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Cash or bonds?

Including Financial Independence and Retiring Early (FIRE)
UnclePhilip
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Cash or bonds?

#461574

Postby UnclePhilip » November 28th, 2021, 12:05 pm

Not sure if this is the right board, please let me know if it should be posted elsewhere.

We are both retired, with state pensions and a bit of rent from an investment property. The bulk of our investments are in global equities, both index tracking and actively managed. We have about £45,000 in a savings account with a paltry interest rate of about 0.6% I think. This is to provide £15,000 per year for three years, to tide us over an average bear market. Our time horizon is infinity, it's all to pass on to our children.

Which brings me to my question; should I begin to think of bonds rather than cash, for this reserve fund? I've not felt the need for bonds until now, having successfully managed to sleep well during all the various excitements since the 1990s.

If I can see the benefit, I'd be happy to do a bit of research....

Thanks,

Uncle

ursaminortaur
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Re: Cash or bonds?

#461588

Postby ursaminortaur » November 28th, 2021, 12:38 pm

UnclePhilip wrote:Not sure if this is the right board, please let me know if it should be posted elsewhere.

We are both retired, with state pensions and a bit of rent from an investment property. The bulk of our investments are in global equities, both index tracking and actively managed. We have about £45,000 in a savings account with a paltry interest rate of about 0.6% I think. This is to provide £15,000 per year for three years, to tide us over an average bear market. Our time horizon is infinity, it's all to pass on to our children.

Which brings me to my question; should I begin to think of bonds rather than cash, for this reserve fund? I've not felt the need for bonds until now, having successfully managed to sleep well during all the various excitements since the 1990s.

If I can see the benefit, I'd be happy to do a bit of research....

Thanks,

Uncle


Rather than cash how about "near cash" eg premium bonds where the annual prize rate is around 1% but you have a small chance of a much larger return and can get your cash back fairly quickly if needed. You can put upto £50,000 into premium bonds each.

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Re: Cash or bonds?

#461600

Postby kempiejon » November 28th, 2021, 1:17 pm

ursaminortaur wrote:Rather than cash how about "near cash" eg premium bonds where the annual prize rate is around 1% but you have a small chance of a much larger return and can get your cash back fairly quickly if needed. You can put upto £50,000 into premium bonds each.


Like UnclePhillip I have a chunk of cash to smooth downturns in investment income and I use premium bonds as my store for those funds. I have other cash as a float in my current account and savings accounts but PBs hold the majority of my funds and PBs are exempted from the tax on dividend interest.

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Re: Cash or bonds?

#461608

Postby dealtn » November 28th, 2021, 1:57 pm

UnclePhilip wrote:
Which brings me to my question; should I begin to think of bonds rather than cash, for this reserve fund? I've not felt the need for bonds until now, having successfully managed to sleep well during all the various excitements since the 1990s.

If I can see the benefit, I'd be happy to do a bit of research....

Thanks,

Uncle


How do you feel about volatility in the worth of you "cash" capital?

Strictly speaking this should be looked at in terms of real capital, not nominal, but intuitively how do you feel about a constant £45,000, earning very little (which guarantees you requirement of 3 years worth of £15,000) compared with one that might vary perhaps £10k up and down around that constant £45k (that also earns very little).

A more subtle question to consider would be how you think that variance would affect your total portfolio capital. Both equities and bonds move in price, but often in opposite directions. You appear happy owning equities, so appear comfortable with capital fluctuations.

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Re: Cash or bonds?

#461650

Postby BullDog » November 28th, 2021, 5:30 pm

Personally, I don't see any more attractive alternative for the OP. I think doing exactly what he/she is doing is absolutely fine and the best that can be achieved given the strange and volatile world we now live in. I too have never seen any attractions in investing in bonds and I don't expect that to change anytime soon.

When the really smelly stuff hits the fan, everything except cash goes down in capital value just the same. The 3 years income float in cash allows you to ignore the volatility and carry on regardless.

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Re: Cash or bonds?

#461718

Postby Wuffle » November 28th, 2021, 10:51 pm

If you want 3 years of 'backup' but are concerned about 3 or 4 percent inflation reducing the effective duration of the safety mechanism, the solution would appear to be to spend 3 or 4 percent less each year and top up the reserve.
It is not as if you haven't shown an ability to defer gratification before, but perhaps the calculations need reassessment.

W.

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Re: Cash or bonds?

#461724

Postby Alaric » November 28th, 2021, 11:07 pm

dealtn wrote:How do you feel about volatility in the worth of you "cash" capital?


ETFs, OEICs and ITs investing in Corporate Bonds and similar will pay a much higher interest rate than cash, so much so that it wouldn't be necessary to hold a fortune to get up to the £ 1,000 tax limit.

Vulnerability to increases in interest rates can be reduced by only holding funds that hold assets due to mature in the near future. Additionally capital values will wobble with changes in the presumed or actual credit risk.

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Re: Cash or bonds?

