The Role of Duration-Matched Bonds in Retirement Planning
When building an investment portfolio for wealth accumulation, the primary focus is maximizing returns while managing risk. However, in retirement planning, the goal shifts from simply growing wealth to ensuring a reliable income stream. This calls for a more strategic approach to asset allocation—one that aligns investment choices with future spending needs. Duration-matched bonds offer a potential solution by helping retirees manage interest rate risk while securing a predictable income stream.
The Difference Between Accumulation and Distribution Strategies
Traditional accumulation strategies for pre-retirees typically focus on an "assets-only" approach, where the objective is to maximize returns relative to risk tolerance. In this framework, bond portfolios are often structured based on an investor’s comfort with volatility rather than their specific future liabilities.
However, in retirement, the priority is different: ensuring that assets can support ongoing spending needs. A more effective approach in this context is liability-driven investing (LDI), where investment decisions are made to match assets with expected expenses. This is where duration matching comes into play.
Understanding Bond Duration and Its Role in Retirement Planning
Duration is a measure of a bond’s sensitivity to interest rate changes. The longer the duration, the more a bond’s price will fluctuate with changes in interest rates. For retirees relying on bonds to generate income, mismatched durations can lead to unnecessary risks. If interest rates rise, bond prices fall, potentially reducing the value of assets earmarked for future expenses. By selecting bond investments with durations that align with retirement liabilities, investors can reduce exposure to interest rate risk and maintain more predictable income streams. This is particularly important for retirees, as their investment horizon becomes more finite and their ability to recover from market downturns diminishes.
Challenges of Duration Matching for Retirees
While duration matching sounds ideal, it is not a simple task. A retiree’s liability—meaning their expected future spending—does not decrease in a straight line as they age. Life expectancy, inflation adjustments, and changing interest rates complicate the calculation. To maintain proper duration alignment, ongoing adjustments and rebalancing are necessary, which can be difficult for individual investors to manage.
McLean Asset Management Corporation (MAMC) is a SEC registered investment adviser. The content of this publication reflects the views of McLean Asset Management Corporation (MAMC) and sources deemed by MAMC to be reliable. There are many different interpretations of investment statistics and many different ideas about how to best use them. Past performance is not indicative of future performance. The information provided is for educational purposes only and does not constitute an offer to sell or a solicitation of an offer to buy or sell securities. There are no warranties, expressed or implied, as to accuracy, completeness, or results obtained from any information on this presentation. Indexes are not available for direct investment. All investments involve risk.
The information throughout this presentation, whether stock quotes, charts, articles, or any other statements regarding market or other financial information, is obtained from sources which we, and our suppliers believe to be reliable, but we do not warrant or guarantee the timeliness or accuracy of this information. Neither our information providers nor we shall be liable for any errors or inaccuracies, regardless of cause, or the lack of timeliness of, or for any delay or interruption in the transmission there of to the user. MAMC only transacts business in states where it is properly registered, or excluded or exempted from registration requirements. It does not provide tax, legal, or accounting advice. The information contained in this presentation does not take into account your particular investment objectives, financial situation, or needs, and you should, in considering this material, discuss your individual circumstances with professionals in those areas before making any decisions.
