41, FI in 2020, Where to put extra cash?

[BreathFree]

Hello all. I am new to the forum. Here are some quick stats:


Forty one years old, single, no children. Approximate net worth of $600,000 dollars. This is split between home, rental properties, and various retirement accounts holding S&P index funds and some international index funds. Approximately $15,000 in cash. No pension. No bonds. No CDs. My income comes from small rental properties business, micro software vendor business, and employment as a merchant mariner totaling around $185,000 a year. My yearly living expenses amount to $35,000 pre tax.


My goals do not include complete retirement as I have enjoyed writing software since I was 13 and plan to continue with my software vendor business. I do plan on being financial independent and retiring from my j*b as a mariner in the next 6 to 10 years.


Ok, so now for the hard part. I have never invested in bonds or CDs as I preferred to pay down the mortgage on my house. My house is now payed off and I find myself having no place to put extra cash. I don't trust bonds since we are at historically low interest rates. I understand the principal will move inversely to the interest rates. CDs are paying nothing, but I intend to put together a two year ladder that is equal to two years worth of living expenses just for peace of mind. Then what? Should I dollar cost average into bonds anyway? Should I hoard cash waiting for inflation to affect interest rates? Am I missing something here? What is the benefit of bonds over CDs when both are paying such low interest rates and bonds principal is not protected? Thanks for any insight. This is an awesome forum.

 

[obgyn65]

Hello - have you given some thought to deferred annuities ?

Welcome to the forum.

 

[pb4uski]

I share your concerns about returns on bonds in the near term, particularly interest rate risk, but I think of my bonds as a balance to my stocks. If the economy gets worse, bonds will hold their own, possibly do well and partially offset losses on the stock side. If the economy gets better, bonds may suffer but my stocks will do well and more than make up any bond losses that I have. Having a balanced portfolio positions me to win no matter what happens - that's the theory anyway (but if you had asked me about that in 2008 I might have been less confident in the result, but it worked out very well in the end).

That said, I have tilted my bond investments to intermediate term investment grade and high yield corporate bonds since government bonds yields are so pathetic. My bonds (84/16 mix) are yielding a bit over 3.5% and have a duration of 4.8 or so.

One other alternative I have considered but not puled the trigger on are Guggenheim Bullet Shares which sort of a target date bond portfolio so is like investing in individual bonds with diversification (for 24 bps IIRC). While the fair value of these bonds would decline if interest rates rise, if you hold them to maturity you would get your purchase yield.

For cash, I favor online savings. I have Discover Bank (0.8%) but IIRC Ally is paying 0.95%.

P.S. Forget about annuities.

 

[Midpack]

I'm a proponent of maintaining an asset allocation irrespective of sector rotation, IOW I hold equity, bonds & some cash at all times though I tweak % and/or tilts from time to time. People have been saying bonds are poised to fall several years now, and while they'll be moderately right eventually for the reasons you mention, they've been wrong (based on total returns) for several years. Incidently that's true of all sectors, predicting timing is something few if any can do.

I'm not an advocate of holding 100% equities (even though I did until I was 51), but I'm curious what makes you ask about wading into bonds or cash right now - especially with your (widely shared) pessimism about both? Not wrong, but why?

+1 on forget annuities, this a historically bad time to buy annuities if you have other options (not everyone does).

 

[BreathFree]

Thanks for the responses. I do not feel comfortable with annuities due to the various fees and the prospect of future inflation affecting the real return.


I find the Guggenheim Bullet Shares very interesting. I have never heard of target date bond portfolios. I am researching them now and haven't found a whole lot of people that know about this. I understand that if you hold a bond to maturity the principal is protected (other than default) but did not know about target date bond portfolios. The expenses seem low too. Do you have any links to more information on these shares? Do you know anyone who has tried this approach? I have started searching myself with a Google search but haven't found a whole lot of discussion on these shares. This may be what I was looking for. At least something to dip my toes into. I need to do my due diligence first of course.


Why Bonds now? Basically my income has only recently reached a level that encouraged investment. I was an hourly wage worker most of my life living paycheck to paycheck. I bought my first stock in 2005, my first rental in 2007, and started my software business in 2009. Now that my house and one of my rentals is paid off I am heavily weighted in real estate, and stocks. I guess I am looking for more diversification as I get closer to transitioning from my maritime career to full time small business owner.

