Cash in a savings account vs tax-free bond ETF

[He-Man]

Here's a question that's been tickling me lately.

I have a present asset allocation of approximately:

• 9% short-term bonds (high-quality corporate and government)
• 46% cash in a savings account earning 0.5% per annum
• 45% stocks (mostly US and European index ETFs)

I'm fully aware that for someone my age (early 30s), I should have a lot more in stocks than in cash and bonds.
The reason I keep bonds is because I invest as a Boglehead. I keep bonds for rebalancing purposes and diversification and have no problem with the low returns right now.
The reason I keep so much cash is because I'm an expat in a potentially volatile country and want to have money to hand in case I need it. It's kept in an off-shore account and is treated as my emergency fund.

I am aggressively adding to my stocks every month to the extent that by the middle of next year a significant majority of my net worth will be in stocks.

But my question and the purpose of this thread is to ask whether I'd be better taking half my cash and simply adding it to my bond ETFs.

The positives of doing this are:

• ETFs are highly liquid, so I could sell the bonds if in dire need
• Each bond share pays a dividend, the cumulative sum of which exceeds the amount of interest earned by the cash account
• The expected return is between 1.5 - 3% per annum vs the 0.5% it would earn in the savings account
• The amount is diversified among many bonds, vs. resting with just one bank

The negatives are:

• I derive psychological comfort from knowing I have a significant sum of cash in case of emergencies
• The value of the bonds may decrease as well as increase (though they are unlikely to decrease by much, especially when dividends are reinvested)
• The TER ranges from 0.08% to 0.2% per annum depending on the ETF I choose (though I could contrast this charge win inflation eating away at the cash if it's left in a current account)
• Mixing up of emergency fund with investment portfolio

In the meantime, all my fresh cash would go into equity every month, so the proportion of my cash and bonds will be decreasing every month as my equity allocation increases.

 

[alwaysonit]

What bonds are you looking at buying? Can you let me know which ones your 9% is already invested in?

I have all of my fixed income side of my portfolio currently in deposit accounts earning about 1% net.

 

[He-Man]

What bonds are you looking at buying? Can you let me know which ones your 9% is already invested in?

I have all of my fixed income side of my portfolio currently in deposit accounts earning about 1% net.

I don't want to derail the subject of my thread, but I have bought Vanguard's BND for the dollar portion of my portfolio. I will keep this under 60k dollars so as to avoid US Estate Tax.

For the euro portion of my portfolio, I am looking at a number of SPDR bond ETFs traded on the Frankfurt exchange: SYB3, SYBA, SYBC. I have not yet made a decision about which one of these to go for. All are pretty diverse, but:

• SYB3 is more stable
• SYBC yields more
• SYBA is more diversified and yields almost as much as SYBC.

But I'd rather not discuss the merits of these particular ETFs; I really want to get a debate going about cash vs bond ETFs for surfeits of cash that you want to grow, but don't want to put into equities.

 

[Jim2007]

I really want to get a debate going about cash vs bond ETFs for surfeits of cash that you want to grow, but don't want to put into equities.

It is very rarely a good idea to buy bond ETFs... Take the time to understand how the bond market works and how bond ETFs are constructed.

 

[He-Man]

Many disagree, Jim. Bond ETFs are an integral component of the Bogle investing philosophy for example - a point also shared by Benjamin Graham. They play a key role in enabling rebalancing and serve as parachutes during market crashes. Why, specifically, are they not a good idea in your opinion? And are they preferable (in your view) to cash when one has a surfeit of cash but doesn't want to put them it into equities?

 

[Jim2007]

Many disagree, Jim. Bond ETFs are an integral component of the Bogle investing philosophy for example - a point also shared by Benjamin Graham. They play a key role in enabling rebalancing and serve as parachutes during market crashes. Why, specifically, are they not a good idea in your opinion? And are they preferable (in your view) to cash when one has a surfeit of cash but doesn't want to put them it into equities?

Well it has been a long time since I read Bogle's book and to the best of my knowledge most of his comments have been on mutual funds rather than the type of ETFs now being offered.... and of course ETFs were not even around in Graham's time. So neither of them were suggesting the use of Bond ETFs.

 

[He-Man]

Obviously, but Bogle currently recommends bond mutual funds OR bond ETFs and is quite clear on this point.

Buffet says Graham would have been an index investor and Graham's core point - that investors should never have below 20% bonds in their portfolio - is incorporated in Bogle's advice in the form of bond funds or ETFs. There is no difference in content, for example, between Vanguard'd total bond market mutual fund and its total bond market ETF.

I should point out as well that Vanguard's portfolio builder tool has no qualms about suggesting bond ETFs as part of a sensible, balanced portfolio.

 

[PMU]

The reason I keep so much cash is because I'm an expat in a potentially volatile country and want to have money to hand in case I need it. It's kept in an off-shore account and is treated as my emergency fund.

You are the best judge of this but you may be exposed more to volatility from the political situation in your country of work than to the market volatility of your stocks. If the money is in an off-shore a/c will you be able to access it in an emergency? You should consider buying gold coins and perhaps holding some USD cash to allow you to bribe your way out of the country if the balloon goes up. (I had relatives some years ago in South Africa and a significant amount of their wealth was in gold / precious stones in case they had to do the midnight flit.)

45% stocks (mostly US and European index ETFs) .

You should diversify this equity holding by investing in emerging market equities, especially if you are in for the long haul.

I keep bonds for rebalancing purposes and diversification and have no problem with the low returns right now.

I don't think this is a valid reason for holding short term bonds. You could just leave the money in your cash fund and then use it to invest when there are market drops etc. Presumably it is easier to access your cash then to sell bonds, incur fees, taxes etc.
Bonds are an asset class and the reason for holding them is like any other asset class, i.e. do they fit into your investment plan. If this is the case, you should invest in them, but you appear to hold bonds for money management purposes and not for investment reasons.

But my question and the purpose of this thread is to ask whether I'd be better taking half my cash and simply adding it to my bond ETFs.

Unless you have a pressing need for additional income from the bonds you should consider investing in other asset classes within which you are not currently invested, e.g. emerging market equities, property (both domestic and foreign), commodities, and timber. Fixed income investing is really for those who need low(ish) volatility and an additional income stream.


[Disclaimer: The above is comment / observation only and is not a recommendation to follow any particular investment strategy or to buy / not buy any particular fund or stock.]

 

[alwaysonit]

Thanks for that he-man, are there any more EUR bond ETF’s you’ve looked at? I’ve been looking at 4 more so we can discuss the merits of these via PM if you want.

To answer your initial questions, I think you should add half your cash to your bond ETFs (dependent on how much cash you have and taking fees into account).

Reading your initial post your positives outweigh the negatives a lot. As you said
- you can sell the bonds if in need
- they are unlikely to decrease in value my much,
- the expected return is between 1% and 1.5% better than what you’re currently earning, this outweighs the TER by a lot

 

[alwaysonit]

Actually looking at your EUR based bond ETFs, the yield to maturity less TER is 1% or less for them all, and I'm pretty sure this is the rate that should be compared to the AER for bank deposits.

If you can deposit DIRT free in Ireland you should get higher returns.