Short term treasuries vs. bond index for emergency funds

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GoldenBuff
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Short term treasuries vs. bond index for emergency funds

Post by GoldenBuff » Sun Jan 15, 2012 3:54 pm

Hello everyone,

Sorry for one more question about emergency funds. I did search through other topics and the Wiki but did not find anything that answered my particular question. Apologies in advance if this has been covered somewhere else.

Because of my personal situation, I am keeping my emergency fund (EF) to cover 12 months of expenses, which tends to become a fairly large amount. Since bank and money market interest rates are rather low, I was thinking of implementing a tiered strategy where a portion of my the EF would be in an FDIC insured account, then some in money market, and the rest in something riskier such as a short term Treasury bills or notes (something that has a maturity of 12 months) or a short term bond fund.

The question I have is what would be the preferred choice between investing directly in Treasuries vs. a fund such as VSGBX or VFSTX? Since this is an EF, preservation of principle is the most important factor. Also, since the dollar amount is fixed, I cannot dollar cost average into either investment choice over a long period of time (as one could do for a retirement account).

My thinking is that if I create a 12 month Treasury ladder, investing a fixed amount every month for 12 months, then I would be less susceptible to changes in interest rates. Even if interest rates go up in the middle, the principle on my Treasury lots before the rate hike won't be lost, unlike in the case of a bond fund.

What is the accepted wisdom in this case? If Treasuries are the way to go, what investment choice would be the most suitable?

Thank you very much in advance.

GoldenBuff.

Call_Me_Op
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Re: Short term treasuries vs. bond index for emergency funds

Post by Call_Me_Op » Sun Jan 15, 2012 5:53 pm

Stick with the individual bonds, as they have a guaranteed maturity date. You can set-up a ladder, although rates are so low it will hardly make a difference.
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winterescape
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Re: Short term treasuries vs. bond index for emergency funds

Post by winterescape » Mon Jan 16, 2012 4:14 pm

Setting up the ladder gives certainty but adds complexity to managing your reserves. If you are O.K. with that, fine. If you want simplicity you could consider a short duration bond fund. The Vanguard short-term bond index currently has a duration of 2.7 years

I even like the Vanguard GNMA, but please be advised that you are moving out in duration...

KyleAAA
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Re: Short term treasuries vs. bond index for emergency funds

Post by KyleAAA » Mon Jan 16, 2012 4:16 pm

A ladder doesn't really give any certainty because, by definition, emergencies are unexpected. Unless your emergency happens to take place the day your bond comes due, you aren't guaranteed any preservation of principal. Your losses will be very small, mind you, but so would they be with a short-term treasury fund.

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ofcmetz
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Re: Short term treasuries vs. bond index for emergency funds

Post by ofcmetz » Tue Jan 17, 2012 9:14 am

First, remember all your wealth counts as your emergency fund. If you had to get at cash to save your life or a loved ones life you would liquidate everything in a certain order. The real question is how easy to access and how liquid certain portions of it are.

If it were me I'd keep 3 to 6 months of it in a cash equivalent. Yes you will lose a little to inflation, but nothing beats cash in a pinch. For the rest I'd probably just go with a short term bond fund. It would reward you the most if rates rose and would be simple to cash out from. Less trouble than selling and buying individual bonds.

Interesting thing is I earn more (3.25%) on my checking account than I could with bonds or CD's. A lot of banks are offering these rates up to $10,000 or so if you use your check card a certain amount and receive direct deposits.
Never underestimate the power of the force of low cost index funds.

Grt2bOutdoors
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Re: Short term treasuries vs. bond index for emergency funds

Post by Grt2bOutdoors » Tue Jan 17, 2012 9:16 am

I use a combination of cash, I bonds, and 5 year Ally Bank CD's (60 day simple interest penalty) with a slightly higher yield with no risk to principal after penalty period.
"One should invest based on their need, ability and willingness to take risk - Larry Swedroe" Asking Portfolio Questions

hazlitt777
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Re: Short term treasuries vs. bond index for emergency funds

Post by hazlitt777 » Tue Jan 17, 2012 9:43 am

I like the short term treasure bond index personally. It is very safe being treasuries. And it gave us better than 2 percent last year and I don't think it was negative only two years. And the worst was a negative return of -1.3% or so. That isn't much risk for an emergency fund.

