savings account vs short term bond index fund

[StressLess]

just wondering what peoples thoughts are about a high yield savings account (ally @ 1%) vs short term bond fund such as:

Vanguard Short-Term Bond Index Fund Admiral Shares (VBIRX)

we have cash earmarked for home purchase one day, but due to insane HCOL in NYC, we can't justify the prices and a giant mortgage.

I've thought about CDs for the cash, but the penalty vs yield doesn't justify the illiquidity.  Was hoping that we could get a bit more than 1% with the bond fund, especially if this money just ends up going in the market if we're locked out of owning, but I am concerned about interest rate risk.

Too risky to put downpayment money in bond fund?  Is it stupid to reach for such a tiny bit of yield?

Do you guys think if interest rates do eventually go up that online savings rates will also go up?

[MustacheAndaHalf]

CDs are not an all or nothing thing.  You can put some money in CDs, and expected liquidity in the 1% Ally savings account.

For bonds, keep tax-exempt bonds in mind also.  You'll want to compare CDs, online savings accounts, bond funds and tax-exempt bond funds.

[Frankies Girl]

just wondering what peoples thoughts are about a high yield savings account (ally @ 1%) vs short term bond fund such as:

Vanguard Short-Term Bond Index Fund Admiral Shares (VBIRX)

we have cash earmarked for home purchase one day, but due to insane HCOL in NYC, we can't justify the prices and a giant mortgage.

I've thought about CDs for the cash, but the penalty vs yield doesn't justify the illiquidity.  Was hoping that we could get a bit more than 1% with the bond fund, especially if this money just ends up going in the market if we're locked out of owning, but I am concerned about interest rate risk.

Too risky to put downpayment money in bond fund?  Is it stupid to reach for such a tiny bit of yield?

Do you guys think if interest rates do eventually go up that online savings rates will also go up?

Yes, it is too risky to chase a tiny bit of yield if the funds are needed in full within a short time period (say, under 3 years). You have no way of knowing how short-term volatility will affect your principal amount, and if you need it within a certain time, then you might not have the luxury of letting it stay in the market and seeing if it recovers, let alone grows.

Savings rates haven't been going up much at all in the last 3-4 years I've noticed so I have no opinion as to the likelihood we might see rates rise.

[Heckler]

I have my "big" emergency fund of $21k in VSB, short term bond.  Although it makes $25 to $40 interest every month and I reinvest dividends (although its an ETF, so a portion also comes out in cash), it has been very stable at $21k +/- $200 for the past year. 

So, due to its price fluctuations I'm not yet making any money, but its my understanding that if I hold it at least as long as its duration of 3 years, I will not lose principle and it should start growing.  This is my plan, unless we both lose jobs at the same time and our $10k cash EF runs out.  I only plan to sell VSB in a big emergency. 

I would not buy bonds if you plan to sell them before thier duration is up.  Savings account won't have loss of principle in the short term.  Now that we are mortgage free I also plan to increase our cash EF by $1000 to reduce the risk of needing to sell VSB.

[Heckler]

And savings account rates do eventually fluctuate with the prime rate.  They could go down too.

[phwadsworth]

I'm in this exact situation.  I had cash from a house sale in Spring 2015, and thought I would buy a house this spring, but now it looks like it will be 2017.  I split the money into a CD making 0.66% at USAA and BND and BSV bond funds, mostly because I was curious, but also because earning less than 1% seemed ridiculous.  It has done well, the total balance is up 1.5% in 8 months (2.2 apy ?), which is great, but I've changed my outlook since I started, and I no longer think chasing a point is worth risking any of the principle over such a short time.  Those bond funds could drop 1-2% at any time, wiping all the gains out, or more, which is more ridiculous.  When the CD matures in a a week I'm pulling the full amount out of that account and opening a new account at Ally.  1% guaranteed and totally liquid is better, imho.

[MustacheAndaHalf]

"... if I hold it at least as long as its duration of 3 years, I will not lose principle ..."

While duration tells you the break even point for one change, it does not reflect what happens if rates rise more than once.  If rates increase and you wait 2 years, rates could increase a second time.  Now you're stuck waiting the original 2 years plus 3 more: 5 years to break even.  And that assumes no more rate increases.

Online savings accounts earn 1.00%.
The SEC yield on Vanguard's short-term bond fund is 1.15%.
Personally I don't feel a 3 year duration is worth 0.15% more interest (0.05% per year).

Ally offers 5 year CD rates of 2.00%, with a penalty for early withdrawal.
Vanguard Total Bond Market offers a 2.08% yield.

One approach might be to keep emergency fund money in a savings account earning 1%, and other money locked up in a CD.  A CD ladder is even better - you start a CD every year, aiming at the 5 year rate.  The ladder gives you a CD that matures each year, but locks in the 5 year rates.