Dear Dr. Don,
As someone trying to diversify the way I save my money, I’ve been spreading my savings into money market accounts, certificates of deposit and Treasuries. Are there different advantages for someone trying to save and eventually build a bond ladder to prefer EE savings bonds versus Treasury notes, or Series I savings bonds versus Treasury inflation-protected securities, or TIPS? I’m not really looking for marketability of these products, just a good place to park my hard-earned savings.
— Jorn Jump-start
When someone tells me they’re looking to park their money somewhere, I think short-term investments, not bond ladders. They don’t want to put their investment vehicle on blocks; they want the flexibility to invest elsewhere. That person doesn’t want a bond ladder.
The problem with parking money short term is that you have to figure out when to take the money out of park and put it back to work in other longer-term investments. Market timing is more art than science, and the typical retail investor is going to struggle with this decision.
Money market accounts and high-yield savings accounts are likely to earn you a much better yield than a money market mutual fund in today’s interest rate environment, but things are pretty ugly when it comes to yield in these short-term accounts.
A bond ladder has you investing at regular intervals over a fixed investment horizon. When the shortest rung matures, the proceeds are used to invest in the longest maturity of your planning horizon. You can build a 3-, 5-, 10-, 20-, or even a 30-year ladder. You can pick short, intermediate, or long-term funds, or even buy a fund that invests in TIPS and have your investments professionally managed.
What’s good about Treasuries and savings bonds is that they give you the opportunity to invest in longer maturities than you can with the typical CD. Savings bonds have the added advantage of allowing the investor to defer income taxes due on the investment earnings until the bonds are redeemed or mature.
Series EE savings bonds and U.S. Treasury securities are really good at protecting principal but not all that good at protecting your purchasing power from the ravages of inflation. Series I savings bonds and TIPS offer inflation protection along with safety of principal but not much more in today’s low interest rate environment. TIPS aren’t tax-deferred unless held inside of a tax-advantaged retirement account, so you have to pay as the money is earned in a taxable account.
You’re putting your hard-earned money aside to fund future life goals. Figure out what those life goals are, and you’ll have a better idea of your investment horizon and can make better choices as to how to invest the funds.
One mistake that people make is keeping their money in short-term investments, waiting for the right time to move into longer-term investments. You’re treading water, but after taxes and inflation, you’re underwater in terms of your portfolio’s purchasing power.
Don’t wait to build an investment ladder. Build a stepladder if you don’t want to be “long and wrong” and then make it an extension ladder as longer-term interest rates head higher.
My dilemma in advising you in designing a fixed-income portfolio is that the fixed income market has gotten so ugly (low yields) that it’s hard to recommend retail investors to go into longer maturities, even in a laddered portfolio. TIPS have been bid up to the point where I don’t find them attractive. And Series I savings bonds, while they offer inflation protection and tax deferral, offer no real return over and above inflation, and the Treasury limits their purchase to $5,000 per year.
There’s a host of asset classes out there besides Treasuries, CDs and savings bonds. Depending on your investment horizon and your attitude toward risk, you also could consider corporate bonds, municipal bonds, real estate, stocks, commodities, or mutual funds and exchange-traded funds, or ETFs, that invest in these assets. Yes, there’s risk, but a well-diversified portfolio of assets will mitigate that risk with the potential to build wealth over time.
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