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Favorite Investments for Short-Term Retirement Assets

Readers share where they're holding money they expect to spend within the next year or two.

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The premise behind the bucket strategy for retirement portfolio management is simple: Get most of your money invested in stocks and bonds, but set aside a portion of your portfolio to cover near-term living expenses. That way, you won't be unduly rattled when your long-term investments fall in value.

Many retired Morningstar.com readers have told us they're using the bucket system to manage their portfolios, so we decided to ask these practitioners how they're doing it. What types of assets are they keeping in bucket 1--the liquidity component of their portfolios? And how much had they staked in it?

Readers were eager to share their approaches. Numerous posters said they had parked the money in true cash instruments such as CDs, money market accounts, and checking and savings accounts. Various online banks received repeated shout-outs for offering decent yields on their cash instruments, both CDs and online savings accounts. Stable-value funds, while not technically cash, also received a thumbs-up from safety-minded retired investors. These posters shared tips for eking out a bit of extra yield with this part of the portfolio, all with an eye toward keeping their principal values stable.

Other respondents said that they were taking a bit of risk with their short-term assets, mixing in some bond or even stock holdings. The rationale from many such investors was that with cash yields as low as they are, the opportunity cost of holding too much in cash is just too great.

Readers also shared disparate views about the size of the liquid component of their portfolios. Some respondents said they were holding a fairly high level of cash--well more than the two years' worth I've included in my model portfolios--while others were holding cash at the low end of the range.

To read the complete thread or share your own management strategy for bucket 1 of your retirement portfolio, click here.

'The Maximum-Security Arms of a Money Fund'
A healthy contingent of posters said that risk control is the name of the game for their liquid reserves. Thus, they're sticking with actual cash instruments such as CDs and money market accounts.

Chip1909 made the case for keeping bucket 1 safe, arguing that "placing Bucket 1 anywhere but in the maximum-security arms of a money fund would be foolhardy."

DONQ agreed, writing that, "Short-term rates are so low that even the minimal risk is not worth the returns."

The knock against cash is that yields are so low right now. But peace of mind is the main attraction for investors like revell10306: "I have no current concerns about these funds generating return; they exist to allow my real investments room to run or buffer in the event of a downturn."

FingerlakesGuy concurred, writing that cash is "[n]ot earning much, but at least I'm guaranteed that my bucket won't leak."

Most of the readers who said they were sticking with cash had taken steps to pick up a bit of extra yield. Online savings accounts received repeat mentions, as did CDs, including those offered by online-only banks. (Morningstar's Sam Lee made the case for CDs as the best option for short-term assets in this article.)

Dndhatcher, not yet retired, is taking a multipronged approach. "[My bucket 1 is] in an FDIC-insured GE Capital online savings account (paying 0.9%) with some in I-bonds and a 'too big to fail' bank account for operational purposes (direct deposit, bill paying, ATM)."

Certificates of deposit from Ally Bank received repeat mentions as attractive depositories for cash. But Island notes that Ally's terms aren't as generous for new purchasers of CDs. "Ally used to be the best deal, but now they charge [a higher] penalty [for premature withdrawals]."

Homebrewer is staging cash holdings by time horizon. This investor uses a short-term savings vehicle as an emergency fund, while holding longer-term CDs (earning more than 3%!) to cover home repairs down the line. "We have enough cash to buy a new roof or other home repairs if needed right away," this poster said, "but we have CDs for future repairs to our 20-year-old house."

Several posters noted that they ladder CDs, buying issues with various maturity dates so that they can reinvest at multiple intervals. Larry Sz holds cash in both an online bank account and CDs, noting that "the CDs are 18-month issues, staggered at 6-month intervals."

'To Protect Principal and Maximize Total Return'
Numerous respondents said they were using a two-part bucket 1, pairing true cash instruments with investments that offer the potential for higher returns as well as the possibility for capital losses.

Many such investors said that they hold true cash for imminent expenses, and take a bit more risk with monies they don't expect to need for a few years or more.