 

[MooreBonds]

I find the Guggenheim Bullet Shares very interesting. I have never heard of target date bond portfolios. I am researching them now and haven't found a whole lot of people that know about this. I understand that if you hold a bond to maturity the principal is protected (other than default)

I believe that you are only partially correct in your view of the Bullet shares: it is true that the bond fund doesn't have to be faced with the prospect of selling/buying new bonds at different prices due to maturing bonds and investor inflows/outflows - which can ultimately lead to capital gains/losses at maturity.

HOWEVER - you must look at what the bond ETF is currently traded at, in relation to the Net Asset Value. If all of the bonds in the ETF's portfolio are priced at 100 and the NAV is $10, but the ETF is trading at $12 to have a yield to maturity that matches the rest of the yield curve, then you are guaranteed to lose $2/share at maturity, even though the ETF's bonds (assuming no defaults) will mature at the price they're at now.

 

[brewer12345]

Why Bonds now? Basically my income has only recently reached a level that encouraged investment. I was an hourly wage worker most of my life living paycheck to paycheck. I bought my first stock in 2005, my first rental in 2007, and started my software business in 2009. Now that my house and one of my rentals is paid off I am heavily weighted in real estate, and stocks. I guess I am looking for more diversification as I get closer to transitioning from my maritime career to full time small business owner.

I have the same dilemma. I have decided that the safest course is a mix of cash, modest duration bonds (under 10 years), and other alternatives like merger arbitrage funds.

What kind of ship are you on most ofthe time? Bulker? Tanker? Something else?

 

[pb4uski]

I believe that you are only partially correct in your view of the Bullet shares: it is true that the bond fund doesn't have to be faced with the prospect of selling/buying new bonds at different prices due to maturing bonds and investor inflows/outflows - which can ultimately lead to capital gains/losses at maturity.

HOWEVER - you must look at what the bond ETF is currently traded at, in relation to the Net Asset Value. If all of the bonds in the ETF's portfolio are priced at 100 and the NAV is $10, but the ETF is trading at $12 to have a yield to maturity that matches the rest of the yield curve, then you are guaranteed to lose $2/share at maturity, even though the ETF's bonds (assuming no defaults) will mature at the price they're at now.

I'm not sure it makes sense that you would lose $2. Assuming that the Bullet share trades at NAV (ie the fair value of the underlying bond portfolio) if NAV is 12, isn't it just then a premium bond where the yield is less than the average coupon and the 12 is the pv of the portfolio's future coupons and principal?

In other words, you don't "lose" anything, it is just that your effective yield is lower than the coupon.

 

[ejw93]

185k per year as a single filer puts you in a HIGH tax bracket.

1) Max out your 401k, even if there is no match.
2) If you have an HSA, max out your contribution annually to the HSA account. Once you have enough $$ in the HSA to cover your annual 'out of pocket max', invest the rest of the HSA funds in a blended/balanced fund.
3) If you are eligible, individual Roth acct contribution.

As for 'what to buy', keep your expenses low and buy anything with a 25% to 50% bond mix. In your tax bracket it may actually matter more what your asset LOCATION is than what your asset ALLOCATION is.

 

[BreathFree]

I believe that you are only partially correct in your view of the Bullet shares: it is true that the bond fund doesn't have to be faced with the prospect of selling/buying new bonds at different prices due to maturing bonds and investor inflows/outflows - which can ultimately lead to capital gains/losses at maturity.

HOWEVER - you must look at what the bond ETF is currently traded at, in relation to the Net Asset Value. If all of the bonds in the ETF's portfolio are priced at 100 and the NAV is $10, but the ETF is trading at $12 to have a yield to maturity that matches the rest of the yield curve, then you are guaranteed to lose $2/share at maturity, even though the ETF's bonds (assuming no defaults) will mature at the price they're at now.

I am new to bonds so forgive my ignorance. Let me see if I understand this. Since the BSCH shares are traded on the open market, if interest rates drop further, the market will bid up the BSCH price per share due to the BSCH dividend becoming more attractive. The NAV will stay the same. So if I purchase the BSCH shares at a cost per share higher than the NAV I am calculating that my total yield will offset the definite reduction in my principal (price paid at time of purchase) at maturity, but not a definite loss.

