7 Years' Living Expenses Largely in Short-Term Bond ETF: Thoughts?

[Cobra9777]

Sounds like your goal is maximizing the size of the portfolio say 10 years down the road? Or maximizing what you leave to heirs?

For some folks, having a larger portfolio is their goal, so they are willing to make sacrifices - lower withdrawals today, belt tightening during market downturns, etc., to accomplish that goal.

Some of us are more interested in spending (and gifting) more in the early years and don't plan to leave a lot after we pass. We just want the portfolio to survive during our lifetime, and prefer to live with less year-to-year volatility.

It really depends on your goals.

I'm not entirely sure how you derived that from what I wrote. Actually, my goal is very similar to yours, as stated in the quote above. At this early stage of ER, legacy considerations are a distant secondary objective for us.

More to the point, I'm just questioning why I'm holding a 5% cash reserve, given the performance hit and other issues I laid out. I'm pretty sure it's because I read dozens of posts on this site and elsewhere suggesting I need to "protect myself against having to sell when equities are down." Turns out, with rebalancing, that's just a kind-of bucket mirage. I'm embarrassed to admit that I had not previously thought this through. Anyone who does will inevitably reach the same conclusion.

I totally "get" the emotional calming effect that cash has, and I am certainly not immune from those effects. As I've said before, I'm still learning the ER ropes and largely untested in rough seas. And yes, it doesn't cost an arm and a leg if one is reasonable about the number of years of cash. I may decide to continue holding 5% cash for AA reasons and the emotional comfort that it provides, similar to an emergency fund. But I'm glad I finally read the Kitces material and have a more rational foundation to evaluate this question going forward.

 

[audreyh1]

I'm not entirely sure how you derived that from what I wrote. Actually, my goal is very similar to yours, as stated in the quote above. At this early stage of ER, legacy considerations are a distant secondary objective for us.

Simply because you expressed concern using the phrase "drag on performance". And I was asking the question.

Glad you found the Kitces and other material.

And I recognized long ago that my asset allocation already satisfied the needs of any "bucket" strategy, so I never used that approach on my retirement portfolio which uses the straight AA with occasional rebalancing method. Well, I do have a minimum on how low I'll let my fixed income drop in $ terms. This limit was actually hit in Jan of 2009 when I rebalanced my portfolio by buying stocks.

However, I do still keep up to two years of cash for living off of outside my retirement portfolio, plus other funds earmarked for short-term plans.

 

[Gatordoc50]

What yield was Kitces assigning to cash in his study from 1926 to 2009? One year treasuries were paying nearly 8 percent in 1990. What did they assign for cash that year?

 

[Gatordoc50]

What yield was Kitces assigning to cash in his study from 1926 to 2009? One year treasuries were paying nearly 8 percent in 1990. What did they assign for cash that year?

Good question, Gatordoc50. lol The research used the SP 500 as equities, Lehman Brothers long term treasury index for bonds and rolling 1 month treasuries for cash in a 60/30/10 allocation. At today's rates VBLTX yields 3.45% compared to the one month treasury at .02%. The conclusion of the paper was that a cash allocation was a drag. Boy, you have to be careful whose research you follow. I like Bernstein who advises a large allocation to riskless assets for those not lucky enough to be able to live off dividends.

 

[samclem]

Good question, Gatordoc50. lol The research used the SP 500 as equities, Lehman Brothers long term treasury index for bonds and rolling 1 month treasuries for cash in a 60/30/10 allocation. At today's rates VBLTX yields 3.45% compared to the one month treasury at .02%. The conclusion of the paper was that a cash allocation was a drag. Boy, you have to be careful whose research you follow.

What's wrong with Kitces' assumptions? The below chart shows the one-month Treasury yields (nominal and real). Right now they are low, but if Kitces used the "then year" stats for his series starting in 1964, that seems fair enough. Sometimes CDs and other forms of "cash" do better than one-month Treasuries, , sometimes they don't.

 

[Gatordoc50]

What's wrong with Kitces' assumptions? The below chart shows the one-month Treasury yields (nominal and real). Right now they are low, but if Kitces used the "then year" stats for his series starting in 1964, that seems fair enough. Sometimes CDs and other forms of "cash" do better than one-month Treasuries, , sometimes they don't.

Exactly. Sometimes cash is a drag sometimes it is not. The OP stated he wanted to have 2 years cash at 1% with safety being his priority. The OP had a sound strategy. It was suggested that the OP forego his cash buffer to increase his returns. Maybe it will, maybe it won't. It will definitely increase his risk of loss. Regardless, Kitces paper used different investments, over a different time frame and enjoyed a 30 year bond bull.

