Episode 3: How to Earn More on Your Short-Term Savings

In the year you retire, you need to make sure that you are well versed in the world of short-term investments.  So in this episode, we’ll explore the short-term investment options that you should consider adding to your retirement planning arsenal.  We’ll guide you through the financial thrill ride of different bond types and the potential benefits that may help boost your earnings. We’ll also discuss FDIC insurance and the pros and cons of brokered CDs.  And we discuss the tax implications and various levels of investment security. 

In this episode, you will be able to:

• Learn essential retirement planning strategies for financial security.
• Discover lucrative short-term cash investment options for your retirement.
• Understand the importance of FDIC insurance for safeguarding your savings.
• Explore various types of bonds and their tax implications for smart investing.
• Master the art of building a bond ladder to maximize your investment returns.

The key moments in this episode are:

00:00:42 - Introduction

00:01:00 - Importance of Short Term Savings

00:03:41 - Options for Short Term Cash

00:05:03 - Bank Options and FDIC Insurance

00:07:36 - Credit Unions and FDIC Insurance

00:14:20 - What is a bond?

00:15:46 - Maturity and Duration

00:16:54 - Zero Coupon Bonds

00:18:29 - US Government Bonds

00:21:02 - Mutual Funds and ETFs

00:28:28 - Closures and Federal Reserve Intervention

00:29:47 - FDIC Insurance Limit

00:31:01 - Selecting Short-Term Investment Options

00:34:02 - Emergency Money and Guidelines

00:35:32 - Retirement Income and Expenses

00:42:37 - Building a Bond ladder

00:43:35 - Shifting Bond Ladder

00:44:13 - Gratitude in Retirement

00:44:45 - Technology and Family

00:45:38 - Appreciating the Seasons

 

Discussed on This Episode

Treasury Direct – https://www.treasurydirect.gov/

Federal Deposit Insurance Corporation (FDIC) – https://www.fdic.gov/

National Credit Union Share Insurance Fund (NCUSIF) – https://www.nafcu.org/ncusif

 

Resources

What Issues Should I Consider When Establishing & Maintaining My Emergency Fund

 

Transcript

Jim Uren: This is The Year You Retire podcast for people who want their first year of retirement to be right on the money. Your hosts are me, Jim Uren and John Bever, CERTIFIED FINANCIAL PLANNER™ professionals with Phase 3 Advisory Services. Retirement is one of the happiest times of life, but getting the most out of it requires you to be properly prepared.

Listen along as we explore the financial topics, tips, and strategies that will help you make your first year of retirement your best year yet. Now let's get planning.

How can I earn more on my short term savings? In this podcast, we're going to discuss ways for you to boost the return on your emergency money and cash reserves. In the year you retire, it's crucial that you have this right. So you need to make sure your emergency savings are fully funded and ready to go.

John Bever: Yeah. We're going to talk about different short term investment options. Some of the tax treatment of these options, how to design an emergency fund, how to build a short term account for short term goals, and also to build income needed over a one to three-year timeframe. It will include a discussion of the types of investments available for short term cash.

Now, Jim, you have a background in counseling, so perhaps you can tell me why the bank account went into therapy.

Jim Uren: I do not know, John, why did the bank account go into therapy?

John Bever: Serious case of low self-interest, but I think the patient is recovering.

Jim Uren: Oh, good.

John Bever: Yeah. We've gone from those zero interest years, too many of them to now we're back to a more normal environment.

But seriously though your master's was in counseling psychology, a great foundation for financial planning. So how has that helped you as a financial planner, Jim?

Jim Uren: So it actually is bigger help than one might think. So as John, our primary job is to help people make decisions and change their behavior.

And one of the biggest fields that has come into existence in the last 30 years has been something called behavioral economics or behavioral finance. And so historically, economists have just assumed that we were these logical people that went around and looked at all the pros and cons and made objective decisions all the time.

And our friends from the field of psychology have said that's not quite how we work. And so we've seen a blend of these two disciplines into this behavioral finance. And we study now how people tend to make mistakes. We're wired for a lot of great things that help us survive and achieve things.

But some of those very strengths we have can be weaknesses when it comes to managing our money and making financial decisions. And probably the most important way that we implement this is actually first and foremost for us as advisors, right? We need to make sure that we're aware of these biases and that we have precautions in place to protect us and our clients from that.

