My Current Return on Low-risk Assets

A few weeks ago, I wrote about moving my asset allocation to 25% less risky assets.  An astute reader asked me about what exactly these investments were.  Today I want to talk about where our 25% low risk assets are invested and how I am getting greater then 2% return on low-risk assets.

Prior Goals for Return on Low-risk Assets

For those that haven’t followed me over the last few years, I set goals yearly that are published around the first of the year.  You can find our latest goals here.  Up until this year that goal list contained an item for return on low-risk assets.  Particularly pre pandemic that target was 4%.

I stopped tracking that goal in 2020.  The obvious reason being returns of low-risk assets dropped off a cliff.  In February of 2020 you could invest in a CD at nearly 2% return.  Here we are in October of 2021 and you would be lucky to get a return of 0.5% on a CD.  

Problems with Goals for Return on Low-risk Assets in a Low Interest Rate Environment

The problem with keeping such a goal in this environment, besides it largely being unrealistic, is it can lead to chasing yields.  To goose my return, I could switch from government issue low-risk bonds, to junk bonds.  Essentially loaning money to companies that are at risk of failing for a higher yield.

With such an approach the whole reason I want a safer investment allocation is negated.  Junk bonds can and do suffer greatly in a market pull back.  What good would 4% safe return be if the first sign of an economic downturn those bonds became worth pennies on the dollar.  So, chasing yields is out.

Inflation and the Incredible Shrinking Low-risk Portfolio

Conversely standing pat is out.  When inflation is running at 5.4% for the year, 0.5% rate of return is losing a huge amount to inflation. I obviously don’t want to stand pat experiencing lost purchasing power either.

The Three Options I Am Utilizing to Goose My Return on Low-risk Assets

So, if I don’t want to chase return by adding risk, but I also don’t want to lose massive amounts to inflation, what are my options?  Well, it just so happens that three vehicles are available to me with significant additional returns for minimal risk over a government bond.  As you will see this does not eliminate our inflation losses, but it does reduce them.

The first are I-bonds.  I have written at length about I-bonds here.  It is a topic near and dear to my heart, in fact I wrote my MBA dissertation on the relationship between I-bonds and TIPS.  But essentially, I-Bonds return a fixed rate plus a rate of inflation adjusted every 6 months.  The current bonds are returning 0 percent fixed, sadly.  But they are getting a 7.12% variable return for the six months starting in November.  So, this portion of my portfolio is handily beating a CD.

I-Bond Contribution Limits

Now, before we go any further with I-Bonds we must add some caveats.  First you can only buy 10K a year per person, plus up to 5K a year from your tax refund, plus another 10K either from a business or trust.  So, the amount of contribution here is limited to somewhere between 25K and 35K a year for a married couple.  (Note you can goose the contribution rate via your tax refund by overpaying estimated taxes).  So, I can’t rely on this for my entire low risk investment option.

But these are 30-year tax deferred investments.  It just so happens that I have been pushing money into them for quite a while.  I-Bonds represent about 40% of my safer investment allocation.  The best part is some of our older holdings have a fixed 3% rate.  Some of our I-Bonds are providing a whopping 10% return…Wow!  A reminder set things up when things are good to profit when things are harder.

I-Bonds Still Lose to Inflation, But They Are Currently the Best Game In Town.

Now, I can’t leave this topic without noting the above I-Bond strategy does ensure a portion of my portfolio will lose money to inflation.  If the current I bonds are returning a fixed 0%, then in essence they are keeping up with the CPI rate of inflation after some time lag.  But that is before taxes.  I am actually losing a yearly amount equal to whatever my marginal tax rate will be when I withdrawal those items a few years down the line.  I expect to be retired by that point so it will be a fairly low percentage.  

But it will not be insignificant.  Still nothing is guaranteed to beat inflation over the long haul, not even stocks.  This is a cost I accept realizing I keep 75% of my investments in risky assets that hopefully keep pace with inflation.

I-Bonds Are Liquid

A final note, the barrier to exit I-bonds later should the situation change is only 3 months of return for holdings over the first 5 years.  After that there is no penalty.  This means I am positioned to cycle to other safer investments that beat inflation should they become available later.

Stable Value Funds as Part of My Low-Risk Return on Assets

Beyond my 40% I-Bond safer asset allocation I have about 50% invested in a stable value fund in my 401k.  What is a stable value fund you ask?  A stable value is an investment in many peoples 401Ks that invests in short term insured bonds.  These funds typically have higher fees, but also are extremely low-risk.  How low-risk?  Well, I am not aware of any of them losing principal during the financial crisis of 2008.  These could always lose money sometime in the future.  But the probability is low.

Net of fees my company’s stable value fund option earns about 1.6%.  About 3x the cd rate I mentioned earlier.  It is also in a 401k, so tax deferred again.  Obviously with inflation where this is, my money’s purchasing power is still dropping.  That is the cost I pay to meet my risk tolerance and remove some sequence of return risk should I decide I am done working in the next 3-4 years.  Blend this with my I-Bond inflation deficit and I am paying a nominal percent of my portfolio for my asset allocation currently.

No Barriers to Changing Investments, A Priority

There are little to no barriers to cycle out of this stable value account.  My 401k charges a fee if I put money into this fund and remove it within 90 days.    I don’t suspect things will change within that 90- day period so effectively the barrier to move if rates change is 0. 

You’ll note I’ve now mentioned the barrier to change where my safer assets sit twice.  This is key.  We are in a market environment of great change.  Being able to transition to other safer asset options depending on how inflation pans out is of high value in the current economy.

The Remaining 10% return on Low-Risk Assets, The Mix

For those paying attention or decent with math the above leaves us with another 10 percent.  This 10 percent is a hodgepodge.  I have some older muni bonds that have 3-5% coupons.  As previously noted individual bonds are largely illiquid, so selling is a poor option.    

I also have a small amount in a savings account earning .5 percent.  Why?  I’m still waffling on buying a vacation home.  This is my fun money splurge account.   You could also think about it as my emergency account in a way.    Anyway, the number is quite low compared to my overall portfolio.  I may or may not move this into something else at some point.

A Guaranteed 3.5% Return from EE Bonds

Finally, I purchased an EE bond this year.   These bonds double if held for 20 years.  So effectively 3.5% guaranteed return.    I am convinced inflation is heading higher.  But as I wrote earlier in the year, predicting inflation or interest rates, like the stock market, is not something people can do reliably.  This is a contrarian bet to my current beliefs.  The amount is small, which should be obvious given the same purchase limits as I-Bonds above apply.

The positives here are again EE bonds blows the current CD rate away. The negative of course is there is no flexibility in this investment.  It’s 3.5% or pretty much no return if I don’t make it 20 years.  As such I am limiting my purchase of these given the potential changes upcoming in the macro economy I referenced earlier.  Still, I suspect if I do decide to weed down the cash currently in my savings account this is where the money would go.  If I don’t buy a vacation home, then honestly, I don’t need the funds available any time soon.

My Situation With Regards To Flexibility and Liquidity of Low-risk Assets 

My accounts are currently structured such that there will be plenty of tax efficient money available should I choose to retire in 3 years. Even if that tax efficient money is invested in risky assets, swapping the risky a low risk between accounts on the same day at the time of need is low risk.  So, flexibility of low-risk assets is more a return play for me then any real need.  As noted, my job is currently incredibly stable.

There we go, that is how my low-risk return on assets look right now.  As you can see, I am easily achieving greater than 2% return on low-risk assets.