Darwinian wrote, "I actually divide my short-term needs into two buckets. To cover income needs for the next 18 months, I use Ally Bank's 0.87% FDIC-insured savings account. This is supplemented by a stable value fund in a former 401(k), paying 2.14%."

Darwinian's next-line reserves (to cover expenses 18 months out or more) consist of  Vanguard Limited-Term Tax-Exempt (VMLUX) and  Vanguard Short-Term Investment-Grade (VFSUX). Of those two offerings, Darwinian wrote, "According to my bond calculator, both should still have (barely) positive returns even if rates rise 1.25% annually for two years, other things equal."

Rule72 also segments cash holdings by anticipated time horizon. "Our quasi-bucket approach is enough cash to cover 1-2 months bills and about 5% of our total portfolio in one intermediate-term muni bond fund if we need more for unexpected expenses."

MUNILHARSH's strategy is straightforward: "I am a Vanguard fan using  Vanguard Short-Term Investment-Grade (VFSTX) as well as a money market fund."

WAB1978 is employing a three-part bucket 1. "[I hold] three years' living expenses split evenly in cash (a money market fund and laddered CDs), a short term bond fund ( T. Rowe Price Short-Term Bond (PRWBX)), and a conservative allocation fund ( Manning & Napier Pro-Blend Conservative (EXDAX))."

WOODJ has toggled between a money market fund and a short-term bond offering for bucket 1; right now, bonds win out. "Presently, [bucket 1] is held in a short-term investment-grade bond fund, Vanguard Short-Term Investment-Grade. In the 2008 downturn it was in the money market fund. I could go back to the money market fund if I feel it is prudent. This is the only place where I would market-time because I don't feel that this example is harmful."

Dtconroe uses a similar strategy, moving assets among vehicles as his perception of risk changes. "Within [my bucket 1, a taxable account], I have a money market banking category, a short/intermediate municipal bond category, and a conservative high-yield bond/floating rate bank-loan category. I will shift monies between these categories periodically, to increase or reduce risk, as market conditions dictate, and to protect principal and maximize total return."


'I Know I Have More Than I Need in Bucket 1'

Posters also shared how they had "right-sized" their bucket 1.

Concentrating on the opportunity cost of holding too much in cash, Chip1909 has kept his bucket 1 svelte: "I'm holding just a single year's worth of expenses in bucket 1, and that includes anticipated dividends for the year. I keep it at this minimum because I'm unwilling to sacrifice the opportunity a larger bucket 1 would represent. I'd rather liquidate assets to cover an unanticipated expense than steal from the investment power of Bucket 2.

But other posters said they were holding a larger bucket 1.

Zorkl55 shared, "My wife and I now have cash reserves sufficient to see us through three to five years. We keep the bulk of this in a TIAA-CREF taxable money market. We also have savings accounts. We determined the size of our cash reserves based on three things: 1) our ages (66) 2) our work status (she's retired, I'm now part-time at work) and 3) how much cash would let us stay calm when bond and/or stock markets drop precipitously."

Dblbogie has increased the assets in bucket 1 in order to get ready for required minimum distribution (RMD) time. "Bucket 1 gets more interesting as I prep for RMDs for the both of us," this poster wrote. "Now we will need bucket 1 monies in each IRA account…to cover the RMDs plus what is now a fixed amount in our taxable account."

Also running with a large bucket 1 currently is FingerlakesGuy. "I know I have more than I need in bucket 1, probably enough for about 10 years of expenses, but I sold off some gains in equities, as well as cashing out a large portion of my bond portfolio last year, anticipating a pullback in equities and bonds (not necessarily at the same time). I intend to put about 25%-35% back into bonds if and when bonds fall and yields rise, as well as putting more into equities if we do have a pullback later this year. If not, I'll still sleep well at night with my 2%-3% yield, as well as still having a sizable amount in equities if the market does keep moving ahead."





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Christine Benz does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.