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Bonds & the Yield Curve
/The New Math on Bonds — Nobody Expected This
/Example Scenario

Example Scenario

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Example Scenario

So you come to me and you spend $100,000 a year. I know some of you are like, who can spend that much? It just makes it easier for me when I'm calculating numbers. So you got a $2 million portfolio, you spend $100,000 a year. So when we're putting together a portfolio, we'd often put, right now, a couple hundred thousand, maybe 2 years of living expenses in ultra short Treasuries or some ultra short cash equivalent.

Why? Because the ultra-short duration, basically 30, 60, 90 days, has almost no interest rate risk, right? You Whatever the yield is, you're going to get, that's what you're going to get in income. 4%, 3 and 1/2%, 3%, whatever that might be, but there's almost no interest rate risk. So, you know that you're going to have $200,000 there to spend, no matter what happens in the market. Then we have another tranche, another couple hundred thousand that tends to be in short duration bonds.

So, think that two, three, four-year time period. And often we do that because as the Fed cuts the Fed funds rate, right? They keep cutting it from four to three and a half, this is why your CDs and your bank interest and everything is going down in value. As that gets cut, that you've locked in a slightly higher yield with the short duration. Now, there is a bit more interest rate risk in that short duration bucket, but if you hold it to maturity, you're protected against a lot of it.

That's the one thing that's important to know about bonds. As long as it doesn't go companies don't go bankrupt. That's why you use a broad diversified fund of bonds. As long as you hold the duration, you get your original par value back, the amount you paid, plus you get paid your interest. It's when you sell before the end of the duration, and so you're forced to sell at a discount. So, couple of years of living expense in cash equivalents, couple of years in short duration bonds.

Then, depending on your risk profile, we might put another two to four years, another 200 to 400,000 in this situation, of living expenses in intermediate bonds, right? This is what's often called a bucket strategy or a liquidity strategy. There's some interesting research that shows that it's not actually that different than a 60/40, assuming we end up somewhere around a 60/40 in in this allocation, but it is from a behavioral standpoint, just much easier to hold because you understand what happens in a crash.

Because if there is a prolonged crash, that six to eight years of liquidity, right? The money in the ultra-short, the money in the short, and the money in the intermediate bond helps make it so you don't have to sell your stocks into a crash, which is the most dangerous thing you can do in retirement is to be forced to sell into a crash in order to be able to fund your living expenses. And so if you can match duration at least to some extent, you reduce some of the risk of the bond portfolio, but it also gives you time to sit through a down market.

And then in this situation, so we've got 800,000, 8 years of living expenses and fixed income, there's still 1.2 million more and that goes into a balanced equity portfolio. That's how we would think about putting together a portfolio for client.