Start building I-Bonds reserve?

[BlueberryPie]

I'm 10 years from retirement. Current AA is 60/38.5/1.5, the 1.5% cash being frictional cash in my various accounts (brokerage, IRA, 401(k)...)
The 1.5% is mostly left from working with an advisor that would automatically assign 1.5-2%% of each account to cash.

I have a separate 6-month income replacement emergency fund (so more than 6 months living expenses if you tighten the belt). That is sitting in I-Bonds (all liquid because they are more than a year old).

I hear that as people are getting closer to retirement they keep 1-3 years in cash so they dont have to dip in their portfolio during down markets. The down side is that 1-3 years of cash can create a pretty significant drag. For example 3 years of cash would be 15% of my portfolio today.

I'm wondering if I should start building that cash reserve slowly over 10 years, and one way to do that would be to buy I-Bonds, it has a natural max yearly limit, and is at least guaranteed to keep up with inflation. On the other hand if I buy $20k I-Bonds every year, it's money I'm not investing in my 60/40 portfolio, so I am missing the returns on that instead.

To be clear, i would still max out my 401(k) and HSA. But I am proposing i would take the money i invest in my taxable account (about $20K/year) and buy I-Bonds instead.
I would keep very little cash in the retirement account or brokerage to reduce the drag on those (less than 1%)

I am no longer working with an advisor, so not sure if it's a wise choice.

Portfolio (not NW) in the low 6-figures if it matters...

 

[mystang52]

I hear that as people are getting closer to retirement they keep 1-3 years in cash so they dont have to dip in their portfolio during down markets. The down side is that 1-3 years of cash can create a pretty significant drag. For example 3 years of cash would be 15% of my portfolio today.

I'm wondering if I should start building that cash reserve slowly over 10 years, and one way to do that would be to buy I-Bonds, it has a natural max yearly limit, and is at least guaranteed to keep up with inflation. On the other hand if I buy $20k I-Bonds every year, it's money I'm not investing in my 60/40 portfolio, so I am missing the returns on that instead.

.

I never give specific financial advice, but only my general opinion on how to decide. That decision process should be driven by what allocations you want in cash. And one chooses a cash allocation for various reasons, knowing there is a tradeoff between principle conservation and market participation. The stock market has done very well in recent times, but it's never guaranteed.
FWIW I have a significant cash position, because that is my comfort level. You should assess what your comfort level is, and only then decide how to achieve that. Again FWIW I think I Bonds are a great cash vehicle.

 

[OldShooter]

... On the other hand if I buy $20k I-Bonds every year, it's money I'm not investing in my 60/40 portfolio, so I am missing the returns on that instead. ...

With respect, that is a false premise. Your I bonds will be part of your portfolio, so the ratio can continue to be whatever you want it to be. If you want it to be unchanged that is as simple as selling $10K from your fixed income tranche each time you buy a $10K I-bond.

Another thing I have mentioned here before is that I think that to be meaningful an I-bond or TIPS strategy has to be a serious part of one's assets. "Go big or go home" IOW. I don't know how a 5% position (sometimes mentioned here) could be of any significant help if serious inflation flares. FWIW almost all of our fixed income position is in TIPS. I-bonds are arguably a better deal but the low purchase limits make them fairly irrelevant to our strategy.

 

[BlueberryPie]

Yes and no. That's saying that 60/0/40 allocation is the same as 60/40/0 isn't it? I know that bonds are in the dumps now but they have historically return more than cash, so cash still is a larger drag than bonds (and ballast/safety against wild swings in stocks).
I suppose it's really whether you think iBonds are closer to cash or closer to say, medium term bonds in terms of what they do in your portfolio.
I think that's really what I'm struggling with, maybe it does help to think of them as part of my bond allocation in the 60/40 split. If I buys $20k (or even $30k a year since we have a RLT) that's over $2/300k over the next 10 years, so a nice cushion (over 3 years in today's money, so in theory in 10-years from now money too since I-Bonds keep that money's buying power constant).

I do agree that to be meaningful you want a sufficient weight, which is why I think I need to start now if I want to use that as a mechanism for my 3 years cash reserves.

 

[OldShooter]

Yes and no. That's saying that 60/0/40 allocation is the same as 60/40/0 isn't it? I know that bonds are in the dumps now but they have historically return more than cash, so cash still is a larger drag than bonds (and ballast/safety against wild swings in stocks).
I suppose it's really whether you think iBonds are closer to cash or closer to say, medium term bonds in terms of what they do in your portfolio.
I think that's really what I'm struggling with, maybe it does help to think of them as part of my bond allocation in the 60/40 split. If I buys $20k (or even $30k a year since we have a RLT) that's over $2/300k over the next 10 years, so a nice cushion (over 3 years in today's money, so in theory in 10-years from now money too since I-Bonds keep that money's buying power constant).

I dunno. I have always viewed the debates between "cash" and other fixed income assets as hair-splitting.

For me, my only cash is in my wallet. Our fixed income investments vary in volatility, risk, return, maturity date, etc. in a mix that is suitable to our expected needs. We have started on a new home build and hence will have need beginning in September for chunks of cash to pay the contractor, so we have a bunch of money parked in VUBFX. Is that "cash?" I don't care. YMMV, however.

