3 Strategies for Bonds & Cash in Wealth Management

January 17, 2024 Rob Williams
Income and diversification are important when creating an investment plan, but timing of cash flow may be more important for part of a portfolio when money is needed soon.

Every portfolio, ideally, starts with an investment plan that has clearly defined goals and a roadmap for how to achieve them. Income and diversification are important when creating an investment plan. However, the timing of cash flows from the portfolio (beyond interest and dividend payments) may be just as—or even more—important.

That's because not all investing goals are long-term. Often, you'll have short-term needs from your portfolio, and the question investors may ask is, "Will I have cash from my portfolio when I need it?" This is especially important if you are nearing or in retirement and need to tap growth and principal from your portfolio, or if you have a near-term specific goal, such as paying for college in a few years.

In both cases, the time horizon is important: When do you need the money?

Here are three strategies for timing cash flow to consider incorporating into an investment plan using bonds, bond funds, and cash and other short-term investments. Consider these strategies as part of your wealth management plan:

Strategy 1: Asset/liability matching

A common use of "ladders" of CDs and bonds as a long-term investment and diversification strategy is to manage and mitigate the risk of changing interest rates in a long-term portfolio. We also suggest that CD and bond ladders can be a useful short-term, cash-flow management strategy sometimes called asset/liability matching.

Here’s an illustration:

Bond ladders for retirement distribution

Tap the whole portfolio to replenish a CD or bond ladder. Then, use maturing bonds or CDs to support spending.

Source: Schwab Center for Financial Research.

The example is hypothetical and provided for illustrative purposes only. The illustration does not represent a specific investment product. For more see, “What Are Bond Ladders?” 

Example

John and Sue, both age 58, would like to step back from their full-time jobs to take on different work and partial retirement in five to seven years. John and Sue saved and invested for this purpose in a brokerage account. They'll have to tap that savings to "bridge the gap" while waiting to file for Social Security after age 67 and while keeping savings invested in their retirement accounts including a 401(k) and IRAs for later in retirement. One way they can invest to achieve this objective is by laddering bonds.

To do it, they could purchase a high-quality Treasury, municipal, or highly rated corporate bond (or bonds) maturing in five years, using principal equal to roughly the amount they plan to need from their investment portfolio to spend in year one of retirement. Then, they could purchase another bond maturing in six years, then seven, and so-on, to have money available when needed when they mature. That is, matching the "liability"—the amount needed—with an "asset" that has a matching investment time horizon, such as the bond maturing on or near the future date John and Sue plan to need available, predictable cash with a maturing par amount equal to that cash-flow need.

They could do this for three to five years of portfolio withdrawals needed. The income generated in the meantime is a bonus, helpful as a form of investment return. When the bonds mature, they provide cash needed, when it's needed, while allowing John and Sue to invest the rest of their savings more confidently in stocks and other investments, if they choose, for future longer-term growth potential. 

Strategy 2: Duration targeting

Typically, this strategy involves a portfolio of bonds and can use bond mutual funds or exchange-traded funds (ETFs). Not every bond mutual fund or ETF is the same. They have different strategies, and often, explicitly invest in bonds with different maturity ranges. Categories can help investors tell the difference. Here are those categories, by maturity:

Laddering by time horizon using bond funds

Use short-term bonds when you need principal in 1 to 4 years, intermediate-term bonds when you need principal in 4 to 10 years, and long-term bonds when principal is needed in more than 10 years.

Source: Schwab Center for Financial Research, using mutual fund classifications and categories used and provided by Morningstar. For illustrative purposes only.

They generally vary on a few dimensions: average maturities, average credit quality, location (US only or international), and type (government bonds, corporate bonds, municipal bonds, or all the above). Choosing wisely is important, by need, goal, time horizon, and risk.

Example

Joseph and Abby, both age 52, have a daughter, Charlotte, starting her junior year in high school. She's a straight-A student, talented in math, studying for placement tests, and considering colleges to apply to next year. Joseph and Abby have been saving and investing in a 529 plan since Charlotte was young to pay for all or a portion of her tuition, including graduate school. They expect a roughly six-year long outlay of tuition for Charlotte.

Joseph and Abby are not interested in, or able to use, CDs or individual bonds in their 529 plan. Instead of repositioning their investments in funds to be sure they're not exposed to a sharp downturn in stock markets, and to increase the confidence that they'll have money starting in a few  years when they need it, they could choose a short-term bond fund for tuition needed in the next two to four years and an intermediate-term fund for money needed later. This combination roughly matches their needs and time horizon.

This strategy has a caveat. Unlike individual CDs or bonds, bond funds do not generally have fixed maturity dates or promised par values to repay a set amount. However, historically, funds holding bonds with shorter maturity dates (e.g., a short-term bond mutual fund, as categorized by Morningstar) have tended to have prices (called Net Asset Value, or NAV) that are less volatile over shorter periods of time than bond funds with longer maturity dates (e.g., intermediate-term or long-term bond mutual funds.) So, the "match" and stability won’t be perfect. Still, thoughtfully choosing bond funds and fund categories can be a helpful portfolio and wealth management strategy. 

