Start building cash reserve or is it cash drag?

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Raspberry-503
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Start building cash reserve or is it cash drag?

Post by Raspberry-503 »

I plan to retire in 10 years at 62. Possibly a couple of years earlier if the market is good to me, or life throw a curve ball (not sure if find the motivation to "rebuild" with a new company at 59 for example).

I'm currently 60/40 AA, Firecalc shows 100 survival rate of my portfolio at 58, and Personal Capital tool rates 95% chance of getting the income i think want and 75% chance I can spend an extra $1000 a month.

So right now I'm more in a " don't screw it up" mode, even though I haven't won the game yet.

My concern is how to deal with a bad sequence life return. I don't want to delay my retirement 2-3 years because the market crashed right as I'm ready.

One way to stave that off would be to start investing in I-Bonds or possibly cash-like instruments (CDs whatever) from now till retirement. Maybe not a rational thought but what i like about I-bonds is that if I buy the $30k/year max i can (me,wife,revocable living trust), then in 10 years I'll have $300k inflation adjusted or just over 3 years of retirement money (I'm not planning on spending $100K a year but it's not a bad approximation with a fudge factor).

I'm maxing out my 401(k) with catch-up, maxing out HSA, and doing Roth IRA although this year I'll be above AGI due to some capital gains. I'm also putting $1500/month into a taxable account. That means I'm tapped out I can't put $30K into I-Bonds in addition to the above. This means every year i'd have to draw $30K from my taxable account and convert it to I-Bonds. Kinda of a reverse dollar cost averaging?

I would consider the I-bonds part of my 40% fixed income portfolio.


The question is, is that too early to start earmarking money to cash, would i be better continuing 60/40 and simply draw from that in retirement even if the market is down because it would make up from the drag of going to "cash" too early.
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anon_investor
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Re: Start building cash reserve or is it cash drag?

Post by anon_investor »

Raspberry-503 wrote: Wed Jul 21, 2021 11:39 pm I plan to retire in 10 years at 62. Possibly a couple of years earlier if the market is good to me, or life throw a curve ball (not sure if find the motivation to "rebuild" with a new company at 59 for example).

I'm currently 60/40 AA, Firecalc shows 100 survival rate of my portfolio at 58, and Personal Capital tool rates 95% chance of getting the income i think want and 75% chance I can spend an extra $1000 a month.

So right now I'm more in a " don't screw it up" mode, even though I haven't won the game yet.

My concern is how to deal with a bad sequence life return. I don't want to delay my retirement 2-3 years because the market crashed right as I'm ready.

One way to stave that off would be to start investing in I-Bonds or possibly cash-like instruments (CDs whatever) from now till retirement. Maybe not a rational thought but what i like about I-bonds is that if I buy the $30k/year max i can (me,wife,revocable living trust), then in 10 years I'll have $300k inflation adjusted or just over 3 years of retirement money (I'm not planning on spending $100K a year but it's not a bad approximation with a fudge factor).

I'm maxing out my 401(k) with catch-up, maxing out HSA, and doing Roth IRA although this year I'll be above AGI due to some capital gains. I'm also putting $1500/month into a taxable account. That means I'm tapped out I can't put $30K into I-Bonds in addition to the above. This means every year i'd have to draw $30K from my taxable account and convert it to I-Bonds. Kinda of a reverse dollar cost averaging?

I would consider the I-bonds part of my 40% fixed income portfolio.


The question is, is that too early to start earmarking money to cash, would i be better continuing 60/40 and simply draw from that in retirement even if the market is down because it would make up from the drag of going to "cash" too early.
Why not just divert that $1.5k/mo to I Bonds? $18k in I Bonds a year will still get you to $180k in I Bonds (before factoring in interest) in 10 years. That is some nice inflation protected cushion.
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Re: Start building cash reserve or is it cash drag?

Post by 22twain »

Raspberry-503 wrote: Wed Jul 21, 2021 11:39 pmI'm currently 60/40 AA
The 40% (presumably fixed income) is for ameliorating the effects of a stock market crash, right? What is that 40% invested in? What do you consider to be the worst likely case scenario for it? How much impact would it have on your lifestyle if that scenario came to pass?
It's "Roth", not "ROTH". Senator William Roth was a person, not an acronym.
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Re: Start building cash reserve or is it cash drag?

