Sanity check for retiree asset allocation heavy on CDs

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AtomicCash
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Sanity check for retiree asset allocation heavy on CDs

Post by AtomicCash » Sun Jul 01, 2018 9:50 pm

I'm looking for a sanity check on my asset allocation.

Here is some quick background:
-My wife and I are both retired.
-I'm currently collecting one pension. I'll start collecting a second pension in 10 years.
-My wife is currently collecting one pension and SS.
-I have multiple years of detailed retirement living expenses to use for forecasting purposes.

56% of my portfolio is in tax advantaged accounts.
44% of my portfolio is in taxable accounts.

Overall, my asset allocation is:
23% domestic stock
10% international stock
30% bonds (not including CD's)
37% CD's and savings accounts (spread out to maintain FDIC coverage)

All the CDs are in the taxable part of my portfolio and are set up in a 2 year ladder with about 10 rungs. My current weighted average return on the CD's is 1.89% but will be over 2% by next month.

Using a forecasting spreadsheet I built, along with a couple other online tools for verification, I believe that I have enough money in CD's alone to outlast me if I can maintain at least a 1.5% return on the CD portion of my portfolio. So I feel that no matter what happens to the rest of my portfolio, I'm under no pressure to panic or sell.

Is there a major risk here that I'm missing? Or does this asset allocation seem reasonable for someone in my position?

Thanks,
Marc

PhilosophyAndrew
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Re: Sanity check for retiree asset allocation heavy on CDs

Post by PhilosophyAndrew » Sun Jul 01, 2018 10:02 pm

Marc, some additional details might be helpful:

How large is your expected spending?

How large is your portfolio?

Do you have any debts?

How large are your pensions?

Will you also receive social security?

How much does your wife receive from her pension and social security?

How old are you and your spouse?

Do you plan to leave a bequest for heirs or charities?


Adding details like these might make it easier for others to assess your planning.

Andy.

Quaestner
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Re: Sanity check for retiree asset allocation heavy on CDs

Post by Quaestner » Sun Jul 01, 2018 10:18 pm

Taking a risk at reading between the lines, without knowing key details, it looks like your various pensions and social security will meet your essential expenses (?). So, you don't need to take much risk with the rest of your money. You COULD take on more risk (stocks), but you don't need to. Importantly, your 33% stock allocation might help you keep up with inflation - which is a big risk for you. (Do the pensions have COLAs?) You seem to be risk averse and like that FDIC protection on the CDs. Nothing wrong with that - sleeping soundly is good! Maybe you'll sleep even better if you don't look at the CD rates and just keep on with your laddering plan?

Steve

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AtomicCash
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Re: Sanity check for retiree asset allocation heavy on CDs

Post by AtomicCash » Sun Jul 01, 2018 11:31 pm

PhilosophyAndrew wrote:
Sun Jul 01, 2018 10:02 pm
...
Adding details like these might make it easier for others to assess your planning.

Andy.
Quaestner wrote:
Sun Jul 01, 2018 10:18 pm
Taking a risk at reading between the lines, without knowing key details,
...
Steve
Thanks for the replies. It wasn't my intention to make you read between the lines. Sorry.

Here's more background and some answers to your questions:
-I have no debt.
-My first pension does have a COLA. It covers the full CPI increase (for the LA and San Fran metro areas) up to the first 2%. And then 75% of any CPI increase between 4% to 7%. My second pension has no COLA.
-Leaving money to my heirs would be great, but spending my last penny when I draw my last breath would be fine too. My kids are proudly independent.
-My forecasting spreadsheet extends out until I'm 100.
-For my expenses, I'm using my current essential and discretionary expenses inflated at 3% each year.
-For my income I'm using my pensions (one has begun and one will start in 10 years) and SS (which I plan to draw in 10 years)
-For the difference between my income and expenses each year, I'm using my CD's and savings account.
-If my CD's and savings have a weighted average return of 1.5%, my forecasting spreadsheet shows that I never run that account dry.
-My wife's pension and SS aren't part of my calculation. She likes her "own" discretionary income. Our discretionary expenses like vacations, entertainment, and dining out (and all our essential expenses) are part of "our" expenses that I use in my forecasting spreadsheet. :D

