Cash? Bonds? Not sure how we should be allocating. Help!

[Mr. Green]

I'm struggling to wrap my brain around something and I'm hoping some of you can help me with this.

We keep an asset allocation of 80% stocks/20% bonds. Our portfolio is about 1/3 in brokerage accounts and 2/3 in IRAs (90% tIRAs/10% Roth). Currently, our bonds are all in tIRAs for tax efficiency, with stocks making up the entirety of our brokerage accounts and Roth IRAs.

We recently sold my father's house and netted ~60k from the sale, which I left in cash in case we wanted to buy a property down the road. We've been renting a house with another family for the last few years and I think that chapter of our life is coming to a close. We recently sold another ~50k of stocks from our brokerage accounts because we were considering buying some land. We've backed away from that idea for now but I like the thought of keeping the cash on hand for a potential future house buy, or in case a deal pops up we can't resist. It's hard to know where this Coronavirus thing is going economically. There might be some great opportunities out there for those with cash later this year or next. We were able to take advantage of the crash in 2008-2009 with a couple of smart property buys but we were still working then so income was flowing freely. Now post-FIRE, income doesn't work that way anymore.

Leaving 100k+ in cash would be a drag on our portfolio, so I would probably reduce our bond exposure so that the cash+bonds was 20% of our portfolio. But then I wondered why I wouldn't just leave the cash in the total bond market fund in our brokerage accounts. That brings back tax inefficiencies BUT it also prevents us from having to sell a ton of stocks at depressed prices, especially if the market would drop significantly further. I know we can always exchange bonds to stocks in our tIRA to negate the selling of stocks in our brokerage accounts but that does still transfer a healthy chunk of money from accounts where it's readily available to an account that can only be accessed in smaller chunks over time. Ideally, we're trying to move money out of tIRAs, not build them up. But I suppose one could argue that might just be the price associated with finding a deal worth doing that for? After all, there's no guarantee that such a deal will even materialize or that we'll buy a house in the next couple years, and then the bonds we'd have been carrying in brokerage accounts would just be a drag on returns and inefficient for taxes.

How do others approach this dilemma?

[ysette9]

I'll throw out some random thoughts in no particular order.

If you think you want to buy something substantial in the near-ish future then yes, keep that money in cash or something similar. I suppose a broad bond index fund may fit that bill. In the past when we were saving for a downpayment the financial advisor we were working with recommended a combo of short- and medium-term bond funds for that savings.

We ran into a similar-ish problem recently when we were increasing our bond allocation as part of the bond tent strategy and had to figure out where to put the extra bonds. We had filled up the tax-deferred retirement account space and were faced with putting more bonds in either Roth space or taxable account. If you read the Bogleheads article on tax efficient asset allocation it does say that generally they recommend putting bonds in a tax-advantaged account but in this low interest rate environment it is pretty much a wash. We decided in the end to put bonds in taxable because 1) it wasn't going to be for the long-term, just for a few years right before and after FIRE; 2) the interest rates are low, so it doesn't generate too much ordinary income; 3) we aren't talking about huge sums of money, so back to #2; and 4) we wanted to leave the stocks in Roth since our long-term drawdown plan is to spend Roth money last, so we want it to grow the most.

So for what is relevant to you, I think it probably doesn't matter than much either way. If you need the money soon then you shouldn't be chasing returns but just want something that will be stable. Even if bonds isn't the best decision tax-wise, it isn't something you'd be doing for long, so it wouldn't make that much of a difference. Or how about a high-interest online savings account/money market and just call it a day? Maybe set this money aside mentally from the rest of your portfolio since you are earmarking it for consumption instead of long-term investing and retirement income?

[MustacheAndaHalf]

Both Vanguard and Morningstar show Total Bond Market ETF (BND) as having 1.78% SEC yield.
https://investor.vanguard.com/etf/profile/overview/bnd
https://www.morningstar.com/etfs/xnas/bnd/quote

That's puzzling to me, since treasury yields are so much lower.  Although that SEC yield is 3 weeks old, treasury yields haven't dropped much since then.  Maybe corporate bonds are holding up the yield?

