Duration matching
Choosing fixed income holdings whose timing corresponds to a known future obligation, so the money arrives when it is needed.
Example
School fees of a known amount due in six years are met most directly by a bond, or a set of bonds, maturing around that date.
Important
This is the job no other asset class does, because a bond is the only instrument that states a sum and a date in advance. It is also a more dependable argument for holding bonds than diversification, which relies on a correlation that has failed in real periods.
Related terms
- Maturity — The date on which a bond repays its par value and the contract ends. Bonds are commonly grouped as short, intermediate or long by how far away that date is.
- Duration — The present-value-weighted average time until a bond's cash flows are received (Macaulay duration), and by extension the measure of how much its price moves when yields change. Modified duration is Macaulay duration divided by one plus the yield.
- Bond ladder — A set of bonds with maturities spaced at regular intervals, so that one matures each period and the proceeds are reinvested at whatever rates then prevail.
- Correlation breakdown — The tendency for historical relationships between assets to stop holding under stress, as correlations between risky assets converge towards one in a severe decline.
Lessons that explain it
All 578 terms in the Investing glossary