Marc

averagedude
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Re: Sanity check for retiree asset allocation heavy on CDs

Post by averagedude » Mon Jul 02, 2018 5:08 am

Seems to me that your allocation is reasonable as it will accomplish your income needs and goals. Great job of planning. I like the fact that you are spending your savings and CD's to support your income needs right now. I would suggest that you determine your asset allocation between stocks and bonds, which seems reasonable now, and rebalance yearly. The way i see your plan, you have a glide path where your stocks are gaining slightly every year and this should give you inflation protection. You should enjoy the rest of your life with no financial worries.

22twain
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Re: Sanity check for retiree asset allocation heavy on CDs

Post by 22twain » Mon Jul 02, 2018 6:17 am

Have you tried Firecalc? It will give you a sense of the potential variability in your outcomes, based on historical data. There's a section where you can adjust the portfolio composition to match yours more closely.

I once spent a lot of time working up my own spreadsheet to project my portfolio balance, but it (and I expect yours as well) can only predict a "typical" or "average" outcome.
My investing princiPLEs do not include absolutely preserving princiPAL.

carolinaman
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Re: Sanity check for retiree asset allocation heavy on CDs

Post by carolinaman » Mon Jul 02, 2018 6:32 am

You seem to be in very good shape. Congratulations!

One thing to consider is high inflation. We have been in a long period of low inflation but that could change. What would the impact of high inflation, 4 to 5% or higher have on your expenses and your CD income?

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tennisplyr
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Re: Sanity check for retiree asset allocation heavy on CDs

Post by tennisplyr » Mon Jul 02, 2018 6:40 am

These tools might also be helpful.

https://www.portfoliovisualizer.com/
Those who move forward with a happy spirit will find that things always work out.

Rogue Wave
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Re: Sanity check for retiree asset allocation heavy on CDs

Post by Rogue Wave » Mon Jul 02, 2018 6:57 am

You mentioned spreading around your CDs and cash to stay under FDIC limits.

Good tool to use to see how much you can have insured at one bank: https://www5.fdic.gov/edie/

For instance, 2 joint owners with 3 pod beneficiaries = $1.5M insured.

dbr
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Re: Sanity check for retiree asset allocation heavy on CDs

Post by dbr » Mon Jul 02, 2018 8:51 am

Some possible issues to anticipate (also mentioned in part by others):

1. Inflation. This depends on whether that pension income is COLA'd or fixed. If it is fixed you should run some models such as FireCalc to get a feel for what inflation has done in the past to retirement situations.

2. Contingency in expenses. You should stress test your forecasts in case you are off in estimating routine expenses or you haven't allowed for major contingencies.

3. If your plan is robust and you have lots of assets you don't need, what is your thinking about what you are going to do with all that wealth.

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AtomicCash
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Re: Sanity check for retiree asset allocation heavy on CDs

Post by AtomicCash » Mon Jul 02, 2018 9:06 am

Thanks guys and gals. I appreciate all the feedback.
averagedude wrote:
Mon Jul 02, 2018 5:08 am
... I would suggest that you determine your asset allocation between stocks and bonds, which seems reasonable now, and rebalance yearly. ...
Good advice. I've been a little lax on my rebalancing efforts.
22twain wrote:
Mon Jul 02, 2018 6:17 am
Have you tried Firecalc? It will give you a sense of the potential variability in your outcomes, based on historical data. There's a section where you can adjust the portfolio composition to match yours more closely.