But we also then use this to help people to help them prevent making a lot of errors. And one of the errors that we tend to make is we tend to underestimate, of course, risk, right? We're just wired to assume we're the exception to the rule, ask any teenager, but we don't unfortunately outgrow that.

And of course, John, one of the things that we need to have to protect us against risk is a well-stocked emergency fund.

John Bever: Yes, very critical.

Jim Uren: So what are the options that we have? When it comes to having short term money and how safe are they, John?

John Bever: Okay I want to start with this. Having your money in the stock market is not a good short term option.

We just came out of this really low interest rate environment and people were looking around going, where can I make money? Oh, the stock market's going up. I'll put my money in there. Just as easily as it goes up, it can come down. And you don't want to tap that emergency account after a market decline.

So that emergency money needs to be away from the stock market. So with rates back to normal, there are many good options. And we think of this as money that you're going to need over the next three years, as well as that emergency piece that you have no idea when or if you will even tap it. But if you need to, we certainly wouldn't want it to be during a market downturn and have that money in the market.

So it needs to be in a safe place. So some of the options. One, we all think about the bank and now it really is an option that we are getting interest to get credit unions, what are called brokered CDs. So you can buy a CD directly at the bank, walking in the front door, or you can come through the back door and a brokered CD and buy a CD inside your brokerage account bonds, of course.

And they come in many forms and shapes and sizes, different types that they calculate the interest and maturities. You can also open up an account directly with the Treasury at treasurydirect.gov and mutual funds, exchange traded funds. So there are a lot of options available. So let's start with the bank.

Let's talk about the bank for just a very brief moment. Of course, everybody's familiar with the bank, but one of the questions that's on people's mind is this $250,000 of FDIC insurance. Is that going up or not? We do know it's $250,000. Whether it will increase, we don't know, but that is per depositor, but not just depositor, but also the entity.

So you can get that FDIC insurance on yourself. You can also get it on an IRA that you have at the bank or a Roth IRA, or if you've established a trust account. And if you have a business, that business has a separate limit also. So there are checking accounts at the bank. You don't want to keep much money there because you're not going to earn much interest.

And now with the ease of movement of money between accounts, it's very easy to keep a smaller balance in your checking account and not let that build up too much. And especially with some of the scams that are going on, especially now check washing it's just not a good idea to leave a large balance in your checking account.

Savings and money market accounts at the banks are also now available options that pay some interest. And it varies quite a bit. There's quite a bit of difference between a money market with, say, a large money center bank that you have to have a large balance at and a money market account at an online bank.

So check out the online banks. There's some very good rates available. And again, with the ease of movement of money back and forth, you can connect your checking account at your large money center bank, and you can have that online money market account with another bank and have that linked electronically.

So it's very easy to move money even the same day. And with that, there is this FedNow system that is now in place. It's going to be eased into the size of money that's able to be moved back and forth. But this FedNow system is a 24/7/365 day a year ability to move money where you don't have to wait over weekends or wait over holidays.

It's going to be brought in over time, but that's going to make this movement of money even much easier. CDs are also viable options at the bank. A CD is a certificate of deposit, and so with a CD you have a particular maturity. You can break the CD prior to maturity. If you need to access the money, you will give up perhaps three months’ worth of interest, which is really not that big of a deal.

And with that CD, you can get a higher rate of return than typically you can achieve inside the money market or savings account at the bank. Credit unions are another option. You were going to say something, Jim.

Jim Uren: Oh, I was just going to say on the FDIC insurance I think early in my career, I had a client who had a CD in a brokerage account and that bank went belly up, Okay. And I was amazed how quickly the FDIC stepped in and the client got their money back. And even in this recent Silicon Valley Bank it's we've talked about FDIC insurance, but this isn't some bureaucratic thing where then you got to apply and fill out paperwork and two years later you get your money back.

I'm amazed. They're really good. Those folks that, even Silicon Valley Bank, they had their money, it was like the next day. Yeah. So the FDIC insurance for these single bank failures is wonderful. You don't have to wait months to get your money. You get it back. You might give up a little recent interest, but fabulous, way to go if you're worried about the protection of those assets.