 

[friar1610]

^ this.

A lot of people want to assign I-Bonds to their cash allocation instead of their bond allocation. I mentally substitute “fixed income” as the label for the category into which bond funds, I-Bonds and CDs go. Each of those has somewhat different characteristics so I think of it as diversification within the fixed income asset. (I think of cash as only savings/checking/MM accounts, although I guess technically cash is another form of FI.

ETA: the up arrow in my post was intended to point to Old Shooter’s post #3. But it just as easily could have pointed to his #5.

 

[Montecfo]

Agreed. I do not have a "cash allocation". Cash is part of my fixed income. So investing in i-bonds within that allocation does not change anything.

And I-bonds are not "cash". They are bonds which can be sold/redeemed subject to their terms.

I have been negative on i-bonds in the past, mainly because the amount you may invest is so limited, and they do not have a great track record relative to other bonds, as I see it.

But I am warming to them as diversification and as part of a long term portfolio building strategy. I think the in inflation surge we are experiencing is temporary but I also think we could be north of 2 percent for a while, for a variety of reasons. While you can't buy enough to hedge meaningfully against inflation, it is a safe way to get some rate diversity. And you may reevaluate every year.

 

[OldShooter]

... they do not have a great track record relative to other bonds, as I see it. ...

That doesn't bother me a bit. We pay annual insurance premiums for fire insurance on our houses. The return difference between I-bonds and TIPs vs normal treasuries is, for us, the annual insurance premium we pay for inflation insurance.

Also, the yield difference between TIPS and treasuries is IMO routinely overstated by the nature of the YTM calculation, which does not take into consideration even inevitable inflation (maybe 2%) effect on the interest payments and principal value. I have never looked hard at I-bonds, but I'd expect to see a similar problem.

 

[Montecfo]

That doesn't bother me a bit. We pay annual insurance premiums for fire insurance on our houses. The return difference between I-bonds and TIPs vs normal treasuries is, for us, the annual insurance premium we pay for inflation insurance.

Also, the yield difference between TIPS and treasuries is IMO routinely overstated by the nature of the YTM calculation, which does not take into consideration even inevitable inflation (maybe 2%) effect on the interest payments and principal value. I have never looked hard at I-bonds, but I'd expect to see a similar problem.

You have made a long-term commitment to I-bonds long ago. Accordingly you regularly self validate that decision.

Fine, but we have a lot of time over which to determine how that has worked out and whether such insurance is necessary. Structural low growth rates say it will not be absent something extraordinary.

But currently the premium is negative, which is part of the basis for my warming to I-bonds.

 

[OldShooter]

You have made a long-term commitment to I-bonds long ago. Accordingly you regularly self validate that decision.

Fine, but we have a lot of time over which to determine how that has worked out and whether such insurance is necessary. Structural low growth rates say it will not be absent something extraordinary.

But currently the premium is negative, which is part of the basis for my warming to I-bonds.

Not sure what "self validate" means. I have explained our rationale a number of times and it has not changed.

Re " ... we have a lot of time over which to determine how that has worked out and whether such insurance is necessary. " Do you buy fire insurance on your home? For how many years have you done this? After all those years have you decided it is not necessary?

Re "something extraordinary." Exactly. Extraordinary things happen all the time. Sometimes even in macroeconomics.

 

[Montecfo]

Not sure what "self validate" means. I have explained our rationale a number of times and it has not changed.

Re " ... we have a lot of time over which to determine how that has worked out and whether such insurance is necessary. " Do you buy fire insurance on your home? For how many years have you done this? After all those years have you decided it is not necessary?

Re "something extraordinary." Exactly. Extraordinary things happen all the time. Sometimes even in macroeconomics.

I do not find the fire insurance analogy apt, since my investment home is not made of flammable materials. But I'm not against it, I just think you like it because it is yours.

Extraordinary things do not happen all the time. Ordinary things do. And we have been in a very sedate inflation environment for decades.

 

[mrfeh]

I'm wondering if I should start building that cash reserve slowly over 10 years, and one way to do that would be to buy I-Bonds, it has a natural max yearly limit, and is at least guaranteed to keep up with inflation. On the other hand if I buy $20k I-Bonds every year, it's money I'm not investing in my 60/40 portfolio, so I am missing the returns on that instead.

Buy the IBonds and consider them part of your fixed income.

Why would you not view them as part of your entire portfolio?

 

[BlueberryPie]

I figured out how to get the Personal Capital site (free tools) to classify I-Bonds as Govt bonds in the portfolio instead of cash as I had it set up before. It will help me consider them as part of the fixed income section. They are the conservative(safe)/inflation-protected portion of my field income. Currently a little over 1.5% of my total investment portfolio, but a proportion that will grow over time as I buy more, even though other components of the portfolio should (historically / on average) grow at a faster rate, but the I-bonds provide stability regardless of market conditions.

I also have a Stable Value Fund in my 401(k) so it could be another vehicle to supplement iBonds