and I expect to live to 90 (glossing over the obvious problem for now.) The midpoint is 15 years. This "duration matching" thing implies I should have zero rate risk in my bonds when I'm 75? Why?

Assuming I maintained a 60-40 allocation in my portfolio, at 75 I'm now 60% stocks and 40 cash. I've got 15 years of 40% of my money doing roughly nothing for me before I kick the bucket. How is this beneficial? I'm still 60% in stocks so my portfolio still has volatility. I've just removed interest rate risk and, importantly, almost all of the bond income for some reason. My equity beta is still .6, I may have international exposure and currency risk etc. etc.

I can see this methodology in rare instances when, say, I'm a corporation with a balloon payment on something on a specific date AND the volatility of my fixed income portfolio needs to track to zero as that date looms, but as a tool for individual retirement, massively overweighting cash to remove one specific risk among many seems odd to me.
Are you using "cash" and "bonds" as equivalents?
I don't think that vineviz ever recommended that anyone go all cash for the fixed income part of their holdings.
He might have recommended duration matched TIPS.
Entirely possible I've misconstrued but how am I getting to zero duration without cash? Short term bonds will lower my duration to be sure, but - if I'm understanding correctly - I have to get to zero duration.
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Re: A bond duration glide path for retirement investing

Post by vineviz »

BrooklynInvest wrote: Thu Aug 04, 2022 12:26 pm I'm using the midpoint of my retirement years as my investment horizon - the point at which my duration becomes zero, no? I realize at best it's a fudge. Or is it a different point? But my question really is why am I removing rate risk while maintaining other portfolio risks?
You want to use the midpoint of your REMAINING retirement years as the duration you're targeting.

When you have 30 more years of retirement, your investment horizon and your target duration are roughly 15 years.

When you have 20 more years of retirement, your investment horizon and your target duration are roughly 10 years.

When you have 10 more years of retirement, your investment horizon and your target duration are roughly 5 years.

And so on.
"Far more money has been lost by investors preparing for corrections than has been lost in corrections themselves." ~~ Peter Lynch
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Re: A bond duration glide path for retirement investing

Post by hudson »

BrooklynInvest wrote: Thu Aug 04, 2022 12:27 pm
hudson wrote: Thu Aug 04, 2022 11:41 am
BrooklynInvest wrote: Thu Aug 04, 2022 11:06 am Someone please correct me -

Let's pretend I'm 60, just retired and I expect to live to 90 (glossing over the obvious problem for now.) The midpoint is 15 years. This "duration matching" thing implies I should have zero rate risk in my bonds when I'm 75? Why?

Assuming I maintained a 60-40 allocation in my portfolio, at 75 I'm now 60% stocks and 40 cash. I've got 15 years of 40% of my money doing roughly nothing for me before I kick the bucket. How is this beneficial? I'm still 60% in stocks so my portfolio still has volatility. I've just removed interest rate risk and, importantly, almost all of the bond income for some reason. My equity beta is still .6, I may have international exposure and currency risk etc. etc.

I can see this methodology in rare instances when, say, I'm a corporation with a balloon payment on something on a specific date AND the volatility of my fixed income portfolio needs to track to zero as that date looms, but as a tool for individual retirement, massively overweighting cash to remove one specific risk among many seems odd to me.
Are you using "cash" and "bonds" as equivalents?
I don't think that vineviz ever recommended that anyone go all cash for the fixed income part of their holdings.
He might have recommended duration matched TIPS.
Entirely possible I've misconstrued but how am I getting to zero duration without cash? Short term bonds will lower my duration to be sure, but - if I'm understanding correctly - I have to get to zero duration.
I'm 74. At 76 when intermediate CDs mature, I'm going to do a form of duration matching.
My plan will cover from ages 76 to 96. That's 20 years; if I divide by 2, the average duration would be 10 years.
I'm thinking my holdings will be made up of half nominal treasuries and half TIPS...again with an average duration of 10 years.
Will my duration ever be zero? No, If I make it to 96, I'm thinking that I won't go under 5 years average duration. I haven't really thought that through.
Will my plan work for you? Most likely not. My plan is customized for my unique situation.
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Re: A bond duration glide path for retirement investing

Post by Wrench »

hudson wrote: Thu Aug 04, 2022 1:15 pm
BrooklynInvest wrote: Thu Aug 04, 2022 12:27 pm
hudson wrote: Thu Aug 04, 2022 11:41 am
BrooklynInvest wrote: Thu Aug 04, 2022 11:06 am Someone please correct me -

Let's pretend I'm 60, just retired and I expect to live to 90 (glossing over the obvious problem for now.) The midpoint is 15 years. This "duration matching" thing implies I should have zero rate risk in my bonds when I'm 75? Why?

