50% intermediate bonds vs. 25%/25% barbell?

[Sam Brazil]

Can someone explain what's the advantage over the barbell? Because they seem like the same thing in effect.

[barrett]

Others will flesh this out but basically you want the LTTs there in the PP because they will give you a strong return in a deflationary environment. No other asset can be counted on to do that. Everyone has been predicting higher interest rates (and therefore lower bond yields) for years but these long bonds really carried the PP in 2008 and added a lot of pop again in 2011. These two examples are often cited by Craig but I think they are important because in both years those performances were not expected.

The 25% in cash you just want to be as liquid as possible. I juice the yield on my cash holdings by considering my US savings bonds (Series I & EE) as a big part of that allocation. I only have enough 0% yielding cash in my PP for easy rebalancing.

The intermediate bonds will give you a smoother ride if you are looking at bonds in isolation. LTTs will help to give the entire PP a smoother ride over time.

[Kshartle]

Good question Sam. I came to the same conclusion.

Depending on the shape of the yield curve, an INT fund is likely to perform nearly identical to a ST/LT barbell. For instance in 2008 (supposed deflation scenario), IEF returned 17.9 and SHV/TLT returned 18.3

The durations won't be exactly the same at any given time so slight differences will occur but I don't think there's any real portfolio advantage to the barbell. There may be convenience ones or it may be a hindrance.

For instance people may have only a ST or INT term option in their 401k. In that case using the INT is an acceptable sub for ST/LT.

I think the main benefit (drawback  ) is psychological. PPer's look at it like they have 4 distinct assets for 4 distinct economic environments. If instead the portfolio idea was 25% US stocks, 25% gold and 50% 10 year treasuries it would lose it's mystique.

Having 50% of your investments in 10 year treasuries which definitely have negative real rates at this point would seem silly. Regardless of yields I think only much older investors would see this as a reasonable asset allocation due to the inflation and interest rate risk.

So I think it's psychological. People feel like there is some additional safety in having a large amount of near-cash and a large amount of LTBs vs. a huge amount of 10 year bonds, even though in the end it's basically the same.

I'm sure others will point out advantages that I don't see.

[Early Cuyler]

Can someone explain what's the advantage over the barbell? Because they seem like the same thing in effect.

Disclaimer: I *believe* this is how it works, please double check.

If we assume that the yield curve doesn't change, a bullet portfolio should have a slightly higher return than a barbell of cash and ltts, atleast in theory. I dont know how true this is in practice, especially when you take things like i-bonds and the option value of cash into account.

I'd say that the best time to use a bullet portfolio is when you dont have access to a suitable long term treasury fund.

[Kshartle]

Can someone explain what's the advantage over the barbell? Because they seem like the same thing in effect.

Disclaimer: I *believe* this is how it works, please double check.

If we assume that the yield curve doesn't change, a bullet portfolio should have a slightly higher return than a barbell of cash and ltts, atleast in theory. I dont know how true this is in practice, especially when you take things like i-bonds and the option value of cash into account.

I'd say that the best time to use a bullet portfolio is when you dont have access to a suitable long term treasury fund.

Early I've never heard the term "bullet" portfolio. What does that mean?

[stuper1]

From what I gather, a lot of people (myself included), include their emergency fund cash as part of their 25% cash in their PP.  You can't do that if you go with the bullet approach (50% intermediate bonds).

Also it's been mentioned several times that, in retirement when you are withdrawing from your PP, that 25% cash really helps stabilize things in times when the other three assets happen to all be down at the same time.

[barrett]

Sam, check out Tyler's excellent post on the role of cash in a PP on 4/27/14 under the topic "Safe Withdrawal Rate." In short, having that cash position ups your SWR considerably.

That being said, I also fall into Kshartle's "much older investors" category. I am 55 and want to have my PP set up so that it is my main source of income starting in about ten years.

[goodasgold]

Also it's been mentioned several times that, in retirement when you are withdrawing from your PP, that 25% cash really helps stabilize things in times when the other three assets happen to all be down at the same time.

