Using Target-Date Retirement Income Funds To Guard Against Interest Rate Risk In Retirement

Using Target-Date Retirement Income Funds to Guard Against Interest Rate Risk in Retirement

Dimensional Fund Advisors (DFA) takes a more direct approach to immunizing retirement liabilities through their target-date retirement income funds. These funds provide a useful case study for understanding the role bond funds play in meeting retirement expenses.

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What Are Annuities?

Annuities are like power tools. In the right hands, they can help you considerably, but if you don’t know what you’re doing, you could cut your fingers off.

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Do You Understand How Bonds Work?

Before we can discuss bonds in depth, it is important that we establish a common understanding of what bonds are and how they work. As a starting point, a bond is a contractual obligation to make a series of specific payments on specific dates.

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3 Ways To Incorporate Bonds Into Your Retirement Strategy

Bonds can be incorporated directly into a retirement strategy in three broad ways:
1. An assets-only approach to build a total returns investment portfolio,
2. Matching the duration of bond funds to the duration of the retirement liability, and
3. Holding individual bonds to maturity to generate the desired cash flows to fund expenses on an ongoing basis throughout retirement.

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Dynamic Programming Methods For Retirement Income

In addition to other methods we’ve discussed, a third type of variable spending model uses dynamic programming methods. These methods rely on complex computing power and mathematical equations to integrate spending and asset allocation decisions more completely over the life cycle.

Dynamic programming provides a road map at each point in time for optimal spending and asset allocation, which have been determined by first considering optimal future behavior stemming from today’s decisions.

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