Strategy 3: Cash management

This strategy is about short-term cash flow (sometimes known as liquidity) management. It may help to think of certain types of cash investments as, functionally short- to very-short-term bonds. (Exceptions exist for "true" cash, such as an FDIC insured checking account.) Cash and cash investment management is an important part of the continuum of portfolio investments and wealth management. And cash can be managed for at least two purposes:

Consider two purposes for cash management

Savings and investment cash
These are cash products that earn a potentially higher yield, help you preserve your principal, and provide easy access to your funds.

You can save with a Federal Deposit Insurance Corporation (FDIC)-insured savings account, a certificate of deposit (CD), or a money market fund.

Everyday cash
This is cash ready for use to purchase investments, such as stocks and bonds. It's also cash available for paying bills and expenses.

You can have this cash in a brokerage account or an FDIC-insured checking account.
 

Source: Charles Schwab & Co., Inc.

Savings and investment cash
These are cash products that earn a potentially higher yield, help you preserve your principal, and provide easy access to your funds.

You can save with a Federal Deposit Insurance Corporation (FDIC)-insured savings account, a certificate of deposit (CD), or a money market fund.

Everyday cash
This is cash ready for use to purchase investments, such as stocks and bonds. It's also cash available for paying bills and expenses.

You can have this cash in a brokerage account or an FDIC-insured checking account.
 

Source: Charles Schwab & Co., Inc.

When creating a cash management plan, start first with a plan. Ask yourself again: When do you need the money? Immediately from an ATM, the next day after selling a money market fund, in three months when a three-month bank CD matures, or "pretty quickly" at a fundamentally "certain" price when you need it because you have emergency, investment, or other need? These considerations should be part of an investment and wealth management plan.

Example

Tiffany, age 38, works full time and receives a paycheck every two weeks that she deposits automatically into a checking account, and she pays her bills from that checking account. She doesn’t like living paycheck to paycheck, and doesn't need to. She leaves about three months of her regular expenses in the checking account. She can pay bills, write checks, and make other payments from this account and considers it to be her "everyday cash." It's the money she lives off of.

Separately, she has some savings that she wants to access quickly, if she needs it. She's in the market to buy a home but isn’t sure if, or when, she'll find the right home for her. She'd like to earn a relatively stable and predictable return on the money she's saving, and she knows she may need that money quickly for a down payment, if she finds the right home. She also doesn't want to be out of the home market because she invested in more volatile investments, such as stocks.

For this purpose, she has a range of options. She might consider a money market fund or high-quality bonds with maturities shorter than four years or so (these are considered "short-term" bonds, useful for shorter-term goals relative to bonds with longer maturities), including U.S. Treasuries or municipal bonds. 

Bottom line

Interest rates have risen, which creates opportunities for investors, particularly those who've held off on investing in bonds. In addition to income and diversification, within a long-term portfolio, bond and bond funds are useful planning tools, if you choose wisely using these three strategies, when you know you will need money soon. 

We can help you build a diverse portfolio.

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Investors should consider carefully information contained in the prospectus, or if available, the summary prospectus, including investment objectives, risks, charges, and expenses. You can request a prospectus by calling 800-435-4000. Please read the prospectus carefully before investing.

The information provided here is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice. The investment strategies mentioned here may not be suitable for everyone. Each investor needs to review an investment strategy for his or her own particular situation before making any investment decision.

All expressions of opinion are subject to change without notice in reaction to shifting market conditions. Data contained herein from third-party providers is obtained from what are considered reliable sources. However, its accuracy, completeness, or reliability cannot be guaranteed.

Examples provided are for illustrative purposes only and not intended to be reflective of results you can expect to achieve.

Investing involves risk, including loss of principal.

The information and content provided herein is general in nature and is for informational purposes only. It is not intended, and should not be construed, as a specific recommendation, individualized tax, legal, or investment advice. Tax laws are subject to change, either prospectively or retroactively. Where specific advice is necessary or appropriate, individuals should contact their own professional tax and investment advisors or other professionals (CPA, Financial Planner, Investment Manager) to help answer questions about specific situations or needs prior to taking any action based upon this information.

Diversification strategies do not ensure a profit and do not protect against losses in declining markets.

Supporting documentation for any claims or statistical information is available upon request.

Tax-exempt bonds are not necessarily a suitable investment for all persons. Information related to a security's tax-exempt status (federal and in-state) is obtained from third parties, and does not guarantee its accuracy. Tax-exempt income may be subject to the Alternative Minimum Tax (AMT). Capital appreciation from bond funds and discounted bonds may be subject to state or local taxes. Capital gains are not exempt from federal income tax.

A bond ladder, depending on the types and amount of securities within the ladder, may not ensure adequate diversification of your investment portfolio. This potential lack of diversification may result in heightened volatility of the value of your portfolio.  As compared to other fixed income products and strategies, engaging in a bond ladder strategy may potentially result in future reinvestment at lower interest rates and may necessitate higher minimum investments to maintain cost-effectiveness. Evaluate whether a bond ladder and the securities held within it are consistent with your investment objective, risk tolerance and financial circumstances.

Fixed income securities are subject to increased loss of principal during periods of rising interest rates. Fixed income investments are subject to various other risks including changes in credit quality, market valuations, liquidity, prepayments, early redemption, corporate events, tax ramifications, and other factors. Lower rated securities are subject to greater credit risk, default risk, and liquidity risk.

Cash equivalent investments are cash management strategies that seek to prevent the loss of an investment's total value. Although a cash management product may seek to maintain a stable or constant net asset value, there can be no assurance it will do so.
 

 

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