For many years I had about 2-4 years of living expenses in Vanguard's MM fund. I knew that I was missing on some return but it was psychologically comforting to know that if things really turned upside down that safety net was still there. Of course, with the current war on savers having significant funds in MM funds is painful and about a year ago I switched those funds to Vanguards short term bond fund for at least some return (actually per Quicken, not to bad - 3.1% over the last 12 months). So at this point, ST funds look Ok. I'm aware that 10% drops in NAV are not unusual (March 2009) for ST funds but this was short lived. BUT I don't know what I don't know. What are the negatives of this approach?
Is it OK to have cash/near cash in a ST Bond Fund?
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I haven't had any cash in a MM or CD since 6 month CD rates dropped below 5%. I think it is a total waste to keep money totally safe when the rest of the portfolio has risk to it anyways.
So I've kept all this kind of money in short-term bond or GNMA fund. And that means since 2007-2008. The downside is that one's fund can drop in value, but so what? It's not like the rest of your portfolio doesn't fluctuate.
So if you are worried, then just increase the amount in such a fund to cover the contingency that it might drop 10%. For example, if you felt the need to have $50,000 in cash in a CD or MM fund, then have $55,000 in a short-term bond fund.
If retired, 2 to 4 years in a MM? My goodness! How about 2 weeks of expenses in cash and the rest invested? And "invested" includes short-term bonds.
So I've kept all this kind of money in short-term bond or GNMA fund. And that means since 2007-2008. The downside is that one's fund can drop in value, but so what? It's not like the rest of your portfolio doesn't fluctuate.
So if you are worried, then just increase the amount in such a fund to cover the contingency that it might drop 10%. For example, if you felt the need to have $50,000 in cash in a CD or MM fund, then have $55,000 in a short-term bond fund.
If retired, 2 to 4 years in a MM? My goodness! How about 2 weeks of expenses in cash and the rest invested? And "invested" includes short-term bonds.
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ERD50
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A BIG +1!
This whole idea that a few % of one's portfolio in cash somehow provides a huge level of security is simply ridiculous.
It reminds me of the "B" horror movies, where the demon has just survived multiple shotgun hits, hand-grenades, just had a 10,000 gallon tanker trunk of gasoline exploded on him, and then a landslide buries him under 100 ft of gravel, but he still is chasing our young starlet. But she gets to her house, runs to her bedroom and shuts the hollow core door behind her, and breathes a sigh of relief - "I'm safe now!". Sure, a couple of 1/8" pieces of plywood and cardboard are going to keep her safe. Right. As the demons hand crashes through the door, our starlet screams....
It doesn't work in the movies, and it won't work in real life.
Do the math, a few % in cash - what does it really do for you?
I keep enough in MM/checking that if required, I would be able to write a check, and not worry about a delay in transferring funds. But since most expenses can be put on credit card, the float would take care of that also. Relax.
-ERD50
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Well, yes, I've been retired for 10 years now. MM funds used to return about 3-4% a year or so before the war on savers started so it wasn't a total loss. But now the short term bond fund seems like a reasonable alternative albeit with more risk. I know there is no rational justification for so much cash/near cash but I sleep better when I have that sort of a balance so an irrational justification will have to do.
Chuckanut
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I have kept 'cash' in the short-term bonds and GNMA for several years. Today, even with a 10% drop in value, at worst I would break even. I still do have some $$'s in MM simply because I will soon need them as part of my retirement plans.
I like your movie scenario it's certainly visceral... your question "Do the math, a few % in cash - what does it really do for you?" is a good one. Actually my understanding is that cash worked rather well around 1929 or so and for a a number of years afterwards. 4 years of core expenses in cash represents about 7% of my current net worth. It's not insignificant but not the end of the world if it doesn't earn world beating returns. And as I said before it lets me sleep well at night rational or not. My question is a ST bond near enough to cash?
rescueme
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I'm with you on this one, regardless of any perceived loss.
DW/I have 3-4 years of gross retirement income (includes taxes due) in cash due to being fairly conservative beings. The market can do what it will (both in equity and bond holdings); however we sleep well knowing that we will never have to sell in an extended down market.
It's just in our DNA and how we do it at this time. OTOH, when my DW's two small pensions start in just over a year, and our respective SS income starts a year later, the amount of actual cash held will drop considerably.
