How exactly to hold short-term bonds

[Pointedstick]

I'm going through my various PP accounts and increasing how directly I'm holding my assets. I started with bonds and I'm now comfortable owning and buying individual bonds instead of TLT and EDV shares. Now it's time to do cash, and I wanted to ask how other folks had already done it. Do you hold a 3-month-6-month-9-month-1-year ladder? All 1 year bonds? T-bills or T-bonds for the 1-year ones? FYI, nothing will be held through TreasuryDirect.

[rickb]

I moved from TLT to actual 30 year bonds a while ago, and am doing the same thing with cash - moving from mostly SHY to other, more direct, alternatives.  I think I-bonds is the first thing to consider.  And, beyond that, I'm creating a ladder of 2-year notes purchased every 3 months.  1/8 of the total amount of the ladder will mature every 3 months, 1/4 every 6 months, 3/8 every 9 months - so if I need to rebalance out of cash I'll either need to wait for a while or sell some notes before they've matured.  Rebalancing from 35% to 25% means you're reallocating about 1/3 of that asset.  With a 6-rung 1-year ladder, this means the maximum wait (without selling before maturity) would be 4 months.  With a 8-rung 2-year ladder, the maximum wait is 9 months.  An approach allowing rebalancing without waiting and without selling anything before it matures might be to keep 1/3 absolutely liquid, and 2/3 in a 1-3 year ladder.  Of course, 2-year notes are pretty liquid to start with - subject to some small interest rate risk.

If you're interested in as direct ownership as possible, and you always want enough liquid cash to cover a 35% to 25% cash rebalancing, I think it's fairly hard to beat

1) 1/3 in individual short term (3 months or less) bills or a treasury backed MM (not SHV)

2) $10k/year ($20k/year for a couple) in I-bonds

3) the rest in a 2 or 3 year ladder of directly owned notes (not SHY)

Buying I-bonds means dealing with TreasuryDirect, but bills/notes/bonds can be purchased with no fee (and 0% ER) through at least Vanguard and Fidelity. By buying individual bills/notes/bonds not only are you making ownership of these assets more direct, you're reducing your expense ratio as well.

[KevinW]

FWIW I think if I were going to manage cash directly, I'd have a ladder of exactly one 12-month T-bill holding practically the entire cash allocation, and let any little scraps of cash sit in a brokerage sweep account until the next rollover. KISS. With T-bills there's no premature withdraw penalty or liquidity issue, so I don't see much of a benefit in using a more complex laddering scheme.

I still use cash funds so the preceding is hypothetical.

Fidelity's Auto-Roll program seems like a reasonable compromise between a fund and doing everything manually:
https://www.fidelity.com/fixed-income-b ... ll-program

[MachineGhost]

I'm going through my various PP accounts and increasing how directly I'm holding my assets. I started with bonds and I'm now comfortable owning and buying individual bonds instead of TLT and EDV shares. Now it's time to do cash, and I wanted to ask how other folks had already done it. Do you hold a 3-month-6-month-9-month-1-year ladder? All 1 year bonds? T-bills or T-bonds for the 1-year ones? FYI, nothing will be held through TreasuryDirect.

5-year CD ladder or I-Bonds.

[sophie]

Great question, PS.  Dealing with cash has puzzled many people on this forum - e.g. this thread:

http://gyroscopicinvesting.com/forum/ht ... ic.php?t=6

I'm also a fan of holding bonds directly for two reasons:  1) saving the expense ratio, and 2) if you buy a HIGH interest bond on the secondary market in a taxable account AND you have high state and local taxes, the tax loss that you get when it matures effectively increases the return you get from the bond to one that is comparable to most CDs.

Right now I'm sticking with one year bonds (taxable) and T bills with auto rollover (in tax-advantaged), because I have a big position in VFISX in a retirement account with no access to a treasury MM or directly held bonds.  Once the <= 1 year bonds are up to 1/3 the cash position, then it'll be possible to move farther out on the yield curve.  I'm thinking, though, that interest rates are likely to go up sometime in the next few years, and the slight increase in interest rate doesn't seem worth the risk.

Oh for the days of treasury MM's that were open to investors and paid interest....

[Pointedstick]

Thanks for the replies, everyone.

...if you buy a HIGH interest bond on the secondary market in a taxable account AND you have high state and local taxes, the tax loss that you get when it matures effectively increases the return you get from the bond to one that is comparable to most CDs.

Could you elaborate on this a bit? How can a tax loss increase the return?

[D1984]

Thanks for the replies, everyone.

...if you buy a HIGH interest bond on the secondary market in a taxable account AND you have high state and local taxes, the tax loss that you get when it matures effectively increases the return you get from the bond to one that is comparable to most CDs.

Could you elaborate on this a bit? How can a tax loss increase the return?

Capital losses can be written off state and local taxes but the interest received on a Treasury security is not taxable income for state tax purposes (only for Federal tax purposes is income from US Treasury securities taxable).