#461734

Postby JohnW » November 29th, 2021, 4:19 am

I think it’s worth distinguishing between ‘bonds’ and ‘bond funds’ when you think about this or discuss it. Now, let me blithely ignore that distinction.
If one is to own bonds, the longer dated ones usually pay more interest so you’d choose those if you could. You say your horizon is infinity, so you’d want the longest possible. But wait….your £45k cash is to draw upon in a bear market for stocks; so the horizon for that cash is more like one year not infinity. Or, since the correct term is probably ‘duration’ which is the average of the times you need the cash, you’d have to allow for a bear to hit anytime so your duration is possibly as low as (0+1+2+3)/3 ie about 2 years. With bond funds it’s safest to duration match, so you might prefer a bond fund with a 2 year duration - I doubt one exists. Or perhaps you could have half your cash in a 5 year bond fund and the other half as cash giving a ‘duration’ of about 2.5 years.
Over the quite long term you’d need to be concerned about your £45k cash reserve suffering from inflation. Only you know how vital for your living expenses is that £15k/year. One option might be to top up the cash if possible every 5-10 years to account for the last 5-10 years of inflation. If you don’t think you can manage that, and you really are worried about inflation on that cash, then you could hold it as soon to mature individual linkers; that swaps the unknown effect of inflation on your cash for a known negative yield at the moment.
Lastly, if we’re considering bonds to rescue you in a bear market they probably need to be the highest quality government bonds not corporate bonds as the former will hold their value better. That’s what you’re after mostly: a return of your capital above a return on your capital.

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Re: Cash or bonds?

#461742

Postby dealtn » November 29th, 2021, 8:06 am

Alaric wrote:
dealtn wrote:How do you feel about volatility in the worth of you "cash" capital?


ETFs, OEICs and ITs investing in Corporate Bonds and similar will pay a much higher interest rate than cash, so much so that it wouldn't be necessary to hold a fortune to get up to the £ 1,000 tax limit.

Vulnerability to increases in interest rates can be reduced by only holding funds that hold assets due to mature in the near future. Additionally capital values will wobble with changes in the presumed or actual credit risk.


Can you illustrate this "much higher" rate you refer to for bonds with a duration close to cash? Much of any rise in interest will surely reflect the increased credit risk (and accompanying potential volatility) associated with the lending to Corporates as opposed to Governments (or cash). That risk may of course be acceptable to the OP, that is for him to decide, but it strays somewhat from "near cash" although he doesn't define what is meant by "bonds" which is a wide spectrum of possibilities.

MrFoolish
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Re: Cash or bonds?

#461758

Postby MrFoolish » November 29th, 2021, 9:22 am

I hold the corporate bond fund SLXX, which has done ok for me both in capital and distributions. But I have zero expertise in corporate bonds so you'd have to DYOR.

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Re: Cash or bonds?

#461761

Postby UnclePhilip » November 29th, 2021, 9:57 am

Thank you for the responses.

To clarify, what I'm after is a reserve to tide us over three years of equity declines. Nothing is certain, but that reflects my level of confidence in equities. More than £45,000 and I'd feel I was passing up opportunities. The reserve has to be available at short notice, and my thoughts relate to holding cash at current interest rates so far below real inflation; that's not a risk, it's a certain loss! But perhaps that's the price to pay for such a reserve.

I've never gone into bonds, perhaps bond funds may be the thing. Also if holdable in ISAs (are they?) I could stick £40,000 in right now.

Those of you who do hold bonds, how do you go about this, please?

Thanks,

Uncle

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Re: Cash or bonds?

#461763

Postby MrFoolish » November 29th, 2021, 10:00 am

SLXX can be bought and sold just like any other share. And yes, you can stick it in an ISA.

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Re: Cash or bonds?

#461793

Postby scotia » November 29th, 2021, 11:43 am

MrFoolish wrote:SLXX can be bought and sold just like any other share. And yes, you can stick it in an ISA.

I had a look at the total return of SLXX over 5 years - its 21.8%. But - most of the growth was over the first 3 years. And it dropped back to around 0% total return in the Covid stock market crash of March 2020, and now is just above its pre-crash level. I'm currently not a fan of Bond funds - and like the original poster we keep a cash buffer (which includes premium bonds). I'm no expert on bonds, but they tend to increase in value as interest rates fall, and fall when interest rates climb. Current thinking is that interest rates will rise - but only slowly, so at best I would expect there to be little gain in bond funds - and the crash of March 2020 suggests that they can also be volatile. So I'll grin and bear the small (below inflation) return on the cash buffer, although with inflation rising steadily it will be more bearing than grinning.

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Re: Cash or bonds?

#461800

Postby MrFoolish » November 29th, 2021, 11:52 am

scotia wrote:I'm no expert on bonds, but they tend to increase in value as interest rates fall, and fall when interest rates climb


Wouldn't some of this expectation of rising interest rates be baked into the price, meaning they are "cheap"?

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Re: Cash or bonds?

#461804

Postby Alaric » November 29th, 2021, 12:01 pm

dealtn wrote:Can you illustrate this "much higher" rate you refer to for bonds with a duration close to


SLXX as mentioned by other posters is one of the possibilities. On an income basis, the distribution is much higher than you would get from an equivalent amount in a deposit. It's risk and reward. Put the capital at risk to an extent and gain a higher reward in terms of interest. In terms of access to funds, it would be no longer than the cycle of stock market sale and transfer of proceeds. That may be a better solution than fixed term deposits as a home for emergency funds.