 

[Gatordoc50]

I found this from Kitces in his research on rising equity glide paths in retirement.
"However, even with an accelerated rising equity glidepath, there is still significant exposure to bonds in the early years, and the results also show that in situations where rates are low and there is an elevated risk of rising interest rates (and associated price declines in bonds), it doesn’t pay to take interest rate risk. As a result, safe withdrawal rates in the worst inflation/rising rate environments are better with Treasury Bills than bonds, even though Treasury Bills may pay “almost nothing” at the beginning of such time periods. This suggests that in the end, while it’s appealing to generate a better return from bonds if available – and higher returns will lead to higher safe withdrawal rates – in the worst environments, compounding bond risk on top of equity risk doesn’t pay. Instead, if there’s risk to bond – e.g., equities may be volatile, and interest rates may rise – the better outcome is to own the (less volatile) bonds, dollar cost average into equities, but don’t take interest rate risk in the process. In essence, the first function of bonds is simply as ballast to stocks, and should only be a return driver when there are appealing bond returns already on the table (or to hedge truly deflationary scenarios). In fact, there is actually a negative correlation (of about -0.25) between short-term bond yields and the outperformance of rising equity glidepaths using Treasury Bills; in other words, the lower interest rates are, the better it is to use low-yield Treasury Bills (due to the risk of rising rates!)."

 

[audreyh1]

Gatordoc50 - your post and point is really good, but the Kitces quote as pasted is really hard to read as a bunch of special characters were added with the paste. Here is an attempt to clean it up:

From Gatordoc50:

I found this from Kitces in his research on rising equity glide paths in retirement.

However, even with an accelerated rising equity glidepath, there is still significant exposure to bonds in the early years, and the results also show that in situations where rates are low and there is an elevated risk of rising interest rates (and associated price declines in bonds), it doesn't pay to take interest rate risk. As a result, safe withdrawal rates in the worst inflation/rising rate environments are better with Treasury Bills than bonds, even though Treasury Bills may pay "almost nothing" at the beginning of such time periods. This suggests that in the end, while it's appealing to generate a better return from bonds if available — and higher returns will lead to higher safe withdrawal rates — in the worst environments, compounding bond risk on top of equity risk doesn't pay. Instead, if there's risk to bond — e.g., equities may be volatile, and interest rates may rise — the better outcome is to own the (less volatile) bonds, dollar cost average into equities, but don't take interest rate risk in the process. In essence, the first function of bonds is simply as ballast to stocks, and should only be a return driver when there are appealing bond returns already on the table (or to hedge truly deflationary scenarios). In fact, there is actually a negative correlation (of about -0.25) between short-term bond yields and the outperformance of rising equity glidepaths using Treasury Bills; in other words, the lower interest rates are, the better it is to use low-yield Treasury Bills (due to the risk of rising rates!).

Wow - that's quite a gem you dug up there, Gatordoc! It really calls into question some of the earlier Kitces statements made. We may be headed for one of those deflationary environments - but who the heck knows!

 

[mathjak107]

while ray lucia used to promote 7 years of money i think that is a big excessive drag on things for the small odds of protecting against a total long term failure in the market.

my origonal plan was rays buckets, but it really was over protective over kill.

we went with a 40/50/10 mix which is about 2 years cash. after we spend down the cash we will glide up to 50/40/10 as a pretty permanent allocation.

 

[papadad111]

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.

I like this approach. Dividend income and top off with cash for x years. I think 3-4 years is reasonable too ...7 feels like s long duration and probably missing out on some alpha / beta in equities.

 

[ikubak]

I sleep better at night knowing I have a year's worth of cash available, so that's what I do. I don't try and time the market; I just like having cash and knowing in an emergency or on a whim, I can do what I want.

 

[audreyh1]

I like this approach. Dividend income and top off with cash for x years. I think 3-4 years is reasonable too ...7 feels like s long duration and probably missing out on some alpha / beta in equities.

I never felt that 7 years needed to all be in cash. If you have at least that many years in fixed income, which includes a little in cash, and a little in short-term, I think you are fine having a good chunk of it in intermediate high-quality bond funds. Those are precisely the kinds of funds that tend to rise in value when stocks (and riskier bonds) get whacked. Also, that way you are matching the duration of the funds to the time you might need them, which always made the most sense to me.

