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What’s the best place to stash money you’ll need to spend in the next few years?

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Catherine
Catherine
7 days ago

I will spend a wad of cash the next few years on college expenses. The problem in planning for this included concerns such as, what if there’s a market correction that takes a decade to rebound? What if there’s a spell of high inflation like 1978-1983? There are more what ifs than answers.

To limit the negative impact of uncertainty, and maximize the effectiveness of my saving/spending, I constructed a conceptual “cash equivalent” sufficient to cover estimated spending from savings for the next few years.
This includes:
Cash in the bank, FDIC guaranteed.
CDs of varying maturity.
EE and I bonds of varying age.
Dividends on stocks in non-retirement accounts.
Stocks/index funds in non-retirement accounts.

In other words, a conservative slice of my diversified portfolio, not a static cash horde. I included some stocks/funds in case there’s a good year where winnings off equities could reduce the bite of spending cash saved dollar-by-dollar after taxes over the past decade. Because I might not have equity wins in these particular years, the size of my “cash equivalent” pool exceeds my anticipated expenditures.

Add to the above, the kids can get jobs and generate some cash of their own. Or apply for and win scholarships, internships, and the like.

medhat
medhat
8 days ago

Not my original idea, and somewhere in HumbleDollar someone else mentioned this recently, but having a home equity line of credit for me is functionally a cash equivalent, as I pay ~ $50/annually for the ability to access up to ~ $100k as quickly as I could get cash. It’s kept me from having to maintain that amount as a cash reserve, and in the > 15 years I’ve had it I’ve never had to tap it for an urgent or emergent need, so during that entire time the cash I would have put aside was invested, more than offsetting the annual fees of the HELOC.

Sanjib Saha
Sanjib Saha
12 days ago

I used to have quite a bit in an online high-yield money market account (Capital One 360), Bank CD ladders, and rest in treasury ladder. When rates dropped last year, I sold the treasuries (captured some LT gains) and also reduced the HY balance to buy short-term TIPS ETF (I use VTIP). The CD ladder is left as-is.

I suggested my daughter to use treasury funds for short-term savings. I think she uses the iShares ETFs (SHY and SHV).

Harold Tynes
Harold Tynes
17 days ago

I use a 7 year bond ladder mixed with a 7 year “ladder” of bond ETF’s. I have 1/7 of my fixed income investments “maturing” every year so liquidity is available.

BenefitJack
BenefitJack
17 days ago

Bucket lists for retirement are not solely about places to see and things to do. Some financial experts recommend buckets for investment and spending in retirement, others for investment and saving in preparing for retirement. One challenge of course, is where to invest the money. 

I say beware… beware the bucket.

Are we at the cusp of another major market correction – the Great Recession II, a COVID relapse, resumption of double digit inflation? Volatility is up (or down). Yields on bonds are going … where? 

Volatility is not predictive of market swings – up or down. Some time ago, I sat through a presentation by Grady Smith, CFA, Vice President & Senior Portfolio Manager, Dimensional. He demonstrated/I learned that:

  • For the period 1990-2017, using the S&P 500 as a proxy, only 33 of the ~6,300 trading days had gains or declines of 5% or more.
  • For the period 1927 – 2016, volatility in the current month is not predictive of returns in the next month (using the Fama/French US Total Market Index). The average monthly return is substantially the same regardless of whether the prior month had high volatility or low volatility! 
  • For the same period, there is no statistically significant difference in annualized compound returns (whether measured after 1 year, 3 years or 5 years) following either a 10% market decline or a 10% market increase (using the S&P 500 index total returns as a proxy). 

Bottom line, volatility, low or high, doesn’t portend the need for a change in investment allocations.

This again is of interest as we acknowledge anniversaries of the 2008 financial storm and the COVID-19 market crash. Those who were in their 50s during the Great Recession may be considering retirement or retired today. Many are concerned about a stock market tumble, others about potential double digit inflation. Unlike past periods, many more are invested in 2020 or 2025 target date funds – some of which still have 55 to 60 percent (or more) equity allocations. Others are concerned about sequence of returns risk. Those of us in our 60’s and 70’s clearly remember the double digit inflation of the 70’s and early 80’s.

