Match your investments with your time horizon

June 16, 2023

Silicon Valley Bank did not match the duration of their debt investments to their deposits.

Being bankers, you would think "well, not them, they're bankers." But yes them, they did, and the reality is a lot of people are making the same mistake with their own investments. Your portfolio's investment profile should match your withdrawal needs. Timing matters. For example, a university may have a time frame of "perpetuity." Someone who sells a house or a business might have a timeframe of "a few months, when my tax bill is due." And everything in between.

Today, a common mismatch is that the higher short term rates on CDs, short-duration bonds, and even sometimes bank accounts (yes they do sometimes pay interest!) have attracted capital without consideration of timing needs. People gave up *a lot* of wealth over the past year selling the market this spring and rushing into these short-term products. The calculation gets worse when you consider the tax-inefficiency of most of these products - the interest is generally taxable, haircutting much of the return. Frankly the opportunity cost loss in this trade has been staggering, and it rarely has made a headline.

Here is the Treasury Yield curve as of today. This looked, and looks, attractive at some level. The duration of the bond is on the x-axis, and the yield is on the y-axis. It seems like you can make more money in short-term instruments:

But there is risk here that may not be obvious. If short-term rates get cut, you will find yourself making less interest, potentially holding a less valuable bond, and at the same time giving up the capital gains on longer bonds that those rate cuts inspire. To get back to longer durations at that point you will pay more.

So then you are in a situation where you have a potentially long-term objective like retirement that is matched to a short-term security, like a bond due in a year or two. That's not a great place be.

For people who bought short-term bonds in the 90's and 00's, their fixed income returns got continually worse as they had to roll over into lower and lower interest-paying securities. But at the time of the decision, it probably felt good. Don't let this happen to you now.

Dan Cunningham

^{1. Chart source: U.S. Treasury Yield Curve}