I've been operating in this manner for the five years I've been retired and have yet to question myself on the matter.
And no, I would not personally use ST Bonds to "act" as cash.
Just my/our POV on the question.
Aiming_4_55
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Since this is for emergency fund... cash....
Would most hold the Short Term bond in their taxable or tax advantage account?
I probably have close to 2 years in emergency cash with 1/2 from rental income. It does help me sleep at night.... still a working stiff, so it increase when I semi-ER or ER.
Would most hold the Short Term bond in their taxable or tax advantage account?
I probably have close to 2 years in emergency cash with 1/2 from rental income. It does help me sleep at night.... still a working stiff, so it increase when I semi-ER or ER.
Thank you for your view. I'm thinking of starting SS at the end of this year when I turn 62 and I hadn't thought about the impact collecting SS would have on my psychological need for a large "just in case" cash balance but I think you are quite right - once SS starts rolling in I should be able to invest the equivalent funds in longer term securities since I wouldn't need the monthly cash from my investments . Thank you!
urn2bfree
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Bond funds can lose value. The whole point of cash is to avoid having to sell anything at a significant loss to pay expenses. So no, short term bonds are not the same as cash. While cash does not grow, it mainly "loses" value with inflation, but so do bonds, so I think the idea of keeping cash to bonds to pay expenses to avoid selling during downturns is not a bad idea.
I understand your rationale, but if history is a guide you'll need more than 3-4 years in cash if you want to "never have to sell [equities] in an extended down market." Even with dividends.
rescueme
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I'm using our actual investment history as a guide on this point.
I have complete records on our investments from 1982 through today. For more than three decades, we have had only three down years - 2001, 2002, and 2008.
Since we only had one occurance of back to back down years, we doubled that occurance and that's the reason why we have the 3-4 year stash in cash. It's not based upon "investment history" of the market, but rather our personal way of investing, and the results obtained.
BTW, we actually have more than that 3-4 years (actually 3 4 me, 4 for DW) since we have not accounted for my DW's pensions nor our respective SS income noted previously, which starts over the next two years.
Looking at our indivudial cashflow, assuming DW would have her pension/SS available today, she would have a decade of cash (yes, 10 years) of gross income available. So in her (and my) case, her actual long term can be stated that she currently has in excess of four years of gross income available.
We're not "harvesting" any more and directing to cash (something we both did, around five years before our respective retirements and as needed to maintain our cash levels during retirement), but just adjusting between equity/bond - rather than equity/bond/cash for the next few years until all our income sources come "on-line". And no, we don't use dividends for income. All distributions are reinvested into additional shares and sold/re-allocated based upon our own overall personal AA.
BTW, our actual cash held (as a percentage of our total joint portfolio value) is really not that high. It's not like we are exposing the vast majority of our "number" to possible inflation risk over the short term.
Anyway, it works for us; and really, that's all that matters IMHO...
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brewer12345
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I keep almost 10 percent of my portfolio in cash, CDs and I bonds. Bond funds are not the same thing.
harley
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I'm curious, were you retired during those down years? Because if you were working and adding to the portfolio that would pull you back up a lot faster. Whereas in retirement those down years might be extended if all you were doing was withdrawing and not adding. Just a point to consider. It sounds like you've got a pretty good buffer in there.
Lsbcal
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What has been the worst 12 month return on the Vanguard Short Term Investment Grade bonds?
Answer: from Dec 1991 through March 2012, the worst 12 month returns has been -5.7%. That was in Dec 2008.
So it wasn't even a -10% loss. I don't see any problem with having much of your short term spending needs in an ST bond fund. Generally you'd have graduated fixed income levels: (1) some actual cash, (2) some ST bond funds, (3) some intermediate bond funds. This would be my choice for the current low rate environment assuming you aren't already holding some of those older high yield CD's, Ibonds, etc.
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BTW, that worst 12 mo loss was followed by a great period of returns. The best 12 mo return was in Nov 2009, +15.9%. The compounded average return over the last 20 years has been 5.6%.
Some rising rate period returns for ST Investment Grade:
From May 2004 to May 2006 cash went from 1.0% to 5.1%, VGSTX returned 1.9%.