Assuming I maintained a 60-40 allocation in my portfolio, at 75 I'm now 60% stocks and 40 cash. I've got 15 years of 40% of my money doing roughly nothing for me before I kick the bucket. How is this beneficial? I'm still 60% in stocks so my portfolio still has volatility. I've just removed interest rate risk and, importantly, almost all of the bond income for some reason. My equity beta is still .6, I may have international exposure and currency risk etc. etc.

I can see this methodology in rare instances when, say, I'm a corporation with a balloon payment on something on a specific date AND the volatility of my fixed income portfolio needs to track to zero as that date looms, but as a tool for individual retirement, massively overweighting cash to remove one specific risk among many seems odd to me.
Are you using "cash" and "bonds" as equivalents?
I don't think that vineviz ever recommended that anyone go all cash for the fixed income part of their holdings.
He might have recommended duration matched TIPS.
Entirely possible I've misconstrued but how am I getting to zero duration without cash? Short term bonds will lower my duration to be sure, but - if I'm understanding correctly - I have to get to zero duration.
I'm 74. At 76 when intermediate CDs mature, I'm going to do a form of duration matching.
My plan will cover from ages 76 to 96. That's 20 years; if I divide by 2, the average duration would be 10 years.
I'm thinking my holdings will be made up of half nominal treasuries and half TIPS...again with an average duration of 10 years.
Will my duration ever be zero? No, If I make it to 96, I'm thinking that I won't go under 5 years average duration. I haven't really thought that through.
Will my plan work for you? Most likely not. My plan is customized for my unique situation.
For shorter terms, why not just use a CD/bond ladder? Pretty easily done for 20 years. If you want higher returns, you could use corporate bonds for some of the rungs. If you plan to spend the proceeds when each rung matures, STRIPS make it really straightforward if the money is in a tax deferred account. (If not, you have to deal with phantom income for tax purposes). Duration matching makes sense for much longer durations, but it seems to me to be more complicated than a simple bond ladder for shorter terms.

Wrench
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BrooklynInvest
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Re: A bond duration glide path for retirement investing

Post by BrooklynInvest »

vineviz wrote: Thu Aug 04, 2022 12:42 pm
BrooklynInvest wrote: Thu Aug 04, 2022 12:26 pm I'm using the midpoint of my retirement years as my investment horizon - the point at which my duration becomes zero, no? I realize at best it's a fudge. Or is it a different point? But my question really is why am I removing rate risk while maintaining other portfolio risks?
You want to use the midpoint of your REMAINING retirement years as the duration you're targeting.

When you have 30 more years of retirement, your investment horizon and your target duration are roughly 15 years.

When you have 20 more years of retirement, your investment horizon and your target duration are roughly 10 years.

When you have 10 more years of retirement, your investment horizon and your target duration are roughly 5 years.

And so on.
Ahhhh. So using Total Bond Market as a proxy, I'd need to more than double my current bond duration at retirement in order to bring it down a year for every two years of retirement? My duration is zero (cash) at 90, not 75 because the target moves as long as I'm still breathing.

I get being more conservative in general as I age. It's just not clear how isolating this one risk does it, especially since I'm dialing my rate risk wayyyy up before I'm bringing it down each year.
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Re: A bond duration glide path for retirement investing

Post by vineviz »

BrooklynInvest wrote: Thu Aug 04, 2022 1:53 pm Ahhhh. So using Total Bond Market as a proxy, I'd need to more than double my current bond duration at retirement in order to bring it down a year for every two years of retirement? My duration is zero (cash) at 90, not 75 because the target moves as long as I'm still breathing.
Almost.

Remember that if you live to age 90, your life expectancy won't be zero at that point. For instance, a 90-year female in excellent health has a 50% chance of living to age 95 and a 10% chance of living to age 101.


BrooklynInvest wrote: Thu Aug 04, 2022 1:53 pm I get being more conservative in general as I age. It's just not clear how isolating this one risk does it, especially since I'm dialing my rate risk wayyyy up before I'm bringing it down each year.
Keeping your duration matched to your investment horizon dials your interest rate risk DOWN, not up.