The same is true with regard to rebalancing before retirement. Cash (my least favorite asset when starting the PP) is very convenient for this purpose, as I now understand. Without a barbell allowing access to all that cash, a PPer could be forced to liquidate some TLTs or Intermediate bonds at exactly the worst time.

Once again, let's praise the wisdom of St. Harry in drawing up his model portfolio, so seemingly simple but blessed with great subtlety and resilience, as the ever-insightful Bill Bernstein acknowledged in his review of the PP.

[Kshartle]

Sam, check out Tyler's excellent post on the role of cash in a PP on 4/27/14 under the topic "Safe Withdrawal Rate." In short, having that cash position ups your SWR considerably.

That being said, I also fall into Kshartle's "much older investors" category. I am 55 and want to have my PP set up so that it is my main source of income starting in about ten years.

Barret i was thinking more like 70 

I think (hope) I will still feel youthful at 55. I'm at the age where I realize I will get there at some point. I haven't envisioned 70 just yet. At least not without a jet pack.

[barrett]

It's OK, K. I am 55 but trapped in the body of a 52-year-old. Robust to the point where the girls who work at the local gym even notice my existence from time to time (the guys who work there will only say goodbye to me if I am with my wife or daughter). Interestingly, I have only run a rough simulation of our retirement assets at age 70. I don't actually have a clear mental picture of myself at that age. Barbells in the PP and also at the gym (just didn't want anyone to think I was going off topic).

[sophie]

Sam, I think we are all happy to have the excuse to hash out something directly related to the PP!

The bullet (IT bonds) will indeed perform similarly to the barbell during the accumulation phase.  Although as CraigR has mentioned many times, cash may provide a boost to the portfolio when a recession hits and all three of the volatile assets drop sharply, as was the case in 2008.  When you start withdrawing, the cash arm will become very important.  It also adds a measure of safety, since you will always have immediate access to that portion of it. 

If your emergency fund is inside the PP then you probably shouldn't use intermediate bonds, but if the cash + bond assets are all in retirement accounts (and those accounts don't have long term bonds available) then it's fine.

[Pointedstick]

Sam, I think we are all happy to have the excuse to hash out something directly related to the PP!

The bullet (IT bonds) will indeed perform similarly to the barbell during the accumulation phase.  Although as CraigR has mentioned many times, cash may provide a boost to the portfolio when a recession hits and all three of the volatile assets drop sharply, as was the case in 2008.  When you start withdrawing, the cash arm will become very important.  It also adds a measure of safety, since you will always have immediate access to that portion of it. 

If your emergency fund is inside the PP then you probably shouldn't use intermediate bonds, but if the cash + bond assets are all in retirement accounts (and those accounts don't have long term bonds available) then it's fine.

If I recall, we concluded that at low withdrawal rates (2-4%), withdrawing from cash has a bonus over selling assets in equal proportions that drops off the higher you push the withdrawal rate. Also that having cash was safer than a 3x33 cashless PP.

I know that personally, I really like having cash during the accumulation phase because I can use it for large expenses that aren't really emergencies, and then make up the withdrawal with new contributions over the coming weeks or months. I can do this and feel like I'm not really destabilizing the portfolio or needing to maintain a separate "non-emergency major expense" fund.

[sophie]

If I recall, we concluded that at low withdrawal rates (2-4%), withdrawing from cash has a bonus over selling assets in equal proportions that drops off the higher you push the withdrawal rate. Also that having cash was safer than a 3x33 cashless PP.

I know that personally, I really like having cash during the accumulation phase because I can use it for large expenses that aren't really emergencies, and then make up the withdrawal with new contributions over the coming weeks or months. I can do this and feel like I'm not really destabilizing the portfolio or needing to maintain a separate "non-emergency major expense" fund.

Agreed on both points.  It's great how the PP comes with a built-in emergency & major expense fund, if you follow the basic prescription.  I would suggest, though, that people keep a separate e fund until the PP is at least 6-8 times your minimum EF needs, so that you don't have to sweat a rebalance out of cash.  I ended up having to do that after I took my active retirement account out of the PP, because there was no way to rebalance into gold (long and painful story omitted).

The intermediate bond solution works for retirement accounts without a suitable long Treasury option, but there is no reason to do it if you don't have to.