Post by SnowBog »

Personally I consider I Bonds (and EE Bonds) as "bonds" - or in a more broad sense - I include them in my "fixed income" number (as I do our "savings" account).

We are mid-40's, targeting a potential early retirement within the next 10 years. We are also 60/40 - and similar to you have reached the point where we "don't want to screw it up."

To add more context, we expect our social security and [small] pensions to cover the majority of our "essential" expenses by the time we hit 70 [or at least as much as anyone can predict expenses 25 years from now]. But at [early] retirement - we'll have essentially $0 income [ignoring dividends/interest]. So we need to ensure our portfolio can survive the "early retirement" years. The other contributing factor is my employment/industry is such that I'm assuming I'll be "without a job" in my 50's - which means we may not have the luxury of waiting/working longer (and I'm past the point of wanting to "start over" if I can help it) if the job loss occurs when markets tank (which probably makes the prospect of losing a job even higher).

Basically we have "far more to lose" than we "need to gain" at this point. So we've ended up adopting a fairly conservative path - in an attempt to build an "income floor" if you will - such that we could have some "income" coming in that wouldn't be impacted by market conditions - giving us a buffer to ride out a bad sequence of returns.

More specifically, 2 years ago we started maxing out both EE Bonds and I Bonds. Our "target" is roughly $40k of nominal "income" a year from roughly age 53 (minimum ideal retirement age based on vesting/benefits) to 69. Note the "target" is more-or-less what we realistically can save in I/EE Bonds before retirement - and it coincidentally lines up with some of our SS/pension income providing a more predictable "guaranteed" income. But had we started purchasing I/EE Bonds earlier - or if we work longer than expected - we'd likely raise that target if possible.

Due to EE Bonds "doubling" in value at 20 years - maxing EE Bonds (1x for each spouse) basically cover those years where we still had a 20 year runway (like 6X - 70).

But since we started too late - and can't "go back" and buy EE Bonds 10+ years ago - we are maxing out I Bonds (including 2 living trusts and via tax refunds), with the intent to "fill in" the missing EE Bond years. I've "mapped out" the intended redemption of the I Bonds - getting us reasonably close to $35k - $40k a year (depending on interest).

To maintain our 60/40 (and leave some room in 401k for rebalancing) - we are also forced to by "bonds" in taxable, which makes I/EE Bonds that are effectively tax deferred (no deduction on contribution - but interest is only taxed when sold or at 30 year maturity) a reasonable option.

If we end up forced out of work [after 52] during a prolonged market crash - we will have roughly $40k/year - completely isolated from market returns - that we can utilize until our pensions/SS kick in at 70. Minimally, that reduces the withdrawal needed from our portfolio, giving more time for markets to recover.

If we "retire" (or forced out) while not in a market crash, we'll likely let the I Bonds continue to mature (as part of our fixed portfolio) - thus increasing our "income floor" (fewer years to cover), to protect against a future market crash. At the point this "income floor" is approaching our expected annual expenses, we'll probably start selling them off - with the intent to have depleted all I/EE Bonds by the time we are 70. (Unless we decide to maintain I Bonds for inflation protection as a long term part of our portfolio.)

This is probably way more conservative than needed - and I'm sure we are sacrificing a larger retirement balance by doing this. But I expect we'll still have "enough" - and that's good enough for me - and spouse is more comfortable with the overall "early retirement" knowing there's conceptually "income" we can utilize if we really needed. [And we recognized we are blessed to have started saving early on, lived below our means, worked hard, and have made it to the point that we have enough saved to give us the flexibility to take a more conservative approach like this. Not everyone will be so lucky...]

One other note, if you wanted to go even further, read up on Liability Matching Portfolios - which attempts to "match" retirement expenses (liabilities) to ultra safe - ideally inflation adjusted - investments like I Bonds and TIPS. Anything "remaining" after filling the LMP is invested in a "risk portfolio" - which is usually for heirs at that point... At the moment, that feels like too much overhead for us... I'm not a fan of TIPS, don't have a good way [that I know of] to buy them in pre-tax, and the thought of building a TIPS ladder seems more complex than I want/need...