If you buy a higher than current coupon bond/note on the secondary market its price will (quite naturally) be higher than a currently issued one's price but the income as a percentage of the bond's purchase price will be the same or almost the same which means a higher income stream (in raw $, NOT as a percentage of purchase price) than you'd get from a currently issued security. You get more return as (free of state tax) income but you also get--since you bought the security at above par--a capital loss at maturity that negates the additional income. In a tax-free account like an IRA or 401K this is a wash but in a taxable account, owing to the uniquely non state-taxable nature of Treasury security interest it means you get the same amount of total gain/loss but less of it is taxable overall.

[Pointedstick]

Wow. That's very clever. I don't suppose it really matters much for small quantities, but nonetheless, that's a good trick to know.

[sophie]

Thanks for the replies, everyone.

...if you buy a HIGH interest bond on the secondary market in a taxable account AND you have high state and local taxes, the tax loss that you get when it matures effectively increases the return you get from the bond to one that is comparable to most CDs.

Could you elaborate on this a bit? How can a tax loss increase the return?

Capital losses can be written off state and local taxes but the interest received on a Treasury security is not taxable income for state tax purposes (only for Federal tax purposes is income from US Treasury securities taxable).

If you buy a higher than current coupon bond/note on the secondary market its price will (quite naturally) be higher than a currently issued one's price but the income as a percentage of the bond's purchase price will be the same or almost the same which means a higher income stream (in raw $, NOT as a percentage of purchase price) than you'd get from a currently issued security. You get more return as (free of state tax) income but you also get--since you bought the security at above par--a capital loss at maturity that negates the additional income. In a tax-free account like an IRA or 401K this is a wash but in a taxable account, owing to the uniquely non state-taxable nature of Treasury security interest it means you get the same amount of total gain/loss but less of it is taxable overall.

Yup - in fact the tax writeoff is far more the pre-tax net gain.  Makes it easy to ignore CDs.  I have wondered why more investors haven't jumped all over this, but maybe not too many are aware of it.

[BearBones]

Yup - in fact the tax writeoff is far more the pre-tax net gain.  Makes it easy to ignore CDs.  I have wondered why more investors haven't jumped all over this, but maybe not too many are aware of it.

Glad you are back, Sophie. It is discussions like this that I enjoy the most.
I have primarily dumped my deep cash at TreasuryDirect. I, too, live in NY state but do not have local taxes. Think it is still worth moving out of TD and buying on secondary market like you? I'd love to have anything that would help with returns, but I also want to keep things very simple.

[MachineGhost]

Yup - in fact the tax writeoff is far more the pre-tax net gain.  Makes it easy to ignore CDs.  I have wondered why more investors haven't jumped all over this, but maybe not too many are aware of it.

I assume this will only work as long as nominal intereste rates are low becuase the tax-writeoff benefit is likely to be only a relatively slight boost?

[sophie]

It depends on your state/local tax situation.  Obviously if you live in New Hampshire or Alaska none of this applies.

And, you have to balance against the desirability of buying T bills in treasury direct, so that you eliminate the counterparty risk of the broker.  Bearbones, you went to treasury direct for that reason, correct?

[melveyr]

It depends on your state/local tax situation.  Obviously if you live in New Hampshire or Alaska none of this applies.

When I graduate university I will be moving to a state with income tax and I will have to learn a whole new bag of tricks it appears. Buying bonds at a premium is very clever. Thanks for bringing this to the forum awhile back.

[BearBones]

And, you have to balance against the desirability of buying T bills in treasury direct, so that you eliminate the counterparty risk of the broker.  Bearbones, you went to treasury direct for that reason, correct?

Yes. I like the purity and the simplicity of it. Plus, I have never bought bonds on a secondary market, so I still find the idea intimidating. Is your trick still relevant in a rising rate environment?

[AgAuMoney]

buying individual bonds instead of TLT and EDV shares. Now it's time to do cash, and I wanted to ask how other folks had already done it. Do you hold a 3-month-6-month-9-month-1-year ladder? All 1 year bonds? T-bills or T-bonds for the 1-year ones? FYI, nothing will be held through TreasuryDirect.

I was doing this ca. 2000 but I was in TreasuryDirect.  There was no 9month or 1yr options then so I was 6month bills staggered so pretty much every week I had mature and buy.  (It started as a ladder and with money added as needed.)

Now I'm about 50% SHY and 50% FDIC insured in an IRA account.

[sophie]

And, you have to balance against the desirability of buying T bills in treasury direct, so that you eliminate the counterparty risk of the broker.  Bearbones, you went to treasury direct for that reason, correct?

Yes. I like the purity and the simplicity of it. Plus, I have never bought bonds on a secondary market, so I still find the idea intimidating. Is your trick still relevant in a rising rate environment?

Until there are no more bonds within 1 year (or so) of maturity with yields exceeding new T-bills, yes.

[dualstow]

Here's Sophie'sTax trickery with short term treasuries thread from mid-2012.
I hold the bulk of my cash in Vanguard's Admiral Treasury money market fund. (Still closed, I believe).
I used to buy SHY and I still buy SHV for my family, but I'm starting to play with 2-YR ladders just to see what it feels like.



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[Tyler]

For PP cash in a retirement account I can definitely see the appeal of a simple STT ladder, especially with an auto roll feature like at Fidelity.  If you won't be touching that money for a long time, you don't really care about letting each bill/bond take a year or two to reach maturity.