To counter those challenges, some financial experts recommend a bucket approach for retirement savings, preparation, investment, and spending – to moderate the impact of a market correction on retirement savings. You set aside a few years worth of spending then invest the remainder of the portfolio more aggressively. So, when an investment portfolio suffers a market correction, a retiree uses money from the cash account – so the investment portfolio has time to recover. However, when the market correction occurred in 2008, it took more than four years to fully recover – and only for those who stayed invested in equities, those who stayed the course.

The bucket approach can also be implemented using mental accounting in both accumulation and decumulation of assets. You allocate/separate assets based on their specific purpose/need. It’s popular, feels good and is plausible. It is easy to implement and it reduces anxiety.

But, it may be suboptimal:

“The evidence shows that a bucket approach underperforms static strategies; however plausible, comforting, consistent with mental accounting and easy to implement the bucket approach may be, simple static strategies, with periodic rebalancing, are just as easy to implement and leave retirees better off” – says J. Estrada, The Bucket Approach for Retirement: A Suboptimal Behavioral Trick? 12/8/18 at: https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3274499

And, just as important, there is significant upside potential from using a “total return” approach says M. Kitces in The Extraordinary Upside Potential Of Sequence Of Return Risk In Retirement, 2/20/19, at: https://www.kitces.com/blog/url-upside-potential-sequence-of-return-risk

So, while we are in our late 60’s, we keep the money in the plans, accumulating tax deferred (or Roth, tax free) using a total return approach (including my spouse’s retirement savings). And, for us, if there is a market decline, we would consider borrowing from my 401k plan. The interest rate on that loan would be ~5+%. Today, as was the situation for the last 10 years of our “retirement”, that 5% “riskless” rate of return is greater than the return we could have achieved on almost all other fixed income investments, and generally it is ALSO less than the rate we would pay on most other commercial sources of liquidity. So, using a plan loan to moderate the impact of a market decline may both improve our household wealth AND increase retirement assets. I just have to remember to rebalance after initiating the loan so that the plan loan principal is treated as the fixed income investment it is. And, should circumstances change, we can accelerate the loan repayment as needed – or, “convert” it into a distribution. 

Note: Some retirement experts also use the term “bucket” to separate retirement assets by tax status. So, when saving and spending retirement assets, incorporating consideration of the tax treatment for each source is important – for both the contribution and the distribution, as well as the impact on the investment portfolio.

Purple Rain
Purple Rain
20 days ago

Inflation adjusted 30-year I-Bonds. The interest compounds without taxes until you need to withdraw. The IRS allows 10k per year per peron, plus an additional 5 per tax return. We have been building a ladder over a few years to reach several years of our annual expenses.

David Powell
David Powell
20 days ago
Reply to  Purple Rain

+1 for I-Bonds

Rick Connor
Rick Connor
21 days ago

Leave it in cash. FDIC insured money market online accounts are a good choice. They are easy to use, liquid, and readily available.

Roboticus Aquarius
Roboticus Aquarius
21 days ago

Leave it in cash, in the form of a high interest savings account, or a money market account, or even just regular savings. I prefer these options because they require the least maintenance, and it’s easy to get 100% of what you need when you need it, and that’s really the most important criteria.

If you make a mistake with a CD, you can miss the withdrawal window and have to pay a penalty to get it when you need it. To me, that’s stress I don’t need.

Putting it to work in the market or even in bonds creates a non-zero chance of a potential shortfall.

Last edited 21 days ago by Roboticus Aquarius
Mike Zaccardi
Mike Zaccardi
21 days ago

There’s no free lunch here, in my opinion. I’d just keep it in an FDIC-insured high yield online savings account.

Perhaps high-income earners can venture into the muni bond space to save on taxes (a little). Other ideas for those looking to take more risk could be a target retirement income fund, but even those carry material risk.

We don’t have to look back far to see how even ‘safe’ securities performed during market turmoil. Safe assets can often become sources of liquidity during market panics, so they can be sold off, too.

Thinking outside the box, individuals with a lot of home equity (which are many people now) could simply tap that when cash needs come.

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