I would hold cash that roughly fits the purchasing you plan to do in the next few months.  You can leave the rest in a short-term or total market bond fund, and it shouldn't be that impacted over a few months.

[Shane]

Given current market uncertainty and the possibility of near term buying opportunities, either in RE or stocks, I'd just put that money into a MM account. VMFXX is currently paying 1.89%, which is actually more than BND at 1.78%.

Contrary to popular advice, we hold bonds (BND) in our taxable account. Since the reason we own bonds is so that we can spend that money when stocks are down, it doesn't make much sense to me to hold them in a tax deferred account that I'm not yet old enough to access without penalties. Obviously, as OP pointed out, we could sell stocks in our taxable account and then buy them back in one of our tax deferred retirement accounts, but that just seems like an unnecessary extra step to me. The ~$200K in BND in our taxable brokerage account has been paying ~$450/month in "dividends", which automatically gets put into our Vanguard money market account each month and has been providing a nice supplement to our FIRE income.

My thinking is that the money in our tIRAs and Roth IRAs will be the last money we spend, so those accounts are 100% VTI. Since we FIREd in 2016, we haven't paid a penny in federal income taxes, so we're not that worried about a few thousand extra in bond interest income. YMMV.

[Mr. Green]

I suppose for us part of the challenge is how long our "retirement" timeline is. I'll be 37 in September so I've got 23 more years before I will touch my tIRA (not planning to use the 72t SEPP rule). Unless we hit an amazing sequence of returns, I fully expect our taxable accounts to be empty before then and we will have moved on to spending down Roth IRA conversions. So there's a subconscious desire to allow that taxable money to grow as much as possible.

[MustacheAndaHalf]

Congress passed a relief bill, the CARES Act, which allows withdrawals or loans from retirement accounts.  I don't know if it's limited to 401(k) plans, or includes IRAs.  Might be worth a look.

Shane - Depends on your tax bracket.  I liked Vanguard Tax-Exempt Bond (VTEB) because it offered Federally tax exempt bonds, but also spread bonds over the entire country.  So there's a bit of diversification gain, at a cost of paying state tax on the bond interest.  You might want to compare your after-tax yield on BND vs VTEB to see which works best.  Both can be sold, like any ETF, whenever markets are open.

[Shane]

Congress passed a relief bill, the CARES Act, which allows withdrawals or loans from retirement accounts.  I don't know if it's limited to 401(k) plans, or includes IRAs.  Might be worth a look.

Shane - Depends on your tax bracket.  I liked Vanguard Tax-Exempt Bond (VTEB) because it offered Federally tax exempt bonds, but also spread bonds over the entire country.  So there's a bit of diversification gain, at a cost of paying state tax on the bond interest.  You might want to compare your after-tax yield on BND vs VTEB to see which works best.  Both can be sold, like any ETF, whenever markets are open.

MustacheAndaHalf, thanks for the suggestion of VTEB. As far as taxes goes, it doesn't sound like VTEB would help us much, since we don't anticipate owing any federal income taxes, but it does look like the yield is higher than BND... Will check it out, thanks!

[Shane]

I suppose for us part of the challenge is how long our "retirement" timeline is. I'll be 37 in September so I've got 23 more years before I will touch my tIRA (not planning to use the 72t SEPP rule). Unless we hit an amazing sequence of returns, I fully expect our taxable accounts to be empty before then and we will have moved on to spending down Roth IRA conversions. So there's a subconscious desire to allow that taxable money to grow as much as possible.

Mr. Green, Makes sense that your perspective is different, given your age. We're hoping our taxable account will carry us through until I turn 70.5 in ~16 years, when I can start taking maximum SS benefits. My wife is older, so we prioritized converting all of her tIRAs to Roth, first. Beginning this year, we're planning on gradually shifting the money in my tIRAs to Roth, hopefully, before RMDs start in 2036. Sounds like we're in kind of opposite situations. Our taxable stash is about double what's in our tax-deferred accounts, so we're hoping to grow that pot of retirement money by keeping it in VTI, so that when we eventually need it, there will be enough to last through until the end of our lives and, hopefully, beyond...