I once spent a lot of time working up my own spreadsheet to project my portfolio balance, but it (and I expect yours as well) can only predict a "typical" or "average" outcome.
Very true that my spreadsheet can only project one outcome. I have used firecalc. My other primary online tool is Fidelity's retirement planner. It allows me to input my multiple pensions at different times with our without COLA. And it uses Monte Carlo simulation with choice of "significantly below average", "below average", and "average" market conditions. It also has a nice RMD chart based on my tax-advantaged accounts. But it can be a little slow and cumbersome to make changes.
carolinaman wrote:
Mon Jul 02, 2018 6:32 am
...One thing to consider is high inflation. We have been in a long period of low inflation but that could change. What would the impact of high inflation, 4 to 5% or higher have on your expenses and your CD income?
Yes, thanks for pointing that out. Inflation is my biggest concern. I hope I'm mitigating that risk somewhat by keeping my CD ladder short (2 years) so I can take advantage of rising interest rates during inflationary periods.
tennisplyr wrote:
Mon Jul 02, 2018 6:40 am
These tools might also be helpful.

https://www.portfoliovisualizer.com/
Wow, that's a fantastic site! I haven't stumbled on it before but I think it will help me visualize a lot of things.
Rogue Wave wrote:
Mon Jul 02, 2018 6:57 am
...
Good tool to use to see how much you can have insured at one bank: https://www5.fdic.gov/edie/
...
Thanks for that link. My approach so far has been to buy brokered CD's and just make sure no two names are the same. :-)

Marc

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AtomicCash
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Re: Sanity check for retiree asset allocation heavy on CDs

Post by AtomicCash » Mon Jul 02, 2018 9:23 am

dbr wrote:
Mon Jul 02, 2018 8:51 am
Some possible issues to anticipate (also mentioned in part by others):

1. Inflation. This depends on whether that pension income is COLA'd or fixed. If it is fixed you should run some models such as FireCalc to get a feel for what inflation has done in the past to retirement situations.

2. Contingency in expenses. You should stress test your forecasts in case you are off in estimating routine expenses or you haven't allowed for major contingencies.

3. If your plan is robust and you have lots of assets you don't need, what is your thinking about what you are going to do with all that wealth.
Thank you. That's a good summary of the situation.
1) My first pension (that I'm currently collecting) does have a COLA. But there is still some risk there because it covers the full CPI increase up to the first 2%, and then 75% of any CPI increase between 4% to 7%. So for example, if inflation is 3%, I'll only get a 2% COLA increase that year.
2) I do have some contingency built into my estimated expenses. We're currently under-spending our "budget" by about 16% (please don't tell my wife!). I feel pretty confident in my expense numbers because it's based on multiple years now that include vacations, buying a new car, etc.
3) Hopefully I have a decade or two to decide what to do with my wealth. The kids will obviously get some. But my wife and I have talked about setting up a scholarship fund at our alma mater. We don't have anywhere near the kind of money to have building named after us. But maybe we could help some kids by having $10k scholarships given out in our name.

Marc

dbr
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Re: Sanity check for retiree asset allocation heavy on CDs

Post by dbr » Mon Jul 02, 2018 9:29 am

AtomicCash wrote:
Mon Jul 02, 2018 9:23 am
dbr wrote:
Mon Jul 02, 2018 8:51 am
Some possible issues to anticipate (also mentioned in part by others):

1. Inflation. This depends on whether that pension income is COLA'd or fixed. If it is fixed you should run some models such as FireCalc to get a feel for what inflation has done in the past to retirement situations.

2. Contingency in expenses. You should stress test your forecasts in case you are off in estimating routine expenses or you haven't allowed for major contingencies.