But I like to think what I'm doing with I/EE Bonds is a "quasi-LMP" - in that I'm effectively matching a "portion" of our liabilities in I/EE Bonds. And given the lower annual purchase limits of I/EE Bonds - it takes many years of purchasing them to get to where we want to arrive...
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Re: Start building cash reserve or is it cash drag?

Post by wish_to_retire »

For newbies, what is an I-Bond ? I invest in BND (from Vanguard).
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Re: Start building cash reserve or is it cash drag?

Post by RickBoglehead »

wish_to_retire wrote: Thu Jul 22, 2021 6:25 am For newbies, what is an I-Bond ? I invest in BND (from Vanguard).
https://www.bogleheads.org/wiki/I_savings_bonds
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Re: Start building cash reserve or is it cash drag?

Post by markjk »

I-Bonds: https://www.treasurydirect.gov/indiv/re ... ibonds.htm

If you are diverting investment from your 40% bond allocation to CD, I-Bonds, Money Market, etc., I don't think there is much difference.

There is nothing wrong with earmarking some cash like a CD or Money Market as you get closer. If that helps you sleep at night, go for it. I will probably do something similar. I don't think there is a material enough impact on your portfolio to worry much about it if you are only talking about diverting your bond allocation.I suggest you go with whatever is easier, simpler, and helps you sleep at night. I don't see a strong pro/con in either direction on this one.

The other thing you could consider is just banking your dividends as you get closer to retirement (say 5 years out) and allowing that to build up a cash base for the first year or two. That way you don't have to sell anything nor do you have to change allocations. You just let the money you have invested throw off money which you would build up in prep for those initial first couple of years.
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Re: Start building cash reserve or is it cash drag?

Post by dbr »

Why not look at what the models say for 50/50 and 40/60 allocations?

There is no reason to amass cash distinct from bonds of all types. You don't have to start investing in something special because you are getting closer to retirement.
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Re: Start building cash reserve or is it cash drag?

Post by SnowBog »

dbr wrote: Thu Jul 22, 2021 8:58 am Why not look at what the models say for 50/50 and 40/60 allocations?

There is no reason to amass cash distinct from bonds of all types. You don't have to start investing in something special because you are getting closer to retirement.
I agree with this!

What I'm doing above I'm choosing to do, knowing full well the tradeoffs. They work for me and our needs. I did not mean to imply "everyone should" do something similar. Although, for others in similar situations, they might find it meets their goals. But do your research!
Last edited by SnowBog on Thu Jul 22, 2021 4:08 pm, edited 1 time in total.
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Re: Start building cash reserve or is it cash drag?

Post by goodenyou »

What you are describing is the tension between a "Safety-First" and a "Probability-Based" retirement portfolio approach. Wade Pfau wrote 2 books on this. You may want to check them out.
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Re: Start building cash reserve or is it cash drag?

Post by 260chrisb »

I think you have to do what makes you sleep best at night. For me it's a bit early at 52 and a 60/40 AA is somewhat conservative in my opinion. I agree with your thought process however and began protecting money from the market myself in late 2019 and have continued to do so as I near retirement early next year and provided market conditions remain favorable will do so at the end of the year and into next year. Having 2-3 years of projected expenses at all times is my plan. I understand cash drag and have simply got my mind around it as I've protected assets as there is no need to risk it for returns. I'm sleeping well at night and the market continues to be favorable to my approach.
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Re: Start building cash reserve or is it cash drag?

Post by nisiprius »

"Cash drag" is a loaded term used by people who are advising you not to hold cash. Maybe they are right, maybe not, but be careful about the term.

There are my own opinions. Others will differ.

Although there is no hard-and-fast line, I distinguish between an "emergency fund" and a "cash holding in the investment portfolio." The difference is that an emergency fund is money that might well get used. Therefore, it is not money you firmly intend to hold to retirement and shouldn't be counted as part of the investment portfolio. Therefore, an emergency fund is not a "cash drag."

Realistically, we all understand that if a part of your investment portfolio is in bonds, in a form which can be easily liquidated separately from other part of the portfolio, in a real emergency it would be available as some kind of backup or second tier, and this might influence how much cash you think you need to have in your emergency fund.

