This is not how immunization against interest rates works. The idea is to align or match the duration of the bond portfolio to the duration of one's liabilities, using nominal bonds to match to nominal liabilities or inflation-linked bonds to match to real liabilities.However, there's a "balance" that happens around the bond duration. Effectively, you hit a "break even" at that point where your bonds are "immune" to those changes. If rates have fallen, you'll earn less interest but make up the difference in increased value. If rates have risen, your value would have fallen but you'd have received more interest - again ending up at about the same place.
Which is why it's relevant to align your duration of bonds.
For a retirement saver, the future asset level at retirement to fund the retirement is a real liability. If long-term TIPS are used as the bond holdings for that, the investor will give up substantial diversification of shorter term volatility due to the moderately high correlation of long TIPS and stocks.
That is fine if what you care about is reducing variance of terminal wealth at retirement in real terms. But it will be less effective than intermediate nominal bonds at providing ballast to an equity-heavy portfolio to avoid heavy drawdowns at times when job loss risk is elevated.
Approximate liability matching in this case could take the form of holding a lower stock allocation and long-term TIPS, say 60-70% VT 30-40% LTPZ. Then one is aiming to beat inflation by a lesser amount than with a stock-heavy allocation, but with less uncertainty in achieving that goal. It can take a moderate amount of portfolio maintenance to maintain the duration match.
Generally, I think a retirement saver wanting a high stock allocation should stick to nominal intermediate bonds (or short-term nominal bonds or cash if not fully comfortable with interest rate risk).
Most target date funds, including Vanguard's use intermediate bonds until close to retirement. Vanguard adds short TIPS when close to or in retirement.
There are, however, proponents on here of holding long duration nominal treasury portfolios for equity diversification based on matching their duration with the duration of future (real) liabilities. That does not account for inflation, and 2022 was an ugly year for that strategy (eg VGLT down 29.45% while VTI was down 19.5%. There seem to be fewer postings advocating for that at present than in the past.
Statistics: Posted by Northern Flicker — Sat Jul 06, 2024 2:53 am — Replies 21 — Views 1856
