Personal Investments • bond ladder construction under uncertainty

We have some proceeds coming from real estate and we want to invest it entirely in bonds. We don’t know when or if we will need the money but instead have a probability distribution of outcomes from which we want to build a bond ladder. Here is the distribution of outcomes:

Let X be amount of total bonds to buy (= distribution from real estate sale). 

• 50% chance: We need ~1/2 of X in ~2 years for another real estate purchase.
• 25% chance: we don’t need any of X for next 5 years
• 12.5% chance: we need ~3/4 of X in ~2-3 years
• 12.5% chance: we need only 1/4 of X in ~2 years

In summary, it seems safe to put 1/4 of X in bonds with a duration of 5 or more years. I would also say we have a 87% chance we can put another 1/4 in for 5 or more years. Thus I’m thinking 

• 1/4 in <2 year bonds
• 1/4 in 2 year bonds
• 1/4 in bonds 3-5 year duration
• 1/4 in bonds 5+ (7 and 10 year bonds)

We will know a lot more in 1 year and can adjust the bond ladder then as needed (reinvesting shorter or longer as needed). 

Q1: Overall, is this a reasonable approach?

We thought that if we absolutely need the 3-5 year duration bonds we can sell them in 2-3 years when close to maturity; if interest have risen then the typical penalty is only 1% per 100bps change. And, also, we can opt for higher coupon bonds for now...I realize that might be "market timing" with the expectation that interest rates will fall but perhaps all things being equal it is best to opt for the higher coupon bonds for now. 

Q2: I'm not that experienced with buying bonds so trying to understand if I should just get an assortment of coupons or just take the highest yield and ignore the coupon amount?

Also, the plan is to use Treasuries only. This gets us close to our desired asset allocation of 70/30 (equities/bonds). We will take the risk on the equity side and just stick to Treasuries and in our case there is no benefit to munis. 

Thanks in advance. Have learned a lot here and hoping to get useful suggestions on tools to use or how to think about bond ladders when considering a probability distribution of needs.

To me it seems unnecessarily complicated. However, we’re sat on a large (to us) growing cash position that’s building annually because we may need to use within the next 5 years, and there is lots of uncertainty to how much we need depending on which direction we ultimately go with life, so I fully appreciate the uncertainty aspect.

I took a far more basic and “good enough” approach. To me, the primary drivers were preservation of capital and liquidity. And for us, this all started when interest rates were still low.

To take the stink off wanting liquidity yet grumbling about having idle cash, at the time I took 10% of said cash and invested in VOO. I was happy to let this amount ride for decades. I had no clue mathematically if this was the correct thing to do, but short term 10/90 stock/cash felt right to me.

Interest rates then started to change and given it’d been a long while since that happened it took a moment for me to started paying attention again, ultimately consolidating the balance into VUSXX Treasury MMF (more tax efficient for us).

As we’ve moved through time uncertainty still remains and I’ve been thinking what we’ll do as/when rates change again. I’ll probably keep 50% in VUSXX and, depending on market conditions, for the remainder look at a 2yr bond if pushing a bit further out looks attractive.

If it becomes evident we are not needing as much cash then I’ll reduce accordingly putting it to work investing longer term per our AA.

(and in a way I'm kind of already doing that, taking some of this idle cash on hand maxing out HSA and back door Roth earlier than usual in the year, and some additional Ibond gift box purchases then back filling our cash position with either monthly cash flow intended for these investments/savings, and/or annual bonus.)

All the best.

Statistics: Posted by RedCabin — Fri Jun 14, 2024 2:39 am — Replies 3 — Views 352

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