And, lo-and-behold, most investors already have that covered by their fixed income in their asset allocation. And I think in terms of the years in expenses, you should just account for after-tax expenses, because when we go through periods of market drops, taxable income tends to drop significantly from equity mutual funds and the fixed income mostly generates taxes by making additional money - capital gains tend to be small.

If you are covering those years of expenses from an IRA/401K, I guess you have to account for it pre-tax.

 

[Chuckanut]

Anybody care to recommend a good intermediate bond fund?

 

[Mulligan]

I never felt that 7 years needed to all be in cash. If you have at least that many years in fixed income, which includes a little in cash, and a little in short-term, I think you are fine having a good chunk of it in intermediate high-quality bond funds. Those are precisely the kinds of funds that tend to rise in value when stocks (and riskier bonds) get whacked. Also, that way you are matching the duration of the funds to the time you might need them, which always made the most sense to me.



And, lo-and-behold, most investors already have that covered by their fixed income in their asset allocation. And I think in terms of the years in expenses, you should just account for after-tax expenses, because when we go through periods of market drops, taxable income tends to drop significantly from equity mutual funds and the fixed income mostly generates taxes by making additional money - capital gains tend to be small.



If you are covering those years of expenses from an IRA/401K, I guess you have to account for it pre-tax.

Audrey you all a well informed person and I enjoy your posts, so I would like to toss a question at you (or anyone else, too) concerning income. Why do you not choose to invest in Preferreds or exchange traded debt, collect the income and not worry about the daily movements of the security?
I frequent an income and investing forum and one recently posted a spreadsheet showing returning 6.5% with a 4% draw and 3% inflation would provide nearly 40 years of income before drawing down.
I have wadded in a lot into these issues, all which are mostly investment grade. I am getting closer to 50/50 in my asset base of index and preferred. I love the income dividends and the 15% tax as bonds pay less and tax me more.
Many investment gurus suggest preferred's to occupy 10-20% of a portfolio, yet outside of a few people on this forum, no one wants to involve or really even discuss these. I was curious as to why you have chosen not to.
Some people revolve their entire portfolio around these issues, and just collect the dividends and are not concerned with the price movement of the issue.


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[mathjak107]

Anybody care to recommend a good intermediate bond fund?

I like fidelity corporate bond fund. It is more volatile than total bond but has produced higher returns

 

[mathjak107]

Audrey you all a well informed person and I enjoy your posts, so I would like to toss a question at you (or anyone else, too) concerning income. Why do you not choose to invest in Preferreds or exchange traded debt, collect the income and not worry about the daily movements of the security?
I frequent an income and investing forum and one recently posted a spreadsheet showing returning 6.5% with a 4% draw and 3% inflation would provide nearly 40 years of income before drawing down.
I have wadded in a lot into these issues, all which are mostly investment grade. I am getting closer to 50/50 in my asset base of index and preferred. I love the income dividends and the 15% tax as bonds pay less and tax me more.
Many investment gurus suggest preferred's to occupy 10-20% of a portfolio, yet outside of a few people on this forum, no one wants to involve or really even discuss these. I was curious as to why you have chosen not to.
Some people revolve their entire portfolio around these issues, and just collect the dividends and are not concerned with the price movement of the issue.


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For anyone not concerned about the price as long as they get their interest or dividend i will gladly pay them a bit more but i keep their principal.

 

[pb4uski]

Anybody care to recommend a good intermediate bond fund?

What I have been doing lately because of my concerns about interest rate risk is target maturity bond funds since I maxed out on the PenFed 3% 5-year CD special from back in late 2013.

I'm in the IBond and Bulletshare Corporate target maturity bond funds that mature in 2020. The former currently yields 2.12% and the latter 2.38% based on Friday's closing prices with durations of 4.12 and 4.75 respectively. I view them as a CD substitute and the returns are about the same as the highest 5 year CD rates but much better than average 5 year CD rates. I prefer these because I hold my fixed income allocation in my IRA and I don't have to have numerous IRA accounts as I would if I used CDs. I made an exception to that for the PedFed special because 3% was too good to pass up.

I'm giving up a little yield compared to the Vanguard Intermediate-Term Corporate Bond fund which yields 2.91% but has a much longer duration of 6.3.

 

[pb4uski]

....so I would like to toss a question at you (or anyone else, too) concerning income. Why do you not choose to invest in Preferreds or exchange traded debt, collect the income and not worry about the daily movements of the security?....