SLXX holds a basket of corporate bonds with near future maturity dates. The effect of a rise in interest rates or a widening of margins over gilts would initially be a fall in capital values, but then followed by increases in distributions as reinvestments into higher yielding replacements of maturing bonds kicked in.

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Re: Cash or bonds?

#461810

Postby dealtn » November 29th, 2021, 12:11 pm

Alaric wrote:
dealtn wrote:Can you illustrate this "much higher" rate you refer to for bonds with a duration close to


SLXX as mentioned by other posters is one of the possibilities. On an income basis, the distribution is much higher than you would get from an equivalent amount in a deposit. It's risk and reward. Put the capital at risk to an extent and gain a higher reward in terms of interest. In terms of access to funds, it would be no longer than the cycle of stock market sale and transfer of proceeds. That may be a better solution than fixed term deposits as a home for emergency funds.

SLXX holds a basket of corporate bonds with near future maturity dates. The effect of a rise in interest rates or a widening of margins over gilts would initially be a fall in capital values, but then followed by increases in distributions as reinvestments into higher yielding replacements of maturing bonds kicked in.


Weighted average maturity of SLXX looks to be 11.99 years.

https://www.fundslibrary.co.uk/FundsLibrary.DataRetrieval/Documents.aspx/?type=packet_fund_class_doc_factsheet_private&id=0fa1a207-798e-4e03-a3bc-8b585c8a5cee&user=vUBYa9kTdyi%2beLF%2f2%2bJcG5tmKOkZ7OQ3Snl7SAhx3MPeMiD7JIKOrxIm%2fI90KbBE&r=1

That makes it, by some way, longer duration than "cash". Not to say it isn't a suitable investment, but would explain why it has a higher "interest" return, and accompanying volatility. You are correct that should capital values of credit corporate bonds fall, either due to rising interest rates, or to a widening credit risk premium over Gilts, then reinvestment should capture this higher yield going forward (assuming of course no default failures of the underlying investments). But the OP had a 3 year horizon, and an average 18 months use of the cash, should it be needed. That is a significant dislocation from the duration and risk profile of SLXX.

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Re: Cash or bonds?

#461815

Postby bluedonkey » November 29th, 2021, 12:44 pm

A possible downside of bonds rather than cash is that there may be a tendency to monitor what's happening to the bonds. It's only natural, in the same way we all look at our share prices. With cash, this aspect doesn't arise.

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Re: Cash or bonds?

#461857

Postby GeoffF100 » November 29th, 2021, 3:38 pm

Why not cash earning 0.75% (Aldermore), 1 year bond earning 1.36% (Investec) and 2 year bond earning 1.63% (United Trust Bank), all protected by the FSCS:

https://www.moneysavingexpert.com/savin ... -interest/

The average time to maturity is then 1 year. If you invest that in a gilt edged stock guaranteed by the UK government, with 1 year to maturity, you will get 0.269%:

https://www.fixedincomeinvestor.co.uk/x ... ?groupid=3

If you invest in a gilt fund with the same risk, you will get less, because of the costs. You can get more, but only by taking more risk. The premium you get for taking more risk has greatly decreased in recent years. You still get all the risk, but you do not get paid much for taking it.

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Re: Cash or bonds?

#461878

Postby UnclePhilip » November 29th, 2021, 5:07 pm

GeoffF100 wrote:Why not cash earning 0.75% (Aldermore), 1 year bond earning 1.36% (Investec) and 2 year bond earning 1.63% (United Trust Bank), all protected by the FSCS:

https://www.moneysavingexpert.com/savin ... -interest/

The average time to maturity is then 1 year. If you invest that in a gilt edged stock guaranteed by the UK government, with 1 year to maturity, you will get 0.269%:

https://www.fixedincomeinvestor.co.uk/x ... ?groupid=3

If you invest in a gilt fund with the same risk, you will get less, because of the costs. You can get more, but only by taking more risk. The premium you get for taking more risk has greatly decreased in recent years. You still get all the risk, but you do not get paid much for taking it.


Thanks for that. Reading all replies, and thinking about it, my Saga account at 0.6% seems probably worth staying with. That only yields £270 a year, and trying to sweat a bit more with low access bank "bonds" which are really savings accounts, or bonds with some capital risk, starts to seem like a faff.

Perhaps I need to see the erosion of value through inflation as the price for having a reserve, and as the reserve is a small proportion of liquid worth, leave all risk in the bigger equity bag?

Hey ho...

Uncle

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Re: Cash or bonds?

#461879

Postby UnclePhilip » November 29th, 2021, 5:09 pm

bluedonkey wrote:A possible downside of bonds rather than cash is that there may be a tendency to monitor what's happening to the bonds. It's only natural, in the same way we all look at our share prices. With cash, this aspect doesn't arise.


That made me chuckle, thanks1


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