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7 Years' Living Expenses Largely in Short-Term Bond ETF: Thoughts?
Old 02-18-2015, 05:39 PM   #1
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7 Years' Living Expenses Largely in Short-Term Bond ETF: Thoughts?

I am about to ER in a matter of days at age 53. I have one year's worth of living expenses in cash in a 1% savings account at Barclays Bank. I also have the next six years of living expenses in a Vanguard short term corporate bond ETF (VCSH).

Do you folks have any suggestions about how I might better allocate that seven years of expenses? My goal is to keep the money in a reasonably safe investment so it is available to draw down over the next seven years. I am thinking of shifting about two of the six years' expenses currently in VCSH, to a Vanguard intermediate bond ETF (e.g., BIV). I also am thinking of shifting one of those six years' expenses in VCSH to the 1% Barclays savings account I already have set up.

So: My seven years of living expenses would be revised to be: Years 1 and 2 in cash in the 1% Barclays savings account; Years 3, 4 and 5 in VCSH short-term bonds; and Years 6 and 7 in a intermediate BIV Vanguard bond ETF.

The balance of my investments are in a mix of stock index ETFs and mutual funds, amounting to another ~ 28 years of living expenses -- on top of the seven years described above (total years' expenses = ~ 35).

Thoughts, please? This forum is such a terrific place to get a critique -- and a lively critique at that....
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Old 02-18-2015, 06:35 PM   #2
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I suggest you simply do what Kitces has figured out:
https://www.kitces.com/blog/research...-market-timer/

and especially: https://www.kitces.com/blog/managing...cing-approach/
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Old 02-18-2015, 07:30 PM   #3
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Thanks! I hadn't read this before, and it's interesting.
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Old 02-18-2015, 07:44 PM   #4
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Sounds like a ladder of CDs or of maturity date bond funds would be what you are looking for for years 3-7. I'm less keen on conventional bonds funds for something like that because of interest rate risk, but your plan isn't horrible.

Since I retired, I converted 6% of my assets from fixed income to an online savings account and that covers 3-4 years of expenses when combined with taxable account dividend income and the liquidity allows me to sleep well at night.
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Old 02-18-2015, 07:55 PM   #5
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I thought this was interesting from the first article:

"In the end, the reality is that while cash reserve strategies appear psychologically appealing, their actual benefits as an enhancement for retirement income sustainability appear to be a mirage upon closer inspection. The buffer zone approach appears to do little to effectively "time" the market, and/or to the extent it does, the benefits are overwhelmed by the adverse consequences of a large allocation of cash in the portfolio that drags down long-term returns."
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Old 02-18-2015, 08:25 PM   #6
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I keep a cash buffer to cover current year and next year (after tax) expenses. Most of it is in high-yield savings accounts.

Then in the retirement portfolio, I maintain an asset allocation. 47% of that portfolio is in fixed income. Of that fixed income, 5% is in cash (there is that cash word again), 5% is in a short-term high quality bond fund, and the remaining 37% is in a diversified mix of intermediate bond funds. That fixed income portion will cover well over 10 years of after tax expenses. So as well as being part of my portfolio for diversification and rebalancing, it could also act as a kind of ladder of increasing duration that could be drawn upon if the stock market went to hell and stayed down for several years. I'd also be adding to the stock allocation from fixed income during such a period, so it wouldn't all be available for living off of.

I had already noticed that the fixed income portion of my allocation could be used as a "short-term bucket" as Kitces later explained in one of his papers:
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- as noted previously on this blog, the reality is that in a regularly rebalanced portfolio, cash reserve strategies are generally unnecessary to avoid selling stocks in a bear market, as the act of rebalancing alone ensures that withdrawals are always taken from the higher returning asset class.
Yes, it's psycological. Managing my psychology is critical to keeping myself on my long term investment plan. Once I understood this, I was able to choose an investment plan I could live with over the long haul.

I don't worry about performance "drag" from having some investments in cash or bonds. My goal is to have decent portfolio survivability and reduced volatility year-to-year. I'm not looking for optimal long-term growth, just good enough to beat inflation. That is how I designed my asset allocation, and why I stick to it and rebalance when things get out of whack.
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Old 02-18-2015, 08:43 PM   #7
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I keep a cash buffer to cover current year and next year (after tax) expenses. Most of it is in high-yield savings accounts.