An investor starting a 30 year retirement with TBM has "wayyyy" more interest rate risk than if they started retirement with a long-term bond fund.
"Far more money has been lost by investors preparing for corrections than has been lost in corrections themselves." ~~ Peter Lynch
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Re: A bond duration glide path for retirement investing

Post by hudson »

Wrench wrote: Thu Aug 04, 2022 1:42 pm
hudson wrote: Thu Aug 04, 2022 1:15 pm
BrooklynInvest wrote: Thu Aug 04, 2022 12:27 pm
hudson wrote: Thu Aug 04, 2022 11:41 am
BrooklynInvest wrote: Thu Aug 04, 2022 11:06 am Someone please correct me -

Let's pretend I'm 60, just retired and I expect to live to 90 (glossing over the obvious problem for now.) The midpoint is 15 years. This "duration matching" thing implies I should have zero rate risk in my bonds when I'm 75? Why?

Assuming I maintained a 60-40 allocation in my portfolio, at 75 I'm now 60% stocks and 40 cash. I've got 15 years of 40% of my money doing roughly nothing for me before I kick the bucket. How is this beneficial? I'm still 60% in stocks so my portfolio still has volatility. I've just removed interest rate risk and, importantly, almost all of the bond income for some reason. My equity beta is still .6, I may have international exposure and currency risk etc. etc.

I can see this methodology in rare instances when, say, I'm a corporation with a balloon payment on something on a specific date AND the volatility of my fixed income portfolio needs to track to zero as that date looms, but as a tool for individual retirement, massively overweighting cash to remove one specific risk among many seems odd to me.
Are you using "cash" and "bonds" as equivalents?
I don't think that vineviz ever recommended that anyone go all cash for the fixed income part of their holdings.
He might have recommended duration matched TIPS.
Entirely possible I've misconstrued but how am I getting to zero duration without cash? Short term bonds will lower my duration to be sure, but - if I'm understanding correctly - I have to get to zero duration.
I'm 74. At 76 when intermediate CDs mature, I'm going to do a form of duration matching.
My plan will cover from ages 76 to 96. That's 20 years; if I divide by 2, the average duration would be 10 years.
I'm thinking my holdings will be made up of half nominal treasuries and half TIPS...again with an average duration of 10 years.
Will my duration ever be zero? No, If I make it to 96, I'm thinking that I won't go under 5 years average duration. I haven't really thought that through.
Will my plan work for you? Most likely not. My plan is customized for my unique situation.
For shorter terms, why not just use a CD/bond ladder? Pretty easily done for 20 years. If you want higher returns, you could use corporate bonds for some of the rungs. If you plan to spend the proceeds when each rung matures, STRIPS make it really straightforward if the money is in a tax deferred account. (If not, you have to deal with phantom income for tax purposes). Duration matching makes sense for much longer durations, but it seems to me to be more complicated than a simple bond ladder for shorter terms.

Wrench
Thanks Wrench!
I'm not doing the perfect glide path. My plan is not to adjust the average duration yearly. I may stay at a 10 year average duration. I haven't totally figured it out.

I never warmed up to ladders; I like to go 5 years minimum especially if I can get 3% or more nominal. Since I like the safest fixed income choices, that rules out corporate bonds, but there are times when they look tempting.

STRIPS...I need to do some research. I was going with regular nominal treasuries and TIPS...some in taxable; some not. I don't have a lot of tax advantaged space.
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Re: A bond duration glide path for retirement investing

Post by BrooklynInvest »

vineviz wrote: Thu Aug 04, 2022 2:01 pm
BrooklynInvest wrote: Thu Aug 04, 2022 1:53 pm Ahhhh. So using Total Bond Market as a proxy, I'd need to more than double my current bond duration at retirement in order to bring it down a year for every two years of retirement? My duration is zero (cash) at 90, not 75 because the target moves as long as I'm still breathing.
Almost.

Remember that if you live to age 90, your life expectancy won't be zero at that point. For instance, a 90-year female in excellent health has a 50% chance of living to age 95 and a 10% chance of living to age 101.


BrooklynInvest wrote: Thu Aug 04, 2022 1:53 pm I get being more conservative in general as I age. It's just not clear how isolating this one risk does it, especially since I'm dialing my rate risk wayyyy up before I'm bringing it down each year.
Keeping your duration matched to your investment horizon dials your interest rate risk DOWN, not up.

