What FI % Should Be In Short-Term Instruments?

[TickTock]

This is an offshoot of "TickTock's Take on Bonds vs. Bond Funds" thread where I state, “Individual bonds, particularly US T-Bills, deserve serious consideration as a portion of a retiree’s portfolio, due to their predictability/lowered volatility/higher possible floor SWR. More research is needed.”

audreyh1 in post #6 of that thread says, “I’m primarily in bond index funds, but I’ve always managed my maturity keeping it a bit shorter buy having a combination of cash, short-term funds and intermediate funds. Nothing longer. Cash is invested in a variety of short-term instruments such as T-Bills, CDs, MM funds, savings, IBonds, etc.”

This is an attempt to quantify how much of the FI allocation should be in short-term instruments. It looks at a “reasonable” worst-case scenario. Adjust the math as needed for different portfolio allocations and assumed 1-year worst-case returns.

Assumptions: 60/40 portfolio. 4% WR. Rebalanced annually.

Planning for a worst-case year 1 in retirement– equities down 50%, FI up 5%

30/38 [FI = 40 +(40*.05) – 4 = 38]

Rebalance to 60/40: 68 * 0.6 = 40.8, 68 * 0.4 = 27.2

40.8/27.2 The portfolio has lost 32% of it’s starting value!

10.8 has been rebalanced from FI to equities.

This suggests keeping somewhere around 11 (rebalance) + 4 (WR) = 15 of the initial 40 in FI in T-Bills, to avoid selling longer-term FI at a loss. 37.5% of the FI allocation.

 

[Marc]

I retired six years ago and moved to a 55/35/10 allocation. The 10% in cash is equivalent to two years of expenses. I, so far, have been able to avoid selling equities in a down market. My cash position is getting perilously low as I need to move an additional $28,000 to cash in order to cover all planned 2024 expenses. My plan is to sell $30K of FXAIX when S&P gets to 4600. If it never gets to 4600 I will have to go to Plan B.

I had decided that I didn't want to worry about my equities, thus the large cash position. I got lucky as I am past any concerns about SORR.

YMMV

Marc

PS I only have one real fear - Inflation. If either the Fed lacks a backbone or the government continues to print money and/or the war on energy causes higher prices I may be screwed.

 

[audreyh1]

One way you can decide is pick a duration goal and then allocate your fixed income investments to match that overall.

 

[jebmke]

One way you can decide is pick a duration goal and then allocate your fixed income investments to match that overall.

this is largely what I do although I am willing to go long with Tips at the right price

 

[pb4uski]

I keep a year of gap (spending less SS less pension... what I expect to withdraw from my retirement portfolio in the next 12 months) plus $25k emergency liquidity in an online savings account currently yielding 4.3%. I view that as the lowest rung of my fixed income ladder. It is 1.3- 4.3% of our total retirement assets. I replenish the online saving account periodically from maturity proceeds and interest.

The rest is in a combinations of brokered CDs, agency bonds, UST, I-Bonds, corporate bonds maturing over the next 5-10 years and some preferred stocks.

 

[Koolau]

I retired six years ago and moved to a 55/35/10 allocation. The 10% in cash is equivalent to two years of expenses. I, so far, have been able to avoid selling equities in a down market. My cash position is getting perilously low as I need to move an additional $28,000 to cash in order to cover all planned 2024 expenses. My plan is to sell $30K of FXAIX when S&P gets to 4600. If it never gets to 4600 I will have to go to Plan B.

I had decided that I didn't want to worry about my equities, thus the large cash position. I got lucky as I am past any concerns about SORR.

YMMV

Marc

PS I only have one real fear - Inflation. If either the Fed lacks a backbone or the government continues to print money and/or the war on energy causes higher prices I may be screwed.

I agree that the big monster in the corner is Inflation. It's pretty much the one thing (short of very long term long-term care for both DW and I) that could sink us. YMMV

 

[OldShooter]

... This suggests keeping somewhere around 11 (rebalance) + 4 (WR) = 15 of the initial 40 in FI in T-Bills, to avoid selling longer-term FI at a loss. 37.5% of the FI allocation.

or at least this is the result if you make up a bunch of numbers and do some arithmetic on them. Other numbers, other results, ...