Then in the retirement portfolio, I maintain an asset allocation. 47% of that portfolio is in fixed income. Of that fixed income, 5% is in cash (there is that cash word again), 5% is in a short-term high quality bond fund, and the remaining 37% is in a diversified mix of intermediate bond funds. That fixed income portion will cover well over 10 years of after tax expenses. So as well as being part of my portfolio for diversification and rebalancing, it could also act as a kind that of ladder of increasing duration that could be drawn upon if the stock market went to hell and stayed down for several years. I'd also be adding to the stock allocation from fixed income during such a period, so it wouldn't all be available for living off of.

Yes, it's psycological. Managing my psychology is critical to keeping myself on my long term investment plan. Once I understood this, I was able to choose an investment plan I could live with over the long haul.

I don't worry about performance "drag" from having some investments in cash or bonds. My goal is to have decent portfolio survivability and reduced volatility year-to-year. I'm not looking for optimal long-term growth, just good enough to beat inflation. That is how I designed my asset allocation, and why I stick to it and rebalance when things get out of whack.
WISDOM!!!

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Old 02-18-2015, 08:45 PM   #8
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Yes, I concede that my 6% in cash is perhaps suboptimal, but it allows me to sleep well at night. Currently, I'm earning only .9% on my online savings and if I was in bond funds and earned 2.5% (10 year treasury recently), I'm giving up 1.6% on 6% of my portfolio, or dampening my overall portfolio return by about 0.1%. The peace of mind is well worth it to me.
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Old 02-18-2015, 08:53 PM   #9
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I'm retired and don't keep cash around. I do own VCSH/VSCSX; it is about 10% of my total portfolio, so one can say it is 2.5 to 3 years of living expenses. I do own other fixed income, too. So one could say that my fixed income is 10 years of living expenses, but none of that is cash.

I will not draw down only my fixed income for the next 10 years. I will spend from my portfolio from whatever asset makes the most sense to pay the least taxes and keep my asset allocation.
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Old 02-18-2015, 11:15 PM   #10
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I have my bond allocation in short term and hi yield funds... I do not consider these cash since they are bonds..

My true cash position is quite small... enough to pay the next months expenses...

I recently changed to have the earnings deposited in my checking account so I do not have to move as much money...

My big problem is all the gain that I have in my taxable accounts.... and I do not want to touch my ROTH this early... so when I have to 'top up' the bonds it cost me on my cap gains taxes...
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Old 02-19-2015, 12:00 AM   #11
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Normally, I would think the bond/stock allocation thing would be sufficient as it generally has been in the past.

However, now both stocks and bonds are at peaks, so I like to keep some cash available as I think both stocks and bonds will decline should interest rates go up, and the longer the Feds delay increasing the interest rate, the faster they will have to do it when needed.

Besides, I have VCSH and its real rate of return for me over the past 12 months has been about 1.35 % if I sold it from a taxable account (accounting for declared Capital gain and lower stock value).

Not much better than a 1% FDIC insured savings account and lots more risk.
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Old 02-19-2015, 07:37 AM   #12
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I have recently sold off more short term bond fund and purchased more 5 yr CDs. So now I am roughly 70 % CDs, 20% intermediate term and 10% cash. The articles by Michael Kitces are interesting but I am not one to take advice from a psychology major with online" advanced degrees" .
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Old 02-19-2015, 08:08 AM   #13
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What is interesting is that I tried to test the notion that a cash buffer is suboptimal with Firecalc. Default assumptions except $1m portfolio, $40k withdrawals (4% WR).

Tried a run with a mixed portfolio of 5% US Small, 55% S&P 500 and 40% LT corporate bonds gets an 85.7% success rate. If I change the LT corporate bond to 34% and add 6% in cash (1 month Treasury) then the success rate INCREASES to 89.8%.

Surprised me and seems inconsistent with the paper's hypothesis.