For 1994 cash went from 2.8% to 5.9%, VGSTX returned 0.0%.
Answer: from Dec 1991 through March 2012, the worst 12 month returns has been -5.7%. That was in Dec 2008.
So it wasn't even a -10% loss. I don't see any problem with having much of your short term spending needs in an ST bond fund. Generally you'd have graduated fixed income levels: (1) some actual cash, (2) some ST bond funds, (3) some intermediate bond funds. This would be my choice for the current low rate environment assuming you aren't already holding some of those older high yield CD's, Ibonds, etc.
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BTW, that worst 12 mo loss was followed by a great period of returns. The best 12 mo return was in Nov 2009, +15.9%. The compounded average return over the last 20 years has been 5.6%.
Some rising rate period returns for ST Investment Grade:
From May 2004 to May 2006 cash went from 1.0% to 5.1%, VGSTX returned 1.9%.
For 1994 cash went from 2.8% to 5.9%, VGSTX returned 0.0%.
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rescueme
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I retired in early 2007, so one of the three down years was during retirement. Remember however that it didn't matter since we do have a good cash buffer.
BTW, all returns are computed on an XIRR basis, so contributions are not counted as part of the actual returns received.
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eytonxav
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IMHO, being able to sleep at night given your portfolio composition is a very rationale justification for keeping a cash buffer. I keep more than most and its always good to have some dry powder.
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So I can go back to 2007 and see the returns. Even if I lost 10% tomorrow, I am still ahead. For those folks sitting in 1% or 0.01% funds, you are losing money every day to inflation. Just because you cannot see it, does not mean it is not happening.
All our fixed income is found in tax-advantaged accounts. We like equities in taxable in order to be able to tax-loss harvest and there are no taxes on unrealized cap gains.
If I have an emergency, I would just sell equity fund shares in taxable and buy the same shares (or similar) in tax-advantaged at the same price, so I just do not care if I have to sell low because it just does not matter.
I guess I didn't read anything here I wasn't already aware of, but I guess I'm going to throw that one years worth of cash into the short term bond fund. Losing some of it to interest rate increase driven drop in NAV would be ... insignificant. Especially over the longer term of a retirement.
When I enter ER, I want to have about 2-3 yrs of living expenses in CASH, meaning CD and other easily accessible instruments. I perceive our annual
budget for living expenses are lower compared to others, but would like to have the convinience of easy access without the hassle of trying to time the market or getting out of the wrong time.
While living with the budget, then we are free to do our AA adjustment and then again, slowly pour more money out to have another 2- 3 years.
Having a little cushion helps in terms of emergency expenses, health problems, and other unforseen big expenses.
budget for living expenses are lower compared to others, but would like to have the convinience of easy access without the hassle of trying to time the market or getting out of the wrong time.
While living with the budget, then we are free to do our AA adjustment and then again, slowly pour more money out to have another 2- 3 years.
Having a little cushion helps in terms of emergency expenses, health problems, and other unforseen big expenses.
walkinwood
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If frequently sell shares to meet your short term needs, be aware that you may run afoul of wash-sale rules if you have your fund set for automatic dividend re-investment.
Eg. you sell a chunk of shares at a loss today (4/2) and then your reinvestment buys shares on 4/30.
Keep careful records and don't reinvest dividends in a fund used to fund short term, frequent needs.
Eg. you sell a chunk of shares at a loss today (4/2) and then your reinvestment buys shares on 4/30.
Keep careful records and don't reinvest dividends in a fund used to fund short term, frequent needs.
rescueme
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Just remember that this refers to taxable (not tax-deferred) situations.
Since our investments used for retirement income are all tax deferred, taxes are at our normal FIT rate and long/short tax techniques do not apply. The rest of our holdings are in Roth IRA's that we probably will not tap for the forseeable future - if ever.
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So, other than the potential ~ 10% drop in NAV or so (Which might not really apply except for a short period of time and to a limited portion of the ST fund portfolio - I would only sell as needed for core expenses over many months) what are the other got ya's for ST bond funds aka Vanguard Short term Investment fund?
As I see it, cash pays nothing, CD's lock you in to low rates and there are penalties for early withdrawal, I bonds are a no-no in taxable accounts ( my ST bond fund is in a taxable account)