Remember what H. L. Mencken told us many years ago: “For every complex problem, there is a solution that is simple, neat and wrong.”

... I only have one real fear - Inflation. If either the Fed lacks a backbone or the government continues to print money and/or the war on energy causes higher prices I may be screwed.

Yes. Which is why over 80% of our FI tranche is in TIPS.

 

[COcheesehead]

There is one podcast I listen to that I really respect and he suggests liability matching your first five years of retirement. So build a five year ladder with rungs maturing every quarter or so that equal your planned expenditures.
Personally I keep a few months of expenses in cash, but my ladder throws off on average $18,000+ a month. So I have plenty of cashflow. I can always not reinvest a maturing bond if I need more.

 

[TickTock]

or at least this is the result if you make up a bunch of numbers and do some arithmetic on them. Other numbers, other results, ...

Absolutely. That's why I said in the original post, "It looks at a “reasonable” worst-case scenario. Adjust the math as needed for different portfolio allocations and assumed 1-year worst-case returns."

I didn't "make up" a bunch of numbers. A one-year 50% equity loss is generally accepted as a reasonable worst-case outcome. Certainly the 5% FI gain is not on as firm ground, but usually when stocks crater, bonds do okay.

I'm not trying to solve for the be-all-end-all perfect solution here, just trying to get to a practical, actionable plan that does well under a variety of scenarios.

For example, our portfolio has traditionally had a 70/30 split between US and foreign developed markets. Is it the optimum solution? Almost certainly not, but it does well under a wide variety of scenarios.

Remember what H. L. Mencken told us many years ago: “For every complex problem, there is a solution that is simple, neat and wrong.”

It is a complex problem. I don't know why you think I thought had a simple or neat solution to it.

 

[Montecfo]

or at least this is the result if you make up a bunch of numbers and do some arithmetic on them. Other numbers, other results, ...



Remember what H. L. Mencken told us many years ago: “For every complex problem, there is a solution that is simple, neat and wrong.”



Yes. Which is why over 80% of our FI tranche is in TIPS.

TIPS. That sounds very simple. And neat.

 

[SnowballCamper]

+1 on this approach

So build a five year ladder with rungs maturing every quarter or so that equal your planned expenditures.

I'm in the SIRE category... but I like this approach to handle SORR. How many years just needs to be how long of a stock market decline (& recovery) you want to plan for. Of course there is still inflation, and then this approach kinda forces some market timing to sell stock to replenish the bond ladder (meaning to wait for an up year).

 

[COcheesehead]

+1 on this approach


I'm in the SIRE category... but I like this approach to handle SORR. How many years just needs to be how long of a stock market decline (& recovery) you want to plan for. Of course there is still inflation, and then this approach kinda forces some market timing to sell stock to replenish the bond ladder (meaning to wait for an up year).

Depends how big your ladder is. You can live off the interest and reinvest the maturing bonds. That’s what I am doing, but originally on a 10 year timeframe.

 

[mrfeh]

Nothing scientific about this at all, but I would say 3-5 years of expected withdrawals to meet expenses.

 

[foxfirev5]

Finally I have 17 year TIPS, Strips & CD ladders nearly complete. I'm putting unused maturing rungs into a 6 year duration bond fund with reinvesting dividends. At age 85 the bond funds will provide auto pilot income for me or whoever is left.

On the short term front, I've got enough T Bills and series I bonds to fund any major expense that may crop up. ( Approx a 15% allocation of FI)

 

[Exchme]

I don't get the example. Bonds went up 5%, so what would be wrong with selling a winner to rebalance?

OP is positing an increase in bond value. Normally cash and other short term investments wouldn't move much, so presumably the longer term bonds did much better than 5% and the short term didn't change much in order to average to 5%. So in that scenario holding so many stable investments hurt you. (Of course in 2022, the opposite was true, holding cash & short term was the winning move.)