3. If your plan is robust and you have lots of assets you don't need, what is your thinking about what you are going to do with all that wealth.
Thank you. That's a good summary of the situation.
1) My first pension (that I'm currently collecting) does have a COLA. But there is still some risk there because it covers the full CPI increase up to the first 2%, and then 75% of any CPI increase between 4% to 7%. So for example, if inflation is 3%, I'll only get a 2% COLA increase that year.
2) I do have some contingency built into my estimated expenses. We're currently under-spending our "budget" by about 16% (please don't tell my wife!). I feel pretty confident in my expense numbers because it's based on multiple years now that include vacations, buying a new car, etc.
3) Hopefully I have a decade or two to decide what to do with my wealth. The kids will obviously get some. But my wife and I have talked about setting up a scholarship fund at our alma mater. We don't have anywhere near the kind of money to have building named after us. But maybe we could help some kids by having $10k scholarships given out in our name.

Marc
I don't think you are missing a major risk except possibly a stress test for major set-backs such as debilitating, expensive, long term illness, for example. Part of the good news is that those CDs are currently earning low yields, so your position is conservative in the sense there is a greater probability of getting higher real yields as those CDs roll over than that you will get lower yields. But the position is not risk free. CD returns still have reinvestment risk always. What you do have is a reasonable allocation to stocks in any case.

megabad
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Re: Sanity check for retiree asset allocation heavy on CDs

Post by megabad » Mon Jul 02, 2018 9:39 am

AtomicCash wrote:
Sun Jul 01, 2018 9:50 pm
56% of my portfolio is in tax advantaged accounts.
44% of my portfolio is in taxable accounts.

All the CDs are in the taxable part of my portfolio
Can I ask why the CDs are in the taxable part of your portfolio? I am not necessarily a proponent of your allocation, but if you decide that CDs are right for you, why not hold them in tax advantaged? I am assuming you are over 59.5.

As others mentioned, your portfolio is abnormally exposed to inflation risk. It is a common suggestion for someone with your investing mentality to be invested heavily in TIPS to help mitigate this risk. If I were you, I would lean more toward a tiered approach based on investment timeline with shorter term in CDs (tax advantaged), medium term in I-bonds, and longer term in TIPs or muni bonds (depending on whether taxable or tax advantaged account).

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AtomicCash
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Re: Sanity check for retiree asset allocation heavy on CDs

Post by AtomicCash » Mon Jul 02, 2018 10:54 am

megabad wrote:
Mon Jul 02, 2018 9:39 am
AtomicCash wrote:
Sun Jul 01, 2018 9:50 pm
56% of my portfolio is in tax advantaged accounts.
44% of my portfolio is in taxable accounts.

All the CDs are in the taxable part of my portfolio
Can I ask why the CDs are in the taxable part of your portfolio? I am not necessarily a proponent of your allocation, but if you decide that CDs are right for you, why not hold them in tax advantaged? I am assuming you are over 59.5.

As others mentioned, your portfolio is abnormally exposed to inflation risk. It is a common suggestion for someone with your investing mentality to be invested heavily in TIPS to help mitigate this risk. If I were you, I would lean more toward a tiered approach based on investment timeline with shorter term in CDs (tax advantaged), medium term in I-bonds, and longer term in TIPs or muni bonds (depending on whether taxable or tax advantaged account).
Thanks for the questions. I'm 55 so I can't yet pull from my tax advantaged accounts. I probably won't be pulling anything out of my tax-advantaged accounts until RMD at 70.5 That also keeps my tax liability pretty low since my income is just my pension(s) and my CD interest.

My reasoning for holding CDs (which may be faulty) is that they're FDIC insured and return higher interest than I-bonds. I'm thinking that if composite I-bond rates get higher than a 2 year CD, I could redirect money at that time. Every few months I have a CD maturing so I have quite a bit of flexibility with reinvestment.

Marc

dbr
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Re: Sanity check for retiree asset allocation heavy on CDs

Post by dbr » Mon Jul 02, 2018 11:07 am

AtomicCash wrote:
Mon Jul 02, 2018 10:54 am
taxable or tax advantaged account).
My reasoning for holding CDs (which may be faulty) is that they're FDIC insured and return higher interest than I-bonds. I'm thinking that if composite I-bond rates get higher than a 2 year CD, I could redirect money at that time. Every few months I have a CD maturing so I have quite a bit of flexibility with reinvestment.