 

[BreathFree]

I have the same dilemma. I have decided that the safest course is a mix of cash, modest duration bonds (under 10 years), and other alternatives like merger arbitrage funds.

What kind of ship are you on most ofthe time? Bulker? Tanker? Something else?

I am going to park my savings into CDs and cash until I feel more comfortable with bonds.

I am the chief engineer on a 280 foot supply boat that services the offshore oil industry in the Gulf of Mexico. I have been working for the same company for 12 years. I did four years in the Navy and picked up the skill set I needed for engine room work. I am burning out though. I will have spent 255 days on the boat this year. Doesn't leave much time for living, but the pay is great.

 

[FIREd]

Currently my fixed income allocation consists of intermediate-term corporate bonds (<5 year duration), i-bonds, and CDs. I haven't added any money to bonds/CDs since the beginning of the year though. I am mostly adding to my cash position now. Depending on the outcome of the fiscal cliff, I may add some munis to the mix next year.

 

[obgyn65]

I do not understand this sentence. Are you saying that you will buy more munis if the US prevent the fiscal cliff from happening or the opposite ? Why? Not getting political, just trying to understand.

Depending on the outcome of the fiscal cliff, I may add some munis to the mix next year.

 

[brewer12345]

I am new to bonds so forgive my ignorance. Let me see if I understand this. Since the BSCH shares are traded on the open market, if interest rates drop further, the market will bid up the BSCH price per share due to the BSCH dividend becoming more attractive. The NAV will stay the same. So if I purchase the BSCH shares at a cost per share higher than the NAV I am calculating that my total yield will offset the definite reduction in my principal (price paid at time of purchase) at maturity, but not a definite loss.

All bond prices move in the opposite direction of rates, including the bullet funds. Rates go up, bond prices go down. The best place to start is to Google the definition of something called duration.

In this environment CDs and I bonds are the safest options.

 

[FIREd]

I do not understand this sentence. Are you saying that you will buy more munis if the US prevent the fiscal cliff from happening or the opposite ? Why? Not getting political, just trying to understand.

My CA state income tax rate just went up and if my federal income tax rate goes up as well next year, then munis might become very appealing (I suspect that my marginal tax rate might exceed 50% next year for Federal and state combined).

 

[pb4uski]

I am new to bonds so forgive my ignorance. Let me see if I understand this. Since the BSCH shares are traded on the open market, if interest rates drop further, the market will bid up the BSCH price per share due to the BSCH dividend becoming more attractive. The NAV will stay the same. So if I purchase the BSCH shares at a cost per share higher than the NAV I am calculating that my total yield will offset the definite reduction in my principal (price paid at time of purchase) at maturity, but not a definite loss.

You're on the right track but not quite there. The NAV is the fair value of the bonds in the fund, so if interest rates decline then the value of the bonds in the fund and the NAV will increase. So let's say they bought all the bonds for that ticker since it is essentially a closed end fund and that the average purchase yield is 3.5%.

If interest rates decline, the bonds in the fund would be more valuable and the NAV would increase and the market yield would decline. If you buy the fund at the higher NAV and hold to maturity, your nominal return should be roughly the market yield implicit in the NAV at the time you buy the shares less 24 bps management fee.

There will be other factors to consider like the bid/ask spread (which I understand varies considerable for the Bullet Shares from what I've read) but I'm trying to keep it simple for now.

That's my understanding of how it works. YMMV.

 

[Midpack]

You may know all this, but just more info on how interest rate changes and duration basically impact bond fund NAVs. Interest rates have no place to go but up now, though not for a few years (so I'm just happily taking the yields for now). When interest rates go up, bond fund NAVs have to drop to equalize value with new issues. How much then depends also on duration, the longer the duration, the bigger the hit - again to equalize value with new issues.

Bond values move in the opposite direction of interest rates, so the value of your bond will go down when rates go up (and vice versa). That means you can lose principal in bond funds when interest rates rise. Even if you buy individual bonds and hold them until maturity, you can lose money if you paid a premium for your bond.

Interest-Rate Sensitivity
You can use a bond portfolio's duration to get a sense of just how much your fund may lose (or gain, if interest rates go down). The rule of thumb is that for every 1% change in interest rates, the value of your bond fund will change by the duration of that fund. For example, if interest rates go up by 1% and the duration of your fund is 5.0, your fund will decrease by about 5%. So, in general, the shorter the bond duration, the less it will be affected by a change in rates.