By splitting the fixed income baby into short and long term, you've created a third category, are you going to rebalance between short and long term? Or is this some kind of hard to analyze bucket strategy that doesn't refill the short term bucket and therefore amounts to taking more duration risk in bonds right after they went up?

Everyone looks at the world differently and has different needs, goals and fears and those may well change over time. So it seems like overthinking it, I don't think a single best strategy exists.

There is an interesting article by Jonathan Clements (former WSJ writer) on HumbleDollar.com that covered overthinking:

https://humbledollar.com/2023/09/on-second-thought/

 

[tulak]

+1 on this approach


I'm in the SIRE category... but I like this approach to handle SORR. How many years just needs to be how long of a stock market decline (& recovery) you want to plan for. Of course there is still inflation, and then this approach kinda forces some market timing to sell stock to replenish the bond ladder (meaning to wait for an up year).

Exactly what I’m doing to deal with SORR, except I’m planning on an 8 year ladder. I use TIPS to mitigate inflation.

 

[TickTock]

I don't get the example. Bonds went up 5%, so what would be wrong with selling a winner to rebalance?

OP is positing an increase in bond value. Normally cash and other short term investments wouldn't move much, so presumably the longer term bonds did much better than 5% and the short term didn't change much in order to average to 5%. So in that scenario holding so many stable investments hurt you. (Of course in 2022, the opposite was true, holding cash & short term was the winning move.)

I don't see a problem with selling a winner in that scenario (longer-term bonds/bond funds). Over time, holding shorter term stable FI investments is very likely to be a drag on overall portfolio return. Those shorter term instruments are in the portfolio to lower overall portfolio volatility and potentially increase the floor SWR (see the Kitces article from the original thread).

By splitting the fixed income baby into short and long term, you've created a third category, are you going to rebalance between short and long term? Or is this some kind of hard to analyze bucket strategy that doesn't refill the short term bucket and therefore amounts to taking more duration risk in bonds right after they went up?

Shorter and longer term FI investments have different volatility/expected returns, so I think considering them as separate asset classes (sub-asset classes?) is justified.

My general thinking is yes, to rebalance between short and long term FI. The research I've seen concludes that bucket strategies perform, in general, worse than rebalancing strategies (because equities tend to recover over longer time periods, making buying "at a discount" attractive). One option that the short-term/long-term split gives is to rebalance or not rebalance.

Everyone looks at the world differently and has different needs, goals and fears and those may well change over time. So it seems like overthinking it, I don't think a single best strategy exists.

I agree that a single best strategy is cannot be determined in advance. I'm trying to construct a portfolio that will do well in a variety of scenarios. And provide the best chance for a maximum SWR.

There is an interesting article by Jonathan Clements (former WSJ writer) on HumbleDollar.com that covered overthinking:

https://humbledollar.com/2023/09/on-second-thought/

So... the article covers overthinking... without once ever using that word...

Johnathan Clements talks about how his thinking has *changed* over two decades. Not how much he was overthinking. We can review his five points in the referenced article if you'd like.

 

[DrRoy]

I keep 1 to 2 years worth of spending in a MM, and refill annually. Otherwise, no short term.

 

[Stormy Kromer]

2 years living expense in VG MM account. Currently over 5% yield.

Another 4 years or so living expense in Vanguard Balanced Fund. The rest is long term such as Total Stock Market and S&P 500.

 

[Alex The Great]

I keep one year of expenses in savings account and CD ladder for 5 years. In addition to that I have a corporate bond ETF. Other funds are in index fund and individual dividend stocks.

 

[OldShooter]

Just for grins, I asked ChatGPT: " For a retiree, what fixed income % Should Be In Short-Term Instruments?"

and got "The allocation of fixed income investments for a retiree, including how much should be in short-term instruments, depends on various factors including the retiree's financial goals, risk tolerance, time horizon, and current financial situation. There is no one-size-fits-all answer ... "<snip TLDR>

The full answer is about a page and is fairly reasonable, ending with a recommendation to consult with a FA for personalized guidance and periodic reviews..