An investor starting a 30 year retirement with TBM has "wayyyy" more interest rate risk than if they started retirement with a long-term bond fund.
I'm in TBM. My duration is about 6 years. If I duration matched for a 30 year retirement that I just started my duration would be 15 years. More than double. I'm in effect taking on a considerable amount more rate risk than I have today, no?

Granted every two years it'd decline by a year but it'd take 18 years in this scenario to shave 9 years off my duration and bring it to that of TBM? Give or take.
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Re: A bond duration glide path for retirement investing

Post by vineviz »

BrooklynInvest wrote: Thu Aug 04, 2022 3:18 pm I'm in TBM. My duration is about 6 years. If I duration matched for a 30 year retirement that I just started my duration would be 15 years. More than double. I'm in effect taking on a considerable amount more rate risk than I have today, no?
No, it's the opposite.

With a 30 year retirement ahead of you, you have MORE interest risk with TBM than you would with Vanguard Long-Term Bond ETF (BLV).

Interest rate risk is a proportional to the difference between your investment horizon and your bonds' duration. Most people, including many professionals", don't understand this.
"Far more money has been lost by investors preparing for corrections than has been lost in corrections themselves." ~~ Peter Lynch
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Re: A bond duration glide path for retirement investing

Post by Nutmeg »

Jaylat wrote: Tue Apr 19, 2022 4:24 pm
vineviz wrote: Tue Apr 19, 2022 12:34 pm
Jaylat wrote: Tue Apr 19, 2022 12:07 pm
vineviz wrote: Tue Apr 19, 2022 10:12 am
Jaylat wrote: Tue Apr 19, 2022 9:18 am The other factor is that individuals are much less diversified than banks. Stuff happens – people get divorced, injured, lose jobs, their house burns down, unexpected kids, etc. Any of these events might require you to liquidate your investment portfolio.
All of those events (specifically, the probability-weighted value of them occurring) are inputs in determining the investment horizon as well, at least indirectly, the overall asset allocation.
Can you explain how this would work in real life? Here's how I would envision this kind of logical thought process:

"I expect to retire in 30 years, but I have a 15% chance of getting a divorce in year 10, plus a 5% chance of my house burning down in year 20, plus a 30% chance of getting run over by a truck in year 25, resulting in a debilitating spinal injury."
That's one way to do it, but I suspect this approach will appeal to only to the overly analytical. I'm definitely try not to be dogmatic about being overly precise, since financial planning inherently involves working with a great deal of uncertainty. But I do think most people who are actively managing their personal finances have a pretty good idea about whether most of their future portfolio-funded consumption lies in the next five years or is more like 10+ years away.
I was actually joking. :happy

But the bigger point is that people are not like banks. They don't have clearly defined liabilities that can be known with certainty.

I find it ironic (and more than a bit worrysome) that you are touting LTT, which are extremely volatile, as a way of eliminating interest rate risk. As I've shown many times above, this is not the case in real life. I am worried that an unsuspecting investor will follow this advice and get burned.

It's very nice of you to engage like this, but as I've said before I don't think we will come to agreement.
I have read this thread and others several times because I am trying to help my relatives match assets and liabilities. This quote stood out:
But the bigger point is that people are not like banks. They don't have clearly defined liabilities that can be known with certainty.
In this case, my relatives do have clearly defined liabilities (other than not knowing how long they will live.) At ages 84 and 90, the couple’s liabilities are $7,000 per month greater than their income due to the costs of a private room in a SNF for the older spouse. I have purchased a Treasury ladder for the next year and plan to buy 52-week Treasury bills every three months to cover that three-month extra cost.

What I am trying to understand now, from both a theoretical and a practical perspective, is how to invest the funds outside the ladder (about four years’ worth to make up the monthly income shortfall) to minimize risk while maximizing income. The couple highly values the benefits of a private room, even if this means the younger spouse will have less money.