That said, typically bond managers will start to add the higher-paying bonds to their portfolios over time. When that happens, you may see an increase in yield that may partially offset the loss in value.

http://news.morningstar.com/articlenet/article.aspx?id=172614

 

[Sun456]

Preferred stocks

I have a portfolio of several conservative mutual funds (mostly bonds), individual bonds, deferred annuities and preferred stocks. I am all about conserving principal at this time even though I am only 45.

For your situation you might want to look at the preferred stocks. They function sort of like bonds in that they have a call amount (usually but not always $25). And they have a yield paid by the company. Here is an example:
Interstate Power and Light Co INTERSTAT PWR & LGHT 8.375% SR B PRF IPL/PrB:NYSE

Last Price $25.75

Latest Dividend Amount $0.5234
Dividends Paid From 2003
Indicated Rate $2.09
Dividend Cash Value (Current Year) $2.0938
Ex-Date Nov 28, 2012
Dividend Cash Value (2011) $2.0938
Payment Date Dec 14, 2012
Dividend Cash Value (2010) $2.0938
Current Yield 7.87%

I use Quantum on-line to research the preferred stocks, Morningstar to look at the underlying company and Schwab to get the above data. You can see the yield of 7.87% is less than the 8.375% of the preferred share. That is because it is trading at a premium which is anything over the call price of $25.

If interest rates go up the price of the preferreds likely would go down because you could maybe do better elsewhere. They also can get called. If called and you paid a premium then you lose that amount. If you paid less than the call price you still get the call price so you make some. They trade like stocks so easier to liquidate than individual bonds. If you hold onto them and they aren't called then you keep getting the return you bought in at regardless of how much the shares are trading for. If the company goes belly up then you get in line with the rest of the creditors. I believe you are behind bonds but before common stock.

The trick is to find good companies who have enough to pay the dividends but not so much cash that they call the shares back in (we owned AT&T when it was called) and reissue at lower rates. We have mostly bought insurance companies and utilities. We have had a number of our shares called, some that look to be good long term performers and some we've taken some risk on for higher returns (old habits die hard).

There are also preferred share ETFs which would be a good way to diversify your holdings.

Another think to look at is their tax treatment. Some are treated like income and some get the 15% capital gains rate. Quantum on-line can tell you this so you pick the right ones for your tax deferred accounts vs your taxable brokerage accounts.

Good luck with your early retirement.

 

[BreathFree]

Thanks for all of the input. I have learned quite a bit already, but have a lot of research to do based on this forums comments and suggestions. I've spent my free time today researching I-bonds and TIPs.

 

[amfox1]

We are 46 years old and I am ER'ed.

Our cash and bond portion of our portfolio is as follows (percentages are to overall portfolio):

Taxable:
2.24% Cash
7.53% Individual municipal bonds
5.31% VWIUX - Vanguard Intermediate-Term Tax Exempt Fund
2.50% VMLUX - Vanguard Limited-Term Tax Exempt Fund
2.23% VMMXX - Vanguard Prime Money Market Fund
1.41% Series I bonds
1.18% TEGBX - Templeton Global Bond Fund
1.03% PGBAX - Principal Global Diversified Income Fund

Tax-Deferred:
10.15% VBTLX - Vanguard Total Bond Market Index Fund
4.64% VWEAX - Vanguard High-Yield Corporate Fund
4.60% VAIPX - Vanguard Inflation Protected Securities Fund
1.10% PRRIX - Pimco Real Return Instititutional

 

[rbmrtn]

HOWEVER - you must look at what the bond ETF is currently traded at, in relation to the Net Asset Value. If all of the bonds in the ETF's portfolio are priced at 100 and the NAV is $10, but the ETF is trading at $12 to have a yield to maturity that matches the rest of the yield curve, then you are guaranteed to lose $2/share at maturity, even though the ETF's bonds (assuming no defaults) will mature at the price they're at now.

That is true in general. The document at Bulletshares claims their defined maturity ETFs take that into account by adjusting the payout with the change in YTM.

http://guggenheiminvestments.com/Gu...th_Look_at_Defined-Maturity_ETFs.pdf?ext=.pdf

 

[gerrym51]

i like trrbx t rowe price 2020 fund