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As a bond provides a contractual right to a series of future payments received at specified points of time, the price for a bond is simply the present discounted value of the future cash flows. The face value of a bond will be repaid at maturity. A zero-coupon bond provides only a bond’s face value,…

Duration matching is not straightforward for bond funds when shares of the bond fund must be sold to meet ongoing retirement expenses. If rates have risen, shares of the bond fund may need to be sold at a loss, with more shares sold to meet a given spending objective. This triggers sequence risk and locks…

Understanding the relationship between bond risk and time to maturity and duration of a bond provides the basis for understanding the bond yield curve. The yield curve shows the yields to maturity for a series of bonds—typically US Treasury bonds—with the same credit quality but different maturity dates, along with the term structure for interest…

This article is part of a series; click here to read part 1. In 2003, Zvi Bodie and Michael J. Clowes published the book Worry-Free Investing: A Safe Approach to Achieving Your Lifetime Financial Goals, in which they argued that typical retirement-oriented investors should rely primarily on TIPS for their retirement savings. Of course, other…

In discussing retirement liabilities, it is also important to address the issue of inflation and how to think about bonds when they are meant to fund a liability that grows with the consumer price index. Fortunately, this is now practical as the United States began issuing Treasury Inflation-Protected Securities (TIPS) in 1997. Backed by the…

Bond prices are sensitive to interest rate changes, and bond duration is a measure of just how sensitive. For instance, in Exhibit 1.1 (shown in my last article), an increase in interest rates for the simple bond from 3 percent to 4 percent caused the bond’s price to fall by 8.1 percent. This bond has…

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. Typically, this includes interest payments made on a semiannual basis until…

This article is part of a series; click here to read Part 1. The safety-first school of thought was originally derived from academic models of how people allocate their resources over a lifetime to maximize lifetime satisfaction. Academics have studied these models since the 1920s to figure out how rational people make optimal decisions. In…

Within the world of retirement income planning, the siloed nature of financial services between investments and insurance leads to two opposing philosophies about how to build a retirement plan. There is an old saying that if the only tool you have is a hammer, then everything starts to look like a nail. This tendency is…

This article is part of a series; click here to read Part 1. Spending shocks Unexpected expenses in retirement come in many forms, including: unforeseen need to help family members divorce changes in tax laws or other public policy changing housing needs home repairs rising health care and prescription costs long-term care Retirees must preserve…