Agent9
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Re: Short term treasuries vs. bond index for emergency funds

Post by Agent9 » Tue Jan 17, 2012 1:53 pm

hazlitt777 wrote:I like the short term treasure bond index personally. It is very safe being treasuries. And it gave us better than 2 percent last year and I don't think it was negative only two years. And the worst was a negative return of -1.3% or so. That isn't much risk for an emergency fund.
Which one? VMLTX?

gtaylor
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Re: Short term treasuries vs. bond index for emergency funds

Post by gtaylor » Tue Jan 17, 2012 2:36 pm

I effectively alternate between Short Term Corporate and the Limited-Term Tax Exempt (muni) funds, depending on my expected tax situation for the coming year(s). Over the long term these compare well against bank CDs, and it's just less hassle to have it all at Vanguard with a checkbook, rather than in a CD ladder or something.

Over the short term, my tax planning led me into the muni fund just as munis went a little nutty and Vanguard flubbed a bit on the corporate short term fund. So a nice bit of luck there, I guess.

One downside is tax time; using a non-MM fund as a savings account of sorts leads to a few dozen transactions per year, which leads to a bunch of puttering with Schedule D just to report a relatively inconsequential gain or loss. This is particularly awkward in states like MA where AVGB always produces some short term gain, that gets taxed at 12%. Thankfully we may now elect FIFO.

ResNullius
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Re: Short term treasuries vs. bond index for emergency funds

Post by ResNullius » Tue Jan 17, 2012 4:36 pm

I use the short term investment grade bond fund, along with Prime MM, for our cash needs for a few years.

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Noobvestor
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Re: Short term treasuries vs. bond index for emergency funds

Post by Noobvestor » Tue Jan 17, 2012 4:41 pm

I Bonds are great - capped at 10K/year, but you can slowly build a stash of 'em
"In the absence of clarity, diversification is the only logical strategy" -= Larry Swedroe

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Kevin M
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Re: Short term treasuries vs. bond index for emergency funds

Post by Kevin M » Tue Jan 17, 2012 4:59 pm

The SEC yield on VG short-term treasury fund (VFISX) is 0.22%, and the most recent yield at auction for a 1 year Tbill was 0.107%. Wouldn't it be better to just use an FDIC insured, online savings account yielding 0.8% or more? Or for an even better yield, supplement with some Ally 5-year CDs for money you are unlikely to need in less than 4 months, unless you are worried that Ally won't honor the 60 day interest penalty and let you withdraw early if desired, in which case, just stick with a savings account. There are many other safe alternatives yielding much more than treasuries, and these alternatives certainly are more convenient than a ladder of treasuries.

Kevin
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kerplunk
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Re: Short term treasuries vs. bond index for emergency funds

Post by kerplunk » Tue Jan 17, 2012 5:02 pm

A benefit of the Short-Term Tax-Exempt Fund (VWSUX) is that you are allowed to transfer money in and out without the 60 day restriction (or whatever the length is).

Dandy
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Re: Short term treasuries vs. bond index for emergency funds

Post by Dandy » Tue Jan 17, 2012 7:31 pm

Forget money market funds (unless a bank Money Market Deposit acct offers a decent yield). I usually hate banks but on line banks now offer the best (though poor by historical standards) rates and have FDIC insurance. Allocating some EF to online savings, CDs, I Bonds, short duration bond funds is fine. In taxable accts I also think LTD Term Tax Exempt also makes sense depending on your tax bracket. Short Term Treasuries are a good place to be if there is a flight to safety due to black swan markets or economic instability.

Some have suggested putting your emergency money in bonds/CDs in tax deferred accounts and an equivalent amount in taxable stock index funds. This may lower your taxes (though the distributions from Total Stock Market may be greater than bonds in the current interest rate environment). If/when an emergency strikes you redeem some stock funds (pay cap gains only on any gains) and then in your tax deferred account sell some bonds and buy a similar stock fund for the amount redeemed. The idea makes some sense since stock funds usually have lower taxable distributions than bond funds and since emergencies may not happen you are better off.

hazlitt777
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Re: Short term treasuries vs. bond index for emergency funds

Post by hazlitt777 » Tue Jan 17, 2012 7:47 pm

Agent9 wrote:
hazlitt777 wrote:I like the short term treasure bond index personally. It is very safe being treasuries. And it gave us better than 2 percent last year and I don't think it was negative only two years. And the worst was a negative return of -1.3% or so. That isn't much risk for an emergency fund.
Which one? VMLTX?
VFISX

GoldenBuff
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Re: Short term treasuries vs. bond index for emergency funds

Post by GoldenBuff » Wed Jan 18, 2012 1:20 am

I am simply overwhelmed by the response I got.

My takeaway is that Bogleheads prefer short term index funds over Treasury ladders. Another thing I ought to pay attention to is funds that hold tax-efficient munis.

Thank you all for your suggestions.

With best regards,

GoldenBuff

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