Matching Durations To Holding Periods

What if we matched the duration of your entire portfolio of stock and bonds to your investment horizon? What benefits could we gain by doing this?

Bonds and Duration:

Bond duration measures sensitivity to interest rates. If your bond portfolio's average duration is 10 years and you plan to hold for 10 years, interest rate risk largely cancels out. You're insulated from rate movements because price risk and reinvestment risk offset each other.

Interest rate risk = it is the potential for financial loss due to changes in interest rates. When interest rates rise bond value fall and when interest rates fall bond values increase.

Why is interest rate risk neutralized? (see below)

When a bonds duration equals your holding period, two offsetting things balance out. 1) Price Risk… when rates rise the market value of the bonds declines, if you sell early that is bad in this scenario because you do not get to reinvest at the higher rates. 2) Reinvestment Risk… This is what helps you “cancel out” price risk. The coupons you receive along the way can now be reinvested at the higher rates. If you hold for the full period/duration the reinvestment at better yields offsets the initial price loss.

If you hold the bond to a duration-equivalent horizon, the capital loss from the rate change is almost exactly offset by the higher reinvested coupon income.
The math works out because duration is defined as the point where these two forces cancel each other out. You immunize the portfolio against interest rate changes by holding bond bonds with a duration that equals holding period.

Equities:

Stocks don’t have a fixed maturity, but they do have an implied duration, typically very long (think 20–50 years or longer). Equity duration is tied to how much of a stock’s present value comes from far-out future cash flows.

For example: If I believe based on my valuation and assumptions that if I hold Stock A for 10 years I will get a rate of return of 8.5.% I could match this portfolio of one stock or multiple stocks to my bond’s duration of 10 years neutralizing interest rate risk.

Benefits of Bond Duration Matching to Holding Period:

Bond interest rate risk is reduced. If my holding period equals my bond duration I have protected myself against interest rate shifts. There is no danger if I plan to hold till maturity.

Smoother expected returns over time. For long-term investors, duration matching provides a more stable return profile because you don't need to worry about mark-to-market losses on long-duration bonds or rate-driven equity volatility.

Protects from sequence of returns risk. Especially in retirement planning, aligning portfolio duration with expected withdrawals ensures you’re not forced to sell assets at a loss during downturns.

Better risk budgeting. You’re more precisely aligning risk exposure to your time-based risk capacity. Younger investors may tolerate high-duration equity-heavy portfolios; older investors may want shorter bond durations and less equity exposure.

It is a framework for strategic allocation. We can use duration as a quantitative lens to adjust equity/bond mixes depending on the time horizon, like using a glide path in a target-date fund.

How do we get the right allocation so everything matches?

We use portfolio math and algebra.

The beauty of it?

The customization we can do for you. We can create your own target date fund like that of a pension with its own glide path and match the durations to your holding period. If you are an organization we could set you up a schedule for your people as they age and get closer to retirement. That is the big perk of working with our firm, we can customize your portfolio to what you need/want and give you a world class portfolio management experience. Nothing is cookie cutter with our firm, we have a way of thinking and doing things that we recommend to a client but if a client wants to go off the path and do their own thing we can set them up a portfolio that they want. Custom, Custom, Custom…