I guess my issue with preferreds in the current low interest rate environment is interest rate risk and once interest rates "normalize", I might well consider some. My understanding is that their value will get hammered much more than bonds if/when rates rise.

 

[Mulligan]

For anyone not concerned about the price as long as they get their interest or dividend i will gladly pay them a bit more but i keep their principal.

If you investment grade rated and can give me 7% lets get the paperwork going! Seriously though, I am not suggesting they are any better or worse than any other plan, just curious as to why they do not get serious consideration from most members here as a least a sliver of portfolio.
Most of the ones I own have been around 20-50 years, and tracking their prices during these periods shows very little price movement other than the short 2008 blip and early 90s.


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[Mulligan]

I guess my issue with preferreds in the current low interest rate environment is interest rate risk and once interest rates "normalize", I might well consider some. My understanding is that their value will get hammered much more than bonds if/when rates rise.

And that is a valid concern. I seen charts that are showing near historical spread difference between preferreds and the 10 yr. treasury. No guarantee they won't get crushed in price, but at times on some of my issues, the preferred yield was within 1% of treasury. Now they are over 4%. The caveat is though that I am not buying the actively traded listed utility preferreds like Southern Co. that are in the 5's but delisted ones that are investment grade utilites from shares that are mostly locked up in a pension fund vault in the 6's such as Baltimore Gas, Northeast Util, and Ameren.


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[audreyh1]

Anybody care to recommend a good intermediate bond fund?

I have a large amount in DODIX. Some in MWTRX. There are a lot of "core" diversified intermediate bond funds out there. Many "total bond" funds qualify - they are usually intermediate, and Vanguard has them as well as others. There are ETFs available for this class of investment as well. I recommend reading up on options on Morningstar.

 

[audreyh1]

Audrey you all a well informed person and I enjoy your posts, so I would like to toss a question at you (or anyone else, too) concerning income. Why do you not choose to invest in Preferreds or exchange traded debt, collect the income and not worry about the daily movements of the security?
I frequent an income and investing forum and one recently posted a spreadsheet showing returning 6.5% with a 4% draw and 3% inflation would provide nearly 40 years of income before drawing down.
I have wadded in a lot into these issues, all which are mostly investment grade. I am getting closer to 50/50 in my asset base of index and preferred. I love the income dividends and the 15% tax as bonds pay less and tax me more.
Many investment gurus suggest preferred's to occupy 10-20% of a portfolio, yet outside of a few people on this forum, no one wants to involve or really even discuss these. I was curious as to why you have chosen not to.
Some people revolve their entire portfolio around these issues, and just collect the dividends and are not concerned with the price movement of the issue.


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a) I choose not to own individual securities.
b) I am a total return investor.
c) The models I studied for portfolio survival and safe withdrawal rates over long periods didn't include preferred among the asset classes they examined.

 

[Texas Proud]

I have owned a few preferred or exchange traded debt.... heck, there was a big discussion of SLM's.... the only one I can remember if JSM...


But, you are in a spot that is not quite a bond and not quite a stock... if there is no conversion into stock, then basically you have a bond that is lower in the pecking order than a bond.... IOW, during BK you can lose much more than a real bond... now, you might be paid for this risk, but I would not ignore it....

SOOO, if you have the choice between a 5% bond or a 5% preferred, all else being equal you would pick the 5% bond...

 

[2B]

I have one year of cash in my plan which is the year I'm spending it in. I don't even include it in my asset allocation because it is supposed to disappear before my next rebalancing. The remainder is 55/45. The fixed income is entirely in a CD ladder. My CD ladder is effectively at the interest rate I purchased the CD at even if it is maturing during the coming year. Most of this will be reinvested out a nominal 5 years to slow slog forward to its next eventual redemption.

 

[Mulligan]

I have owned a few preferred or exchange traded debt.... heck, there was a big discussion of SLM's.... the only one I can remember if JSM...


But, you are in a spot that is not quite a bond and not quite a stock... if there is no conversion into stock, then basically you have a bond that is lower in the pecking order than a bond.... IOW, during BK you can lose much more than a real bond... now, you might be paid for this risk, but I would not ignore it....

SOOO, if you have the choice between a 5% bond or a 5% preferred, all else being equal you would pick the 5% bond...

That is defintiely true, Texas. The trouble is for me anyways in the sandbox I'm playing in, the companies that have 6% plus preferreds are issuing their senior debt at 3-4%. Right or wrong I made decision to buy lower capital structure "debt" from higher rated companies, than senior debt from lower rated companies.
Audrey, thanks for sharing your reasons.


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