Marc
[/quote]

This sounds like you are making the blunder of miss-comparing real and nominal interest rates. You do know that I-bonds are also incremented in value by the current inflation rate, right? My apology if I am not understanding what you mean. If by composite rate you mean including inflation, then it could be CDs pay a little more at any given time, but now you are dancing on the head of a pin. If you really feel more return is critical for your plan, you should have more in equities. Also, you can't direct much into Ibonds given the $10K/person/year purchase limit (or play games with tax refunds) unless you start a long term plan here. It matters if this asset is $100k vs $1M, etc. Also a Treasury savings bond is even safer than FDIC insurance, niggling at the edges.

In reality I bonds might not be a bad choice at all, but keep in mind offsetting the damage to non-cola'd pension income by exactly indexing part of your investments is not that big a help. The problem becomes how to increase income from assets by far more than inflation to offset loss of spending power from fixed income streams. It takes some modeling to do that and the outcome depends on the relative proportions. This might be a reason to invest a little more in equities in order to outrun inflation on average, but with risk. In any case the system has to be considered as a whole rather than as a decision about alternatives for one piece of your assets.

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AtomicCash
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Re: Sanity check for retiree asset allocation heavy on CDs

Post by AtomicCash » Mon Jul 02, 2018 11:55 am

dbr wrote:
Mon Jul 02, 2018 11:07 am

This sounds like you are making the blunder of miss-comparing real and nominal interest rates. You do know that I-bonds are also incremented in value by the current inflation rate, right? My apology if I am not understanding what you mean. If by composite rate you mean including inflation, then it could be CDs pay a little more at any given time, but now you are dancing on the head of a pin. If you really feel more return is critical for your plan, you should have more in equities. Also, you can't direct much into Ibonds given the $10K/person/year purchase limit (or play games with tax refunds) unless you start a long term plan here. It matters if this asset is $100k vs $1M, etc. Also a Treasury savings bond is even safer than FDIC insurance, niggling at the edges.
Thanks for the explanation. I do understand that I-bonds are incremented by inflation. But I didn't know that the purchase limit was so low. I think I missed that boat as it would take a decade to get even $100k moved over now. So thanks for pointing that out.

Marc

emlowe
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Re: Sanity check for retiree asset allocation heavy on CDs

Post by emlowe » Mon Jul 02, 2018 1:44 pm

On I Bonds - you can do 10k for a trust as well - so a married couple with a trust could do 30k/yr in I-Bond purchases (yourself, spouse, and trust)

(There is some debate that you could create numerous trusts for the purposes of purchasing more)

megabad
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Re: Sanity check for retiree asset allocation heavy on CDs

Post by megabad » Mon Jul 02, 2018 2:52 pm

AtomicCash wrote:
Mon Jul 02, 2018 10:54 am
Thanks for the questions. I'm 55 so I can't yet pull from my tax advantaged accounts. I probably won't be pulling anything out of my tax-advantaged accounts until RMD at 70.5 That also keeps my tax liability pretty low since my income is just my pension(s) and my CD interest.

My reasoning for holding CDs (which may be faulty) is that they're FDIC insured and return higher interest than I-bonds. I'm thinking that if composite I-bond rates get higher than a 2 year CD, I could redirect money at that time. Every few months I have a CD maturing so I have quite a bit of flexibility with reinvestment.
Ok, didn't realize your age (though a 401k can be withdrawn penalty free at age 55).

Even though this is probably not super relevant to you since I-bonds would not be a large part of your portfolio, I would just point out two things about how I think about I-bonds. Remember that CDs and traditional bonds have duration that affects them. An I-bond (after 5 years) is what I would call a 0 year bond/CD. In other words, can you find a 1 month CD that gives you a tax deferred 2.5% interest? A more fair comparison would be to a penalty free CD or a high yield savings account in my mind.