[barrett]

As I alluded to above, Desert, I have a bunch of EE and I Bonds as a big percentage of my PP cash. When I get to the stage where I am withdrawing from the PP for living expenses, it will have a lot more of the cash allocation as T-Bills and a lot less in savings bonds. The savings bonds also have the advantage of being US government debt with essentially the same 'guarantee' as LTTs or T-Bills (meaning that they can be paid back with tax revenues or printed $).

A lot of my comfort level with the PP comes from my mental accounting. I figure on the LTTs and cash barbell, my yield is close to 4% (the savings bonds were issued between 1991 and 2002). The S&P yield is almost 2% so I figure my entire PP yields around 2.3%. So - more mental gymnastics here - I feel better about gold not paying dividends.

I figure we all need our coping mechanisms.

[sophie]

One thing to keep in mind when comparing CDs to short term treasuries or savings bonds is that you pay state and local taxes on the interest from CDs.  With the Treasuries, you only pay federal taxes.  Savings bonds have the additional benefit of deferring the interest income for up to 30 years, effectively increasing the size of your tax-deferred space (as long as you are within 30 years of retirement).

I also figured out a neat little trick for people in high tax states:  buy secondary high coupon treasuries maturing within one year.  Collect the high coupon payments, then when the bond matures you have a loss to set against the interest payments on the federal tax return, PLUS you get to claim the loss on your state return.  It effectively increases the yield to something a lot better than a CD.

[barrett]

Savings bonds have the additional benefit of deferring the interest income for up to 30 years, effectively increasing the size of your tax-deferred space...

Thanks for the reminder, Sophie. I forgot to mention that. More honestly, I had just plain forgotten that benefit. Sometimes it's good to just be lucky.

I had the same question as Desert. Does the "high coupon treasuries maturing within one year" strategy juice returns in such a low-interest rate environment? I love the idea but yields really need to be higher for that trick to provide much pop, no?

[buddtholomew]

Can someone explain what's the advantage over the barbell? Because they seem like the same thing in effect.

Psychologically, I would feel more comfortable holding intermediate term bonds (bullet) over a 50/50 allocation to short and long-term treasuries (barbell). Realistically however, the investments (IT and ST/LT) should perform similarly as long as there is a parallel shift in the yield curve when/if rates rise/decline.

Others have already mentioned the benefits of holding short-term treasuries (cash).

[rickb]

Savings bonds have the additional benefit of deferring the interest income for up to 30 years, effectively increasing the size of your tax-deferred space...

Thanks for the reminder, Sophie. I forgot to mention that. More honestly, I had just plain forgotten that benefit. Sometimes it's good to just be lucky.

I had the same question as Desert. Does the "high coupon treasuries maturing within one year" strategy juice returns in such a low-interest rate environment? I love the idea but yields really need to be higher for that trick to provide much pop, no?

The critical thing here is the coupon rate, not current yields.  In fact, the larger the difference between the coupon rate and the current interest rates, the better.  Pretty much any bond issued in the last 30 years will work for this strategy since coupon rates for the last 30 years are virtually all substantially higher than the current 0% rates.

For example, these 30 year bonds issued in 1985 have a coupon rate of 10.625%

https://fixedincome.fidelity.com/ftgw/f ... renceName=

They mature in August 2015.  If you buy $1000 face value of these bonds right now, you'll pay about $1115. You'll receive dividend payments of $106.25 per year (half this amount, twice annually).  The dividend is subject to federal but not state tax.  In August of 2015 you'll receive the face value of $1000, and at that point you can claim a $115 loss on your investment (which will offset the income from the dividends).  This loss reduces both your federal and state taxes.  So you're effectively gaining a state tax reduction for free.

The yield to maturity for these bonds is approximately 0%, but because of the differential tax treatment (dividends do not affect your state tax but investment loss does) you effectively pocket whatever your state tax rate is on the dividend.  If your state tax rate is 5%, in this example you pocket about $5 on your $1100 investment, i.e. .5% (after tax, so proportionally more than this before tax).  Not huge, but lots better than you can currently do with a 1 year CD.