Building a short-term bond portfolio for 20+ years


Moderator Emeritus
Dec 11, 2002
For those of you tired of reading this at the FundAlarm or M* boards, I apologize, and please humor my attempt to reach the rest of us ERs. Don't feel obligated to respond to the lifestyle issue, but I'm happy for more suggestions on building the bond portfolio.

This question could be subtitled "Discussing money with your parents". It was a lot easier when the "discussions" went like this:
"Dad, can we please raise my allowance a quarter?"
"Get a job, kid."

Today it's a grown-up situation that makes me long for the "good ol' days". I've blissfully ignored bond investing for years and now I'm paying catch-up for my sins. I'd appreciate the board's suggestions on developing a short-term bond portfolio for the long term, to be built with money gifted by parents-in-law. The understanding is that the money is for their long-term care (if necessary).

They're both in their late 60s, healthy, and spry. No medications, non-smoking, one coffee/day, 1-2 beers/week, and only very minor arthritis. They regularly walk >20 miles/week, pump iron, eat healthy, stay slim & trim, and all their parents made it to high 90s. Their idea of a fantasy vacation is a two-week Elderhostel at Gettysburg fixing Lee's strategy. They've started gifting their two adult children (one of whom is my spouse), and I suspect that they'll be gifting for at least 25 years. (I also fear that I'll be with my spouse for a VERY long time, but that's a different issue!)

We don't need (or even use) the gifted money and I don't think they do either. They won't carry LTC insurance or annuities. I think they gift so that if they die before bankrupting their estate on LTC, then we're that much farther ahead of estate taxes. (But I don't know the size of their estate.) So effectively we control a fraction of their estate and we've been asked to be ready to use it for LTC. Financially they live a comfortable life, frugal yet full, and expenses are well in hand. Being raised during the Depression, they can squeeze a buffalo until it whimpers. They don't have home equity, but they have a cheap long-term rental (we're the landlords) and their only real inflation is Medigap insurance. I believe (but don't know) that their retirement portfolio is entirely in bonds or bond funds, with about 10% "play" money in individual stocks. A conventional IRA RMD will start this year. I think that they prefer to "diversify" by buying different types of govt/muni bonds and CDs from different credit unions. I do know that when they sold their home in 2000 they put the money in a three-year 7% CD-- FIL jokes that the credit union threw them a party when the CD expired and he almost cried when he had to roll it over at 3%. So they don't need our help with their expenses or their retirement portfolio, and this project is only about designing a LTC bond fund.

They're extremely familiar with my pension, our aggressive 100% stock allocation, and our own frugal lifestyle. They know that we're fine without the gift money. My brother-in-law is a high-earning CPA (he does their taxes) who also invests exclusively in stocks. So the only gift guidance we get is "keep it short & safe". The last gift was delivered with instructions on how to buy an I bond, which we dutifully purchased. Right now this LTC fund is evenly split among I bonds, 2-year T-notes, and a one-year credit-union CD.

Renewal options on the LTC fund aren't exactly juicy. We're looking at one- or two-year credit-union CDs (2.07% & 2.53%, after-tax 1.76% & 2.15% in our 15% bracket), more I bonds (currently 2.19%) or more 2-year notes (1.93%). I understand that we could chase a higher yield with TIPS but, without a plan (yet) and in a taxable account, we're reluctant to hold to maturity. I don't know their tax bracket, but after FIL's 30 years of 70-hour weeks on union overtime I think they're in at least the 25% bracket.

We're not chasing yield or going long & wrong. But if this continues for a couple more decades, I think that we're going to miss a considerable amount of return at the risk of falling behind the inflated health-care costs. My own grandfather spent 14 years in long-term care after decades of neglecting his health, so I can only imagine how many years of LTC my in-laws might endure. (Also a different problem for another discussion.)

OK, so I've recognized the heck out of the problem, but I'm not sure that my parents-in-law have thought about it. So when spouse and I raise this subject with them, what should we suggest? Since I'm retired, I'm concerned that I STILL might hear "Kid, get a job." Given their strong preferences (prejudices?), I'm not going to destroy my credibility by bringing up stocks or annuities or LTC insurance. I think we'd be wise to have a year or two of the LTC fund in MM/CDs with the rest in a ladder until the ladder yields enough to pay the annual LTC expenses. We probably have 10-20 years to spend building a ladder. Since spouse & I hold the funds, we could buy individual bonds (including munis or even corps) to maturity, or use a low-cost bond fund. I tend to favor laddering individual bonds, including I bonds, munis, & short-term corporates, with perhaps some long-term CDs or step-up CDs. Comments & ideas?
Re: Building a short-term bond portfolio for 20+ y

Personally, I like the "KISS" method for bond
investing and would lean to I-Bonds and/or
Vanguard's Short Term Corporate Fund. The
fund pays 2.86% now and has a duration of
about 1.8 years. The I-Bonds pay 2.19% and
you can sell them, if you wish, after 1 year if
real rates spike up. It seems to me that the
tax deferral of I-Bonds is a big plus if you don't
need the income now. You can buy up to $30,000
per year on one SS #.

Good Luck!

Re: Building a short-term bond portfolio for 20+ y

Hey Nords,

In lieu of the 2 year T-notes, I'd favor EE bonds. Tax deferred for 30 years (like I bonds), earn 90% of average of 5 year T-notes for previous 6 months, and guaranteed to double in value in 20 years (Treasury will make a one time adjustment if rates are so low it doesn't happen). After 1 year, fully redeemable (just like I bonds) - with 3 month penalty if cashed in before holding for 5 years.

Also note that you can buy more than $30,000 per year of EE or I bonds. $30,000 in paper (e.g. the gov't sends you the actual paper bonds) EE and $30,000 in paper I bonds, and another $30,000 in paperless EE and $30,000 in paperless I bonds through Treasury Direct. So, that's a total of $120,000 per Social Security Number, until the Treasury discontinues the issue of paper bonds.

Since I and EE bond are redeemable any time after 1 year, you may not need all that much in a MM account/fund. A very, very good feature of I bonds is that if the real rate (currently at a paultry 1.1%) increase, you can just cash in the lower yielding I bonds and purchase higher yielding I bonds (and pay the taxes due of course). It's a nice "put" feature.

You might also find out what "short and safe" exactly means. Can you use ladders of 5 year FDIC insured CD's from a bank, or 5 year CD's from a credit union? If you're in the 15% tax bracket, I'd think that CD's would net a higher after-tax and after-expenses return than munis for you. Also a lot simpler. Does your FIL know the benefits of laddering 5 year CD's vs. just buying a 2 or 3 year CD and then rolling it over when it matures?

I think a combo of laddered CD's, EE and I bonds should be nice and simple and cheap. By staying short (like under 2 years), you are certainly paying a steep opportunity cost.

- Alec
Re: Building a short-term bond portfolio for 20+ y

Does anybody know what happens if you buy more than the allowed limit of ee/i bonds? I ran a small experiment last year that suggested that the limits aren't enforced (just kidding if any T-men are reading this).

And remember, if you buy ee/i bonds, always buy them near the end of the month to get 1-month's free interest (not a huge win, but free is free).

Finally, the treasury doesn't seem to publish how they come up with the base (real) i-bond rate, but it seems to follow the 5-year TIPS yield more or less. 5-year TIPS are now yielding less than 1% real, so that paltry 1.1% might drop even lower in May (although the inflation component might go up a bit).
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