I then did a run using the total market with 60% equities and the success rate was 95.6%. Then I reduced the $1m to $940k as if one had 6% in cash earning nothing and it reduced the success rate to 91.2%. This is probably too conservative as the cash would earn something (say 1% +/-).
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Old 02-19-2015, 08:25 AM   #14
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I know VCSH is yielding a lot more than a high quality short-term bond fund like VBISX or BSV. But I hope folks realize that using a corporate bond fund as a cash substitute is pretty risky compared to other options. Along with stocks, corporate bond funds can be slammed due to weak ecomonic conditions or financial concerns - just when bond funds holding higher quality paper tend to appreciate.
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Old 02-19-2015, 08:31 AM   #15
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I have this years spending in cash and a CD ladder that goes out 6 years for the fixed income portion of my portfolio. I could meet my basic expenses with approximately 1/4 of the CDs that mature every year but I plan on spending above this level by liquidating equities during my annual rebalancing. The cash I have allocated for this year's spending is not part of my portfolio for rebalancing purposes.
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Old 02-19-2015, 08:32 AM   #16
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What is interesting is that I tried to test the notion that a cash buffer is suboptimal with Firecalc. Default assumptions except $1m portfolio, $40k withdrawals (4% WR).

Tried a run with a mixed portfolio of 5% US Small, 55% S&P 500 and 40% LT corporate bonds gets an 85.7% success rate. If I change the LT corporate bond to 34% and add 6% in cash (1 month Treasury) then the success rate INCREASES to 89.8%.

Surprised me and seems inconsistent with the paper's hypothesis.

I then did a run using the total market with 60% equities and the success rate was 95.6%. Then I reduced the $1m to $940k as if one had 6% in cash earning nothing and it reduced the success rate to 91.2%. This is probably too conservative as the cash would earn something (say 1% +/-).
Long term corporate bonds were probably never used in any model.

Try AGG or some other broadly diversified intermediate bond index.

Personally I don't invest in long-term bonds as models I studied showed they provided less inflation-adjusted diversification benefit compared to short and intermediate bonds.
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Old 02-19-2015, 08:37 AM   #17
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While we all hear about short duration bonds being a safer option in a raising rate environment, what happens if short term rates shoot up, while longer ones do not. Personally, I think a duration of 4 to 5 years might be a better sweet spot.
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Old 02-19-2015, 08:40 AM   #18
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Tried a run with a mixed portfolio of 5% US Small, 55% S&P 500 and 40% LT corporate bonds gets an 85.7% success rate. If I change the LT corporate bond to 34% and add 6% in cash (1 month Treasury) then the success rate INCREASES to 89.8%.

Surprised me and seems inconsistent with the paper's hypothesis.
If by "cash buffer" we are talking about a bucket of money to be withdrawn when stocks are down, I don't think we can simulate that with FIRECalc. Kitce's paper (here) shows that such a bucket isn't better than just counting that same money in cash as part of the whole asset allocation >if< we'll be rebalancing anyway. It's a good paper and has helped me see things more rationally.
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Old 02-19-2015, 08:47 AM   #19
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While we all hear about short duration bonds being a safer option in a raising rate environment, what happens if short term rates shoot up, while longer ones do not. Personally, I think a duration of 4 to 5 years might be a better sweet spot.
Yes, that scenario occurred in the mid-2000s, and IMO could again. There are a couple of factors:
  • The short end of the curve tends to get "crowded", i.e. a lot of people buy up the shorter term bonds trying to avoid the pain of anticipated rising interest rates. But this can make short-term bonds the most expensive part of the yield curve and so it can correct more strongly.
  • If the bond market thinks the Fed is too aggressive, or if they are concerned about economic weakness due to rising Fed rates, or they think Fed action will reduce future inflation, long-term interest rates will drop when the Fed raises their funds rate.
I tend to keep the bulk of my fixed income in intermediate bonds as I do consider that the "sweet spot" most of the time. Plus, since I'm holding them for decades, I'm holding them well past the duration, which I see as another consideration when choosing bond duration.
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Old 02-19-2015, 08:49 AM   #20
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I also tried a mix of 20% LT Treasuries and 20% LT Corporates and the success rate was the same. I actually prefer investment grade corporates over government bonds.

I suspect no matter what bonds you use it probably doesn't have a big effect.
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