Next, an I-bond (and TIPS for that matter) are typically considered as a hedge against unexpected inflation. If you knew inflation was going to be 10% next year, you would never accept a 2 yr CD at 3% interest. An I-bond protects you from this event (unforeseen inflation change), a CD does not.

Bang for the risk buck, for low risk/short duration fixed income, I don't think you can do much better than I-bonds. But investment in them is limited each year so I have a habit of trying to get folks to start investing in them young to make them a more viable portfolio element later in life.

Practically, in your case, I might move most of my CDs to tax advantaged when terms end (except for 5 yrs of expenses). I would invest maybe half of my fixed income allocation into at TIPS fund in tax advantaged. The rest of my taxable would be mostly equities (with qualified dividends) hopefully and maybe a small amount of muni debt. Basically I might hold the same asset allocation (well with TIPS added) but switch the holdings between taxable and tax advantaged. These moves would reduce your exposure to a sudden inflation spike and reduce taxes, but are of course, not necessarily going to result in a higher return.

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AtomicCash
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Re: Sanity check for retiree asset allocation heavy on CDs

Post by AtomicCash » Mon Jul 02, 2018 3:43 pm

megabad wrote:
Mon Jul 02, 2018 2:52 pm

Ok, didn't realize your age (though a 401k can be withdrawn penalty free at age 55).

Even though this is probably not super relevant to you since I-bonds would not be a large part of your portfolio, I would just point out two things about how I think about I-bonds. Remember that CDs and traditional bonds have duration that affects them. An I-bond (after 5 years) is what I would call a 0 year bond/CD. In other words, can you find a 1 month CD that gives you a tax deferred 2.5% interest? A more fair comparison would be to a penalty free CD or a high yield savings account in my mind.
...
Practically, in your case, I might move most of my CDs to tax advantaged when terms end (except for 5 yrs of expenses).
...
Thanks for that explanation about I-bonds. That helped my understanding a lot. I appreciate your time.

I retired at 52 and I'm now 55. Correct me if I'm wrong, but my understanding was that anything I pull out of an IRA or 401k before I turn 59.5 will come with a 10% penalty. It's not critical either way since I won't need to touch the tax-advantaged accounts before then.

I'm confused about how I would move my CDs to tax advantaged when terms end. I thought I can't contribute to an IRA anymore since I have no earned income. Or maybe you're suggesting I convert some equities in my tax advantaged account to fixed income assets and I likewise convert some CDs in my taxable account to equities?

Marc

megabad
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Re: Sanity check for retiree asset allocation heavy on CDs

Post by megabad » Mon Jul 02, 2018 5:28 pm

AtomicCash wrote:
Mon Jul 02, 2018 3:43 pm
Thanks for that explanation about I-bonds. That helped my understanding a lot. I appreciate your time.

I retired at 52 and I'm now 55. Correct me if I'm wrong, but my understanding was that anything I pull out of an IRA or 401k before I turn 59.5 will come with a 10% penalty. It's not critical either way since I won't need to touch the tax-advantaged accounts before then.
My understanding is the same as yours in your case.

I'm confused about how I would move my CDs to tax advantaged when terms end. I thought I can't contribute to an IRA anymore since I have no earned income. Or maybe you're suggesting I convert some equities in my tax advantaged account to fixed income assets and I likewise convert some CDs in my taxable account to equities?
Yes to your latter statement, but I was guilty of poor word choice ("move"). Kind of a pain, but it is what I would lean toward doing if my portfolio were large and I had your allocation. Not a big deal if you are getting 1% interest on $100k. I am more envisioning a scenario where you are getting 5% interest on a million which could eliminate roth conversion strategies or simply throw you into a higher tax bracket. Plus I like TIPS to replace some of those CDs in your situation and the tax treatment of those is atrocious so they need to go in tax advantaged if used. Just a suggestion and a little bit convoluted at that, so decide considering your own situation (income, tax bracket, needs, etc).

Marc

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