Money market in 401K

[Bill]

I am planning on early retirement in about 4-7 years (I'm 49 now). Most of my investments are in my company's 401K. I currently have it split in mostly Vanguard mutual funds as 23% large cap, 12% mid cap, 10% small cap, 15% international, 30% bond funds and 10% money market, mostly index funds.

I'm wondering about the money market and am considering moving that into the other funds. Right now, the money market is losing money when I consider inflation and since it's in a 401K I can't really us it for emergencies. It's just sitting there glaring at me.

I was thinking of moving the money market to the inflation protected fund - VIPSX. Another possibility is to add a percent to the stock funds and six percent to the bond funds. Or just two percent more to all of them.

Thoughts?

Thanks a lot and I can't wait to FIRE. God I'm bored.

 

[Telly]

Bill, I'm having similar thoughts. A Money Market account using Qualified money (as in an IRA) is a good safe parking zone for short term use. But longer term, as you point out, it loses vs. inflation.

I have a similar problem, but with unqualified money. Early in the year, I was happy with the amount of cash-like I had, at least I wasn't losing any of it! But time is getting on, my stocks are picking up, and the bonds are doing mostly acceptable too. I need to start doing something about some of the cash-like now. I'm thinking some into TIPS directly, or VIPSX, maybe some in both. I like the idea of another diversified asset class.

There was a study performed by Ibbotson Associates that showed TIPS is a new asset class, that it doesn't correlate with stocks or bonds. But I wonder what the effect of building a mutual fund like VIPSX primarily, but not exclusively around TIPS does to the previous lack of correlation. Whether it starts to have some correlation, and loses a bit of its diversity.

Anyway, I'll also be debating what to do with some of the rest beyond TIPS, whether to salt that across existing investments in the same proportions as now, or what.

 

[Ted]

The main function of a money market account for most people should be to provide liquidity -- i.e., a ready source of cash for large purchases like a car or for emergency use. The most logical place for this type account is therefore outside of any "qualified" accounts. The fact that the interest is taxable does not matter too much now that short term interest rates are so low.

An alternative investment that pays somewhat more interest and is still highly liquid is a short term bond fund of the type that Vanguard offers. About the only disadvantage to such a fund is the nuisance of having to report the capital gain or loss on each withdrawal on Schedule D of your annual income tax form. (Usually, these capital gains/losses are very minor and tend to offset one another.)

"Qualified" accounts are best used for long-term investments that presumably will pay a higher rate of return, which will then be tax-deferred or (in the case of Roth IRAs and educational savings accounts) tax-free. I think that TIPs are a great addition to these accounts -- especially as a substitute for "conventional" long-term bonds that are quite possibly in a "bubble" of their own now. The return on TIPs can be expected to correlate with the total return on other Treasuries of similar maturity, but not to fluctuate to nearly the same degree -- especially on an inflation-adjusted basis, which is what really matters.