How to use duration matching in a stock/bond portfolio

Discuss all general (i.e. non-personal) investing questions and issues, investing news, and theory.
User avatar
vineviz
Posts: 14921
Joined: Tue May 15, 2018 1:55 pm
Location: Baltimore, MD

Re: How to use duration matching in a stock/bond portfolio

Post by vineviz »

TN_Boy wrote: Mon Aug 08, 2022 9:33 am As I noted above, there IS a place in portfolio visualizer to do the exact test required. It's harder to find and you need a login. This is the link:

https://www.portfoliovisualizer.com/bac ... allocation

For settings, click on "Compared Portfolio" then select static allocation and you can define a portfolio. But as I said, you have to create a login (14 day free trial!) to actually upload an allocation history and run a backtest.
Good catch. I'd forgotten (or maybe never noticed) that the static allocation could contain different assets from the dynamic allocation.

I was able to roughly replicate my earlier finding for this particular time period using PV after all, so thank you.

Image


The static allocation in this test is 50% VFINX, 25% VFITX, 25% VFISX.

The dynamic allocation is 50% VFINX and moves from 50% VUSTX on 1/1/1992 to 50% CASH on 1/1/2021. Portfolios start with $100k and have $6,200 inflation adjusted withdrawals annually.

As you observe, keeping the duration of the static allocation's bond fund as close to the 7.5 year mark as possible will reduce the differential. But I don't think this is what most investors are doing in practice.

For one thing, the duration of total bond fund has historically been much shorter than it is currently. For another, I frequently observe investors using TBM as a "core bond fund" but matching it with significant cash-like allocations (e.g. a "bucket" for 2-5 years of expenses).

However, I certainly agree that with 50%+ stocks a static bond duration of 7-8 years throughout retirement is a totally reasonable approach.
"Far more money has been lost by investors preparing for corrections than has been lost in corrections themselves." ~~ Peter Lynch
Topic Author
TN_Boy
Posts: 4076
Joined: Sat Jan 17, 2009 11:51 am

Re: How to use duration matching in a stock/bond portfolio

Post by TN_Boy »

vineviz wrote: Mon Aug 08, 2022 10:15 am
TN_Boy wrote: Mon Aug 08, 2022 9:33 am As I noted above, there IS a place in portfolio visualizer to do the exact test required. It's harder to find and you need a login. This is the link:

https://www.portfoliovisualizer.com/bac ... allocation

For settings, click on "Compared Portfolio" then select static allocation and you can define a portfolio. But as I said, you have to create a login (14 day free trial!) to actually upload an allocation history and run a backtest.
Good catch. I'd forgotten (or maybe never noticed) that the static allocation could contain different assets from the dynamic allocation.

I was able to roughly replicate my earlier finding for this particular time period using PV after all, so thank you.

Image


The static allocation in this test is 50% VFINX, 25% VFITX, 25% VFISX.

The dynamic allocation is 50% VFINX and moves from 50% VUSTX on 1/1/1992 to 50% CASH on 1/1/2021. Portfolios start with $100k and have $6,200 inflation adjusted withdrawals annually.

As you observe, keeping the duration of the static allocation's bond fund as close to the 7.5 year mark as possible will reduce the differential. But I don't think this is what most investors are doing in practice.

For one thing, the duration of total bond fund has historically been much shorter than it is currently. For another, I frequently observe investors using TBM as a "core bond fund" but matching it with significant cash-like allocations (e.g. a "bucket" for 2-5 years of expenses).

However, I certainly agree that with 50%+ stocks a static bond duration of 7-8 years throughout retirement is a totally reasonable approach.
Okay, so I used the traditional 4% adjusted for inflation, you used 6.2%, which would account for different ending portfolio values. 6.2 is pretty aggressive!

From what I saw, a duration of around six years would have probably matched the duration matching approach. Using 4%, intermediate treasuries were pretty darn close.

Could you run the test with 4% withdrawals, from 1992 to end of 2021? I'd like to see if your numbers match mine for the duration matching test, as a check on my methodology.
User avatar
vineviz
Posts: 14921
Joined: Tue May 15, 2018 1:55 pm
Location: Baltimore, MD

Re: How to use duration matching in a stock/bond portfolio

Post by vineviz »

TN_Boy wrote: Mon Aug 08, 2022 10:30 am Okay, so I used the traditional 4% adjusted for inflation, you used 6.2%, which would account for different ending portfolio values. 6.2 is pretty aggressive!
Treasury yields were such in 1992 that a non-rolling ladder would have produced an expected SWR of roughly 6.2% without taking needing to take any equity risk. The realized SWR was almost 7%.

It wouldn't have made much sense to hold 50% in stocks and also target a lower withdrawal rate than 100% bonds would support.
"Far more money has been lost by investors preparing for corrections than has been lost in corrections themselves." ~~ Peter Lynch
Topic Author
TN_Boy
Posts: 4076
Joined: Sat Jan 17, 2009 11:51 am

Re: How to use duration matching in a stock/bond portfolio

Post by TN_Boy »

vineviz wrote: Mon Aug 08, 2022 1:50 pm
TN_Boy wrote: Mon Aug 08, 2022 10:30 am Okay, so I used the traditional 4% adjusted for inflation, you used 6.2%, which would account for different ending portfolio values. 6.2 is pretty aggressive!
Treasury yields were such in 1992 that a non-rolling ladder would have produced an expected SWR of roughly 6.2% without taking needing to take any equity risk. The realized SWR was almost 7%.

It wouldn't have made much sense to hold 50% in stocks and also target a lower withdrawal rate than 100% bonds would support.
But even with high nominal yields, a future burst of inflation could have put a serious dent in that plan. Without the ability to predict the future, a 6.2% withdrawal is very risky.
rossington
Posts: 1806
Joined: Fri Jun 07, 2019 2:00 am
Location: Florida

Re: How to use duration matching in a stock/bond portfolio

Post by rossington »

TN_Boy wrote: Mon Aug 08, 2022 2:39 pm
vineviz wrote: Mon Aug 08, 2022 1:50 pm
TN_Boy wrote: Mon Aug 08, 2022 10:30 am Okay, so I used the traditional 4% adjusted for inflation, you used 6.2%, which would account for different ending portfolio values. 6.2 is pretty aggressive!
Treasury yields were such in 1992 that a non-rolling ladder would have produced an expected SWR of roughly 6.2% without taking needing to take any equity risk. The realized SWR was almost 7%.

It wouldn't have made much sense to hold 50% in stocks and also target a lower withdrawal rate than 100% bonds would support.
But even with high nominal yields, a future burst of inflation could have put a serious dent in that plan. Without the ability to predict the future, a 6.2% withdrawal is very risky.
Yes but certainly you would stay at or around 4%.

I think if I were to duration match I'd calculate the percentages (needed to allocate to the bonds each year of the investment horizon as the duration declines) up front to simplify the required work for the process. Otherwise I might forget to calculate annually as I age.

If we just trust Taylor's or Jack's advice (as well as dbr's conclusion above) then even as Vineviz said TBM will be adequate for a 50/50 portfolio.
"Success is going from failure to failure without loss of enthusiasm." Winston Churchill.
Post Reply