Traditionally, there are three basic asset classes: Stocks, bonds, and cash, and traditional advice called for having a nonzero cash holding within the investment portfolio. For example, the Vanguard LifeStrategy funds included a meaningful allocation to "short-term reserves" up until at least 2010. Since it was locked up inside the fund, there was no possible way to consider use it as an "emergency fund"--you couldn't seel the short-term reserves without selling bonds and stocks at the same time.

The 2020 edition of Burton Malkiel's A Random Walk Down Wall Street suggests that 5% of the portfolio be in cash even in one's mid-twenties, increasing to 10% in the late sixties.

Image

What about "cash drag?" Who cares? Why should eliminating "cash drag" be a high priority for an individual retirement saver? The cash isn't in there to propel the portfolio. Shock absorbers aren't in a car to add horsepower.
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Re: Start building cash reserve or is it cash drag?

Post by EnjoyIt »

nisiprius wrote: Thu Jul 22, 2021 2:03 pm "Cash drag" is a loaded term used by people who are advising you not to hold cash. Maybe they are right, maybe not, but be careful about the term.

There are my own opinions. Others will differ.

Although there is no hard-and-fast line, I distinguish between an "emergency fund" and a "cash holding in the investment portfolio." The difference is that an emergency fund is money that might well get used. Therefore, it is not money you firmly intend to hold to retirement and shouldn't be counted as part of the investment portfolio. Therefore, an emergency fund is not a "cash drag."

Realistically, we all understand that if a part of your investment portfolio is in bonds, in a form which can be easily liquidated separately from other part of the portfolio, in a real emergency it would be available as some kind of backup or second tier, and this might influence how much cash you think you need to have in your emergency fund.

Traditionally, there are three basic asset classes: Stocks, bonds, and cash, and traditional advice called for having a nonzero cash holding within the investment portfolio. For example, the Vanguard LifeStrategy funds included a meaningful allocation to "short-term reserves" up until at least 2010. Since it was locked up inside the fund, there was no possible way to consider use it as an "emergency fund"--you couldn't seel the short-term reserves without selling bonds and stocks at the same time.

The 2020 edition of Burton Malkiel's A Random Walk Down Wall Street suggests that 5% of the portfolio be in cash even in one's mid-twenties, increasing to 10% in the late sixties.

Image

What about "cash drag?" Who cares? Why should eliminating "cash drag" be a high priority for an individual retirement saver? The cash isn't in there to propel the portfolio. Shock absorbers aren't in a car to add horsepower.
Is it wrong to consider cash as part of your fixed income allocation? So when we say 60/40 we mean 60% in equities and 40% in fixed income such as bonds, CDs, money market accounts, and high yield savings account. If that is the case, then why not include the cash one has in their high yield savings account as part of their portfolio. Is it not simply additional mental accounting when we take a very large emergency fund and ignore it from our portfolio. I have seen some people keep 3 years of expenses in cash which is fine, but that is a big chunk to ignore from one's AA.

I guess in todays low interest rate environment, There probably isn't much difference between a total bond fund vs holding cash in a high yield interest account.

As for opening poster's question, I personally do not see a reason to hoard cash or cash like investments just because I plan to retire in 10 years. My asset allocation is designed to withstand market turmoil. If I feel like I need to add cash, maybe I need to reevaluate my asset allocation.
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Re: Start building cash reserve or is it cash drag?

Post by JBTX »

Raspberry-503 wrote: Wed Jul 21, 2021 11:39 pm I plan to retire in 10 years at 62. Possibly a couple of years earlier if the market is good to me, or life throw a curve ball (not sure if find the motivation to "rebuild" with a new company at 59 for example).

I'm currently 60/40 AA, Firecalc shows 100 survival rate of my portfolio at 58, and Personal Capital tool rates 95% chance of getting the income i think want and 75% chance I can spend an extra $1000 a month.

So right now I'm more in a " don't screw it up" mode, even though I haven't won the game yet.

My concern is how to deal with a bad sequence life return. I don't want to delay my retirement 2-3 years because the market crashed right as I'm ready.