I proposed investing most of the funds outside the one-year ladder in a bond fund with a longer duration, such as the Fidelity ST Treasury Bond Fund with a duration of 2.59 years, but a family member is concerned that the fund value will decline as interest rates rise, causing the younger spouse to worry. The alternative I see would be to construct a longer-term ladder now by buying Treasuries in the secondary market and holding them to maturity,

I am posting here, in a theory discussion, because I truly want to understand the reasons for making a particular choice. I probably should write a separate post for a different sub-forum, but am writing to ask the experts here:

How should we invest funds beyond one year to correspond with known liabilities, preserve principal, and maximize yield given the first two conditions?
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Re: A bond duration glide path for retirement investing

Post by vineviz »

Nutmeg wrote: Fri Aug 05, 2022 5:19 pm
What I am trying to understand now, from both a theoretical and a practical perspective, is how to invest the funds outside the ladder (about four years’ worth to make up the monthly income shortfall) to minimize risk while maximizing income. The couple highly values the benefits of a private room, even if this means the younger spouse will have less money.
A lot depends on how much life expectancy you want (or are able) to plan for. For my example below, I'm assuming that you want a plan that will cover them each to age 95. Whether that is optimistic or pessimistic I'll leave up to you.

If you are comfortable buying 52-week nominal Treasuries, then I presume you'd be equally comfortable buying individual TIPS as well? If so, "from both a theoretical and a practical perspective" it seems to me the indicated path is simply to buy a ladder of about 10-11 individual TIPS spread out evenly over the next decade or so (at either annual or biannual intervals).

You're avoiding both interest rate risk and inflation risk, and the "family member" is accommodated because no bonds will need to be sold. They'll just mature and the proceeds will be spent.

Otherwise, a short-term Treasury ladder should be paired with an intermediate-term bond bond (again, I prefer TIPS in this case but total bond market would be okay). Each year, peel off a bit of that bond fund to add a rung to the Treasury ladder. And when each Treasury note matures, spend it.
"Far more money has been lost by investors preparing for corrections than has been lost in corrections themselves." ~~ Peter Lynch
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Re: A bond duration glide path for retirement investing

Post by Nutmeg »

vineviz wrote: Fri Aug 05, 2022 5:58 pm
Nutmeg wrote: Fri Aug 05, 2022 5:19 pm
What I am trying to understand now, from both a theoretical and a practical perspective, is how to invest the funds outside the ladder (about four years’ worth to make up the monthly income shortfall) to minimize risk while maximizing income. The couple highly values the benefits of a private room, even if this means the younger spouse will have less money.
A lot depends on how much life expectancy you want (or are able) to plan for. For my example below, I'm assuming that you want a plan that will cover them each to age 95. Whether that is optimistic or pessimistic I'll leave up to you.

If you are comfortable buying 52-week nominal Treasuries, then I presume you'd be equally comfortable buying individual TIPS as well? If so, "from both a theoretical and a practical perspective" it seems to me the indicated path is simply to buy a ladder of about 10-11 individual TIPS spread out evenly over the next decade or so (at either annual or biannual intervals).

You're avoiding both interest rate risk and inflation risk, and the "family member" is accommodated because no bonds will need to be sold. They'll just mature and the proceeds will be spent.

Otherwise, a short-term Treasury ladder should be paired with an intermediate-term bond bond (again, I prefer TIPS in this case but total bond market would be okay). Each year, peel off a bit of that bond fund to add a rung to the Treasury ladder. And when each Treasury note matures, spend it.
Thanks very much! To be clear, the invested funds will last only about four years at this rate of spending. I hope to gain a better understanding of investing in individual TIPS before doing so, but am very grateful for your response!
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Re: A bond duration glide path for retirement investing

Post by international001 »

so if I follow rights and I have 5 years of life expectancy, I should split my $1M into 5 and buy:

$200k in 1 year bonds
$200k in 2 year bonds
$200k in 3 year bonds
$200k in 4 year bonds
$200k in 5 year bonds

what about the nominal value of the bond (the $200k you get every year upon maturity)?
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Re: A bond duration glide path for retirement investing

Post by rossington »

international001 wrote: Mon Aug 08, 2022 6:38 pm so if I follow rights and I have 5 years of life expectancy, I should split my $1M into 5 and buy:

$200k in 1 year bonds
$200k in 2 year bonds
$200k in 3 year bonds
$200k in 4 year bonds
$200k in 5 year bonds

what about the nominal value of the bond (the $200k you get every year upon maturity)?
This is somewhat of a loaded question but if you know you have a life expectancy of 5 years then yes and spend it all any way that is best!

Other than that if you want to spend 1M in roughly equivalent amounts over 5 years then yes to to that too.
what about the nominal value of the bond (the $200k you get every year upon maturity?
...all or part of the 200k would be needed each year because the interest only is obviously not going to cover your expenditures.
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