Bonds or Money market?

[dangbe]

If someone had all cash right now and wanted to retire today, the prevailing wisdom seems to be to invest 60/40 in index funds/bonds to reduce your sequence risk.  However I'm wondering if a money market with a 5.25% interest rate wouldn't be better in the place of bonds since this person is already in cash.  The MM would make that 5.25% whether we had a good year or a bad year.  Obviously if interest rates change this has to be reevaluated. 

Perhaps I'm ignorant of how bonds work but do you think the MM replacing bonds is a better strategy in this scenario or no?

[Ron Scott]

If someone had all cash right now and wanted to retire today, the prevailing wisdom seems to be to invest 60/40 in index funds/bonds to reduce your sequence risk.  However I'm wondering if a money market with a 5.25% interest rate wouldn't be better in the place of bonds since this person is already in cash.  The MM would make that 5.25% whether we had a good year or a bad year.  Obviously if interest rates change this has to be reevaluated. 

Perhaps I'm ignorant of how bonds work but do you think the MM replacing bonds is a better strategy in this scenario or no?

No tax deferred accounts?

Start with a couple months expenses in cash/MM, maybe a little in treasuries, then 6040 with the 40 heavy in munis.

KISS

[RWTL]

If someone had all cash right now and wanted to retire today, the prevailing wisdom seems to be to invest 60/40 in index funds/bonds to reduce your sequence risk.  However I'm wondering if a money market with a 5.25% interest rate wouldn't be better in the place of bonds since this person is already in cash.  The MM would make that 5.25% whether we had a good year or a bad year.  Obviously if interest rates change this has to be reevaluated. 

Perhaps I'm ignorant of how bonds work but do you think the MM replacing bonds is a better strategy in this scenario or no?

Except the Fed may cut rates this year if inflation continues to decline.  If this happens, bond prices will go up along with the dividend.

I'm holding 60/35/5...with the 5% in cash and the 35 in VBTLX (or similar)

[Financial.Velociraptor]

You note high MM returns on 8JAN2024.  Will those returns still exist on 8JUL2024?   You can lock in an interest rate with Treasuries.   Or you can buy long dated bonds that could double in price if the Fed reduces FFR from 5+ to 2+/- 

The future is uncertain.  A bond/income/cash/etc allocation is intended largely as a hedge against volatility.

[Radagast]

There are two bond risks: rising yields make your existing bonds worth less, and falling yields mean that the higher yielding bonds you were counting on suddenly aren't available any more in the future (and bankruptcy but we'll ignore that for now). Bonds are more vulnerable to the first, money markets to the second. The point where these two risks balance is expressed as a bond fund's duration (look it up in the funds info sheet or page). Conventional wisdom then says to make the duration of your bond fund match the time you expect to need the money.

If that's too much work, then a total bond fund or total treasury bond fund is fine. Money markets are really for short term or need-to-have-in-a-crisis money only (assuming you aren't using an FDIC account).

[MustacheAndaHalf]

My preference is floating-rate treasuries.  Unlike bonds, they react immediately to interest rate changes without taking losses or gains (they have "zero duration").  The floating rate resets weekly, so it adapts as rates change.  And they pay a small premium (about 0.3% in the one I hold) over money market funds that invest in treasuries.

[ChpBstrd]

I'm heavy into short term government notes (the BIL ETF, specifically) and the experience of being in this position is constant anxiety about whether one's already-meager return will get cut to nearly nothing in the next couple of years. With rates probably set to fall, now seems like a good time to lock in longer-term yields before they disappear. Unfortunately everyone is thinking this way, so longer-duration treasuries yield about 4% and longer-duration corporate bonds are barely above that. LQD has a SEC yield of 5.08%, for example.

Of course, stepping away from short-term means stepping into long-term. Unlike short-term rates, long-term bounces all over the place, introducing a lot more risk to your fixed income allocation. I sold my EDV, TLT, and ZROZ in the final weeks of 2023 and my timing was perfect, because they're down 3-4% YTD.

There are still deals out there in the corporate space. For example, I personally think junk bonds from APA Corp. with a 7% YTM are underrated. YMMV.

[nalor511]

My preference is floating-rate treasuries.  Unlike bonds, they react immediately to interest rate changes without taking losses or gains (they have "zero duration").  The floating rate resets weekly, so it adapts as rates change.  And they pay a small premium (about 0.3% in the one I hold) over money market funds that invest in treasuries.