One way to stave that off would be to start investing in I-Bonds or possibly cash-like instruments (CDs whatever) from now till retirement. Maybe not a rational thought but what i like about I-bonds is that if I buy the $30k/year max i can (me,wife,revocable living trust), then in 10 years I'll have $300k inflation adjusted or just over 3 years of retirement money (I'm not planning on spending $100K a year but it's not a bad approximation with a fudge factor).

I'm maxing out my 401(k) with catch-up, maxing out HSA, and doing Roth IRA although this year I'll be above AGI due to some capital gains. I'm also putting $1500/month into a taxable account. That means I'm tapped out I can't put $30K into I-Bonds in addition to the above. This means every year i'd have to draw $30K from my taxable account and convert it to I-Bonds. Kinda of a reverse dollar cost averaging?

I would consider the I-bonds part of my 40% fixed income portfolio.


The question is, is that too early to start earmarking money to cash, would i be better continuing 60/40 and simply draw from that in retirement even if the market is down because it would make up from the drag of going to "cash" too early.
We are in similar situation and have funded ibonds for years. At this point they are good or better than most bonds.

At this point we have probably a year's expenses in ibonds and another year in cash. About half of the cash is in an HM Bradley 3.0% bank account. We keep a modest low interest mortgage to facilitate this cash/ibond reserve.

I just like the idea of having the extra liquidity. If gives us options. Maybe I decide not to go back to work. Maybe we decide to do some Roth conversions. Of if we just want to wait before tapping into retirement accounts.
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Re: Start building cash reserve or is it cash drag?

Post by dbr »

EnjoyIt wrote: Thu Jul 22, 2021 2:27 pm

Is it wrong to consider cash as part of your fixed income allocation? So when we say 60/40 we mean 60% in equities and 40% in fixed income such as bonds, CDs, money market accounts, and high yield savings account. If that is the case, then why not include the cash one has in their high yield savings account as part of their portfolio. Is it not simply additional mental accounting when we take a very large emergency fund and ignore it from our portfolio. I have seen some people keep 3 years of expenses in cash which is fine, but that is a big chunk to ignore from one's AA.

I guess in todays low interest rate environment, There probably isn't much difference between a total bond fund vs holding cash in a high yield interest account.

As for opening poster's question, I personally do not see a reason to hoard cash or cash like investments just because I plan to retire in 10 years. My asset allocation is designed to withstand market turmoil. If I feel like I need to add cash, maybe I need to reevaluate my asset allocation.
No, it is wrong to not include cash in the asset allocation. Cash is a form of fixed income, has a return, and has risk (aka variability of return). If you do everything in real dollars the return on cash is usually one of the worst.

People should not be confused over differences in what is an asset and what is liquidity and what is practical for managing cash flow and, at the other end, what it means to plan an asset allocation, meaning the risk and return of all one's assets that can be meaningfully thought of that way. There are long discussion regarding how investment real estate can be fit to that (probably not) and how income streams can be fit to that (not in any rational way).
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Re: Start building cash reserve or is it cash drag?

Post by EnjoyIt »

dbr wrote: Thu Jul 22, 2021 2:42 pm
EnjoyIt wrote: Thu Jul 22, 2021 2:27 pm

Is it wrong to consider cash as part of your fixed income allocation? So when we say 60/40 we mean 60% in equities and 40% in fixed income such as bonds, CDs, money market accounts, and high yield savings account. If that is the case, then why not include the cash one has in their high yield savings account as part of their portfolio. Is it not simply additional mental accounting when we take a very large emergency fund and ignore it from our portfolio. I have seen some people keep 3 years of expenses in cash which is fine, but that is a big chunk to ignore from one's AA.

I guess in todays low interest rate environment, There probably isn't much difference between a total bond fund vs holding cash in a high yield interest account.

As for opening poster's question, I personally do not see a reason to hoard cash or cash like investments just because I plan to retire in 10 years. My asset allocation is designed to withstand market turmoil. If I feel like I need to add cash, maybe I need to reevaluate my asset allocation.
No, it is wrong to not include cash in the asset allocation. Cash is a form of fixed income, has a return, and has risk (aka variability of return). If you do everything in real dollars the return on cash is usually one of the worst.

