Effect of cash assets on Stock/Bonds ratio

[briang_g]

Assume a percentage of assets are tied up in cash for whatever reasons (10 year CD’s. Annuities, personal preference, etc). This percentage may be small (around 10%, or large, around 50%)

The remaining assets will be invested in the Market using the Bogleman approach.

Assume that the starting point ratio for the Bogleman assests to be a totally standard split of Stocks (domestic and international), and Bonds based on age.

How should that standard ratio of assets be adjusted to account for the large cash position ?


On one hand, I was thinking since there are other safe assets (the cash), that the percentage of bonds could be make smaller or even 0.

On the other hand, something I saw on here was that the bonds are not just in the portfolio to be conservative, but are in the portfolio to be a “counter-weight” to the stocks (stocks go up, bonds go down, and visa versa).

Peoples thoughts ?

From my point of view, I am ultra conservative and in my mid 40’s. Although it goes against the conventional wisdom, I wont be able to sleep at night with most of my assets in the Market. My thought process (however flawed), is that I can live (and sleep at night) with the almost 100% certainty that my captial will be depreciated due to inflation, but I cant live (or sleep), with the knowledge that my entire portfolio might lose half its value (2008) and never make it up (at some point, 10 years from now, 50 years from now, the economy will shrink, and we wont be able to make the money back. That what I think at least, but what do I know?)

On the other hand, I want to have SOME assets in the market, and I want to handle those assets using the Bogleman philosophy.

[jhd]

Cash is effectively a short-duration fixed income investment. 30-day T-bills (bonds of 30 day maturity) are considered to be cash or cash-like. So it is reasonable to consider cash to be a part of your fixed-income assets.

So if you want a 50/50 portfolio of $200,000, and you have $50K in cash, you could hold $100K in stock, $50K cash, and $50K in a bond index. If you were to exclude the cash, you effectively end up with 37.5% in equities ($75K), and 62.5% in fixed income ($50K cash, $75K bonds).

However, this only makes sense for long-term holdings. If you have $50K in cash for a down payment on a house in a year or two, that probably shouldn't be part of your long-term AA. And reasonable people disagree as to whether an emergency fund should be part of an overall AA or outside of it.

[nisiprius]

Assume a percentage of assets are tied up in cash for whatever reasons (10 year CD’s. Annuities, personal preference, etc). This percentage may be small (around 10%, or large, around 50%)

1) I'm puzzled with the concept of "tied up in cash." To me--this is a personal definition and might not match any official definition--the two essential characteristics of a near-cash asset are that it is liquid and that it never declines in dollar value.

2) I tend to think of my portfolio in terms of "stocks" and "not-stocks." I feel that the difference between stocks and bonds is much larger than the difference between bonds and cash. To a rough approximation, yes, I think, you can sort of lump bonds and cash together.

3) I seriously doubt that differences in stock allocation of less than 10%, 15%, maybe even 20% are of any real practical importance. I base this on the observations that a) Vanguard does not think it needs to have more than four LifeStrategy funds; b) Books that give suggested allocations for different life stages, e.g. Burton Malkiel's A Random Walk Down Wall Street, typically suggest about four.

[briang_g]

1) I'm puzzled with the concept of "tied up in cash." To me--this is a personal definition and might not match any official definition--the two essential characteristics of a near-cash asset are that it is liquid and that it never declines in dollar value.

As you point out, I didnt put that correctly. I should have simply said its cash that I dont want to invest in either stocks or bonds becasue I desire the absolute security of cash.

[dbr]

1) I'm puzzled with the concept of "tied up in cash." To me--this is a personal definition and might not match any official definition--the two essential characteristics of a near-cash asset are that it is liquid and that it never declines in dollar value.

As you point out, I didnt put that correctly. I should have simply said its cash that I dont want to invest in either stocks or bonds becasue I desire the absolute security of cash.

But the point is that the highest level in the hierarchy of risk/return is, as nisi pointed out, stock (risky)/not-stock (not risky). For the stock bond allocation cash IS bonds. If you want 50% stock, your allocation would look like 50/25/25 stock/bonds/cash, or whatever it is. There is nothing exactly wrong with going to the second step and partitioning "not risky" into actual bonds and cash if you want to do that. There is something a little bit wrong with that which is that it misses that cash is really just an extreme end of a continuum of risk and return for debt instruments on a scale of return, volatility, liquidity, and so on. Cash holding is at maximal inflation risk, for example, a problem that can be avoided with certain types of bonds, but at other kinds of risk.

[PoeticalDeportment]

There is good "tied up in cash" and there is bad "tied up in cash" i.e. actual cash (which loses ~2% per year of purchasing power).

Usually, I only think of EE bonds and I bonds as being good investment choices after exhausting all tax advantaged space, but for someone with your risk preferences, they may be able to play a more prominent role in your portfolio. I would consider these to be good (maybe even the best in our current environment) "tied up in cash." Plus, you can call these part of the "bond" portion of your portfolio (rather than just having money on the sidelines).

Backed by the full faith and credit of the US government.

Wiki article link: I Savings Bonds
Wiki article link: EE Savings Bonds

[RyeWhiskey]

From my point of view, I am ultra conservative and in my mid 40’s. Although it goes against the conventional wisdom, I wont be able to sleep at night with most of my assets in the Market. My thought process (however flawed), is that I can live (and sleep at night) with the almost 100% certainty that my captial will be depreciated due to inflation, but I cant live (or sleep), with the knowledge that my entire portfolio might lose half its value (2008) and never make it up (at some point, 10 years from now, 50 years from now, the economy will shrink, and we wont be able to make the money back. That what I think at least, but what do I know?)

On the other hand, I want to have SOME assets in the market, and I want to handle those assets using the Bogleman philosophy.

You are conducting what most people call basic "risk tolerance." You're basically saying that you can't stomach 100% stocks, or even 100% stocks/bonds. This is fine and totally normal - especially since you qualify yourself as "ultra-conservative."

If you were to ask me personally what I think you should do given what you've stated above, I would recommend you consider (perhaps as a starting point) a relatively even split between stocks, bonds, and cash. So if you had, say, $100,000, you'd have:
- $35,000 in the either the Total US Stock Market Index or the Total World Stock Market Index (I'd pick the latter)
- $35,000 in the Total US Bond Market Index
- $30,000 in I-Bonds/CDs/Short-Term Treasuries.
With this allocation you are neither all-in, nor all-out, and re-balancing will be simple. BUT, this is just my opinion, it is up to you to decide how much risk you can take with any given asset. Many people here will lump the latter two asset classes into one, thereby giving you a 35/65 split between stocks/non-stocks and this is a rather conservative allocation for someone in their mid-40s. Common Boglehead wisdom would advocated the opposite really, something along the lines of 60/40 stocks/bonds - perhaps in a nicely diversified Vanguard Life Strategy Fund. But at this point you'd need to consider where your assets are located, tax-shelters, etc... and that's a whole new set of questions.