I admit to never having looked into these until just now. So there's no 'guaranteed YTM' like with regular notes, and you're moreso guaranteed "FFR+0.25%", if I understand correctly?
https://smartasset.com/investing/floating-rate-notes
https://www.treasurydirect.gov/marketable-securities/floating-rate-notes/

[Scandium]

If someone had all cash right now and wanted to retire today, the prevailing wisdom seems to be to invest 60/40 in index funds/bonds to reduce your sequence risk.

The main point of bonds for this purpose is to reduce the drop from a market crash (2022 bond crash says hello...). The "gains" from bonds is largely irrelevant (ERN SWR series explored this).
Though I agree with others; most likely the yield on MM funds will only go down, and the price on bond funds will most likely only go up (though with a lower yield). I hold any extra cash in MM funds, for short term use. But my small amount of bonds is in intermediate term bond funds in my IRA.

[dangbe]

Thank you all for the differing answers.  I now understand bonds a tiny bit more, but I don't really understand how a bond fund stacks up against a long term bond.  I like to keep things relatively simple so a bond fund is enticing but I dont know what I'm missing out on buy not buying individual bonds.

[Heckler]

Thank you all for the differing answers.  I now understand bonds a tiny bit more, but I don't really understand how a bond fund stacks up against a long term bond.  I like to keep things relatively simple so a bond fund is enticing but I dont know what I'm missing out on buy not buying individual bonds.

https://www.bogleheads.org/wiki/Bond_basics

https://www.bogleheads.org/wiki/Individual_bonds_vs_a_bond_fund

[ChpBstrd]

Thank you all for the differing answers.  I now understand bonds a tiny bit more, but I don't really understand how a bond fund stacks up against a long term bond.  I like to keep things relatively simple so a bond fund is enticing but I dont know what I'm missing out on buy not buying individual bonds.

99.9% of people should just buy a bond fund like BND. The most important factors to shop around are:

1) What it's invested in. E.g. treasuries, corporate bonds, municipal bonds, junk bonds, etc. These affect the credit quality which starts to matter in recessions.
2) The "effective duration" which is defined here.
3) The expense ratio, although this is a minor factor.

Back in November, I specifically targeted some individual bonds with characteristics which would make their values rise fastest in the event of a decrease in the market's yield. So I was looking for treasuries with the absolute highest possible duration and the lowest possible coupon payments. Some of the individual bonds I bought yielded 1.25% when originally issued for 30 years, and I bought them at a steep discount. Others yielded 0% and had over two decades to go until the owner received $1,000. They performed exactly as expected as long-term rates collapsed.

I also bought high-duration bond ETFs with my spare change and interest payments, because you can only buy individual bonds in increments of $1,000, and sometimes $5k or $10k. I used morningstar to identify the funds with the highest effective duration, because that was my thesis at the time. (It is not my recommendation today)

So if you don't have a specific gamble like this, just BND set and forget. In hindsight, I could have accomplished most of my objectives with ETFs and probably paid a lower bid-ask spread.

Picking individual bonds might also appeal if you are an analyst looking to get more yield for less risk.

[dangbe]

99.9% of people should just buy a bond fund like BND. The most important factors to shop around are:

1) What it's invested in. E.g. treasuries, corporate bonds, municipal bonds, junk bonds, etc. These affect the credit quality which starts to matter in recessions.
2) The "effective duration" which is defined here.
3) The expense ratio, although this is a minor factor.

Back in November, I specifically targeted some individual bonds with characteristics which would make their values rise fastest in the event of a decrease in the market's yield. So I was looking for treasuries with the absolute highest possible duration and the lowest possible coupon payments. Some of the individual bonds I bought yielded 1.25% when originally issued for 30 years, and I bought them at a steep discount. Others yielded 0% and had over two decades to go until the owner received $1,000. They performed exactly as expected as long-term rates collapsed.

I also bought high-duration bond ETFs with my spare change and interest payments, because you can only buy individual bonds in increments of $1,000, and sometimes $5k or $10k. I used morningstar to identify the funds with the highest effective duration, because that was my thesis at the time. (It is not my recommendation today)

So if you don't have a specific gamble like this, just BND set and forget. In hindsight, I could have accomplished most of my objectives with ETFs and probably paid a lower bid-ask spread.