People should not be confused over differences in what is an asset and what is liquidity and what is practical for managing cash flow and, at the other end, what it means to plan an asset allocation, meaning the risk and return of all one's assets that can be meaningfully thought of that way. There are long discussion regarding how investment real estate can be fit to that (probably not) and how income streams can be fit to that (not in any rational way).
It just reminds me of all these 100% equities investors who also have 1-2 years in a cash emergency fund. They are not 100% equities which is fine, but somehow they ignore the cash that they need to manage the risk of their high equity portfolio.
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Re: Start building cash reserve or is it cash drag?

Post by etfan »

nisiprius wrote: Thu Jul 22, 2021 2:03 pm The 2020 edition of Burton Malkiel's A Random Walk Down Wall Street suggests that 5% of the portfolio be in cash even in one's mid-twenties, increasing to 10% in the late sixties.

Image
The chart says cash or short term bond fund.

Regarding the OP's concern, what is the difference between holding cash and between simply increasing your bond allocation (which you can sell for cash if needed)?
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Re: Start building cash reserve or is it cash drag?

Post by Raspberry-503 »

I think that's what I'm asking, i-Bonds vs my "regular bond allocation" (BND+BNDX+some munis). Is the difference in risk)returns worth worrying about? I-bonds have better i flatiron protection so why not have part of your fixed income in it?
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Re: Start building cash reserve or is it cash drag?

Post by SnowBog »

Raspberry-503 wrote: Mon Jul 26, 2021 6:55 pm I think that's what I'm asking, i-Bonds vs my "regular bond allocation" (BND+BNDX+some munis). Is the difference in risk)returns worth worrying about? I-bonds have better i flatiron protection so why not have part of your fixed income in it?
In the grand scheme of things I doubt it makes a significant difference... (Just like if you get say 3% interest on your "savings" vs. getting 0.5% - it will make little difference to your retirement plan... Although the 3% definitely feels/sounds better... In much the same way "inflation protection" (on just the small balance you have of I Bonds) sounds better - but is likely too small a % of your overall net worth to make a significant difference...

That said, I still max out I [& EE] Bonds annually, for reasons as noted above. And I likewise see an insignificant difference between having an AA of say 60/35/5 (with the last 5% being I Bonds) vs. 60/40 (including 5% I Bonds).
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Re: Start building cash reserve or is it cash drag?

Post by retired@50 »

Raspberry-503 wrote: Mon Jul 26, 2021 6:55 pm I think that's what I'm asking, i-Bonds vs my "regular bond allocation" (BND+BNDX+some munis). Is the difference in risk)returns worth worrying about? I-bonds have better i flatiron protection so why not have part of your fixed income in it?
Is the difference in risk/returns worth worrying about? No.

In a 7 figure portfolio, $10k of I-bonds per year is fine, but it's probably not really making a huge difference.

Regards,
This is one person's opinion. Nothing more.
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Re: Start building cash reserve or is it cash drag?

Post by chassis »

Raspberry-503 wrote: Mon Jul 26, 2021 6:55 pm I think that's what I'm asking, i-Bonds vs my "regular bond allocation" (BND+BNDX+some munis). Is the difference in risk)returns worth worrying about? I-bonds have better i flatiron protection so why not have part of your fixed income in it?
@Raspberry-503

What is your total cash position today as a pct of net worth? What is your emergency fund status?

Cash on one hand is trash in that it loses purchasing power over time. On the other hand cash is a legitimate portfolio holding because of it low volatility and negative correlation to equities.

Cash serves a purpose. Too much cash (subjective) can become a foregone opportunity vs equities.

I like a solid cash position, in addition to taxable holdings. Total liquidity is also important to me, which brings taxable accounts into the discussion.

To your question, your current cash position will guide a more specific reply.
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Re: Start building cash reserve or is it cash drag?

Post by Raspberry-503 »

Right now I'm cash rich because I have my son's next 3 years of college in a HYSA, I've got 6 month essential expenses stored in I-bonds (some not redeemable yet, but they will be before I spend all the college money, which is why it's doesn't matter it's not liquid).

I don't count either as part of my portfolio.

As for the investment portfolio itself I have very little cash, about 1%, do the "ballast" is basically all bonds
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