Picking individual bonds might also appeal if you are an analyst looking to get more yield for less risk.

BND it is!  I appreciate the in depth explanation of some opportunities you might seek when you know what youre doing.  I, however, do not know what I'm doing, so your BND recommendation is perfect for me.

[Mariposa]

Like everyone else, I have bonds to mitigate the huge swings in securities. In 2022, VBTLX/BND went down significantly because of rising interest rates at the same time that the stock market dropped precipitiously. At that time, I was chasing the 9.62% yield of i-bonds like many others, and I've since decided to make them a permanent part of our portfolio. They're a an inflationary hedge (obviously), and they're a deflationary hedge too because the interest rate can't go below 0%. You also don't have to pay state or local taxes on the interest.

The limitation to i-bonds is, you can only buy 10k per person per year, so it takes time to build up a substantial position. I'm stacking our gift boxes up right now with a fixed rate of 1.3% (plus a variable rate that adjusts according to inflation every 6 months).

We still have more than half of our bonds in total bond indexes in our retirement accounts. Plenty of cash in MM, but it's designated for specific expenses throughout the year, or to be invested in the market.

[farmecologist]

There are two bond risks: rising yields make your existing bonds worth less, and falling yields mean that the higher yielding bonds you were counting on suddenly aren't available any more in the future (and bankruptcy but we'll ignore that for now). Bonds are more vulnerable to the first, money markets to the second. The point where these two risks balance is expressed as a bond fund's duration (look it up in the funds info sheet or page). Conventional wisdom then says to make the duration of your bond fund match the time you expect to need the money.

If that's too much work, then a total bond fund or total treasury bond fund is fine. Money markets are really for short term or need-to-have-in-a-crisis money only (assuming you aren't using an FDIC account).

Yep...Far too few folks seem to understand exactly how bonds work, and the risk involved.

I think the point is to never have all your assets in one asset class.  Diversification is key. 

Personally, I'm parking substantial short term funds in a HYSA for now and will reassess once rates start to drop. 

[mcneally]

For 60/40 split, are you talking about a "bond tent" for the first several years to reduce sequence of return risk, then something more like 80/20? Historically for long retirements like 50 years, 60/40 has a meaningfully higher failure rate (or lower withdrawal rate) than a split more like 80/20.

[MustacheAndaHalf]

My preference is floating-rate treasuries.  Unlike bonds, they react immediately to interest rate changes without taking losses or gains (they have "zero duration").  The floating rate resets weekly, so it adapts as rates change.  And they pay a small premium (about 0.3% in the one I hold) over money market funds that invest in treasuries.

I admit to never having looked into these until just now. So there's no 'guaranteed YTM' like with regular notes, and you're moreso guaranteed "FFR+0.25%", if I understand correctly?
https://smartasset.com/investing/floating-rate-notes
https://www.treasurydirect.gov/marketable-securities/floating-rate-notes/

Correct, they cannot guarantee a yield because the yield resets weekly.

In the past, floating rate notes have offered negative premiums, so "FFR+0.25%" is not guaranteed.  The last offered spread was +0.17% in Oct 2023.  The next auction occurs at the end of this month, so we'll see.
https://www.treasurydirect.gov/auctions/announcements-data-results/frn-daily/

I like the 0.15% expense ratio and 5.5% average yield of WisdomTree Floating Rate Treasury Fund (USFR).  You could argue investing in treasuries is overly conservative, but I prefer to make my gains from equity risk - not bond yield.
https://www.wisdomtree.com/investments/etfs/fixed-income/usfr

If you move to slightly riskier bonds, investment grade (IG), you can get 6.0% yield with a 0.15% expense ratio in either of these ETFs:
https://www.ishares.com/us/products/239534/ishares-floating-rate-bond-etf
https://www.ssga.com/us/en/intermediary/etfs/funds/spdr-bloomberg-investment-grade-floating-rate-etf-flrn

The only thing I'd suggest avoiding is CLOs.  Back in 2008, CDOs collapsed the world financial markets.  Maybe that problem has been addressed, but I don't trust changing "debt" in CDO to "loan" in CLO.  The only big crash since 2008 was in March 2020, with a very quick recovery - not much of a stress test for CLOs, in my view.  But I could be wrong.