John Bever: And in some cases, the government has actually increased that coverage. That's what they've done in the most recent situation. They've been a little cryptic about what that is because they don't want to commit to anything for future possible failures. But yeah. Found that both the Treasury Department and the Federal Reserve have been very willing to support the banking system of course.

Yes. all right, credit unions. They're also very safe. They offer the same options as banks. The insurance there is through the national credit union share insurance fund NCUSIF. And again, that is $250,000 per depositor and entity and institution. We'll talk a little bit more about that a little bit later.  And it is backed by the full faith and credit of the U S government.

So let's talk about brokered CDs.  So you can buy a CD by walking in the front door of the bank or the credit union, but you can also buy a CD inside your brokerage account. You have the same protection as at a bank. They are the obligations of the bank, not the broker. So as a result, they do have the $250,000 FDIC insurance limit. Now, credit union CDs are not available right now in brokerage accounts, but bank CDs are.

What if you have a joint account at your brokerage account and you buy a CD? Is that CD is protected then up to $500,000? What if I buy two CDs from the same bank inside my brokerage account? You are only going to have $250,000 of protection. If those CDs are at the same bank, you're only going to have $250,000. So if you have $200,000 in one CD, $300,000 in another, you're going to be over that $250,000 limit. However, if you buy those same CDs in different accounts, one in a joint account, one in a trust account, or one in an IRA account, you have $250,000 of protection per entity.

And that's a really nice protection that can be brought into these accounts. You can also buy CDs from multiple banks inside the same account. If you have a different CD from a different bank. Each one having $250,000 in it, you are protected up to $250,000 per institution. And one nice thing about these brokered CDs, you can have them all in one account and have exposure to multiple institutions.  This is particularly helpful for businesses.

Now with a brokered CD, you don't have an early withdrawal penalty that you do in a typical retail CD. However, you may experience a loss on that CD if you sell it prior to maturity. It's a brokered CD, so you can sell it. You can sell it prior to maturity, and you may have a gain or a loss dependent on what happens with interest rates.

Now what happens with bonds and with CDs is when interest rates move up, price of the bond moves down. How much it moves depends on the maturity, depends on the rate, a lot of different things. But typically, in shorter term CDs and bonds, that price movement is very little, unless it is a dramatic move in interest rates in a very short period of time.

You will be taxed on interest on these CDs, on these accounts, as it's earned if it is in a non-qualified account. Jim, can you explain to us what a qualified account is versus a non-qualified account?

Jim Uren: Certainly. When we talk non-qualified accounts, we typically mean a regular account, meaning there's no tax advantage of that.

A qualified account, in turn, would be something like your 401k or an IRA. To use the example you laid out John, if you do buy a CD in your IRA and it pays you a $500 interest payment, you don't actually have to pay tax on it right now. That continues to be deferred and it's really once you withdraw the money that you'll pay tax on it.  But in a typical account, yes, when you get that $500 next year, sometime in January, February, you'll get that that letter from the bank saying, “Hey, we've told the IRS you made some money.”

So you do have to you do have to be prepared to do it. But that's the main difference between the qualified and non-qualified accounts.

John Bever: All right. Thank you. So think qualified has some type of tax qualification with it. Non-qualified has no tax qualification with it. And that will help you keep straight in your mind what this language is that we use qualified versus non-qualified.  All right.

Jim Uren: And with these CDs, John with these low interest rates, we've just come off of, we've not seen this much, but now it's starting to make a big difference between these brokered CDs and the CDs at the bank.

John Bever: Oh, yes.

Jim Uren: And so that's nice. It can make a big difference. Another thing to keep in mind, though, is that you're going to have to put up a little bit more money for a brokered CD.

This is not like your bank that might be happy to sell you a CD for a $1,000. And typically it's going to pay much lower interest rate than a brokered CD, but you do typically have to have a little bit more money to go the brokered CD route because it's almost, it's like getting a volume discount, if you will.  You get a better deal, right?

John Bever: That is correct.  That is correct. And sometimes you can pick up CDs from very obscure banks, but don't worry, you still have $250,000 worth of coverage per account per institution.

Jim Uren: Because you can go to the same bank and buy their brokered CD. You get a higher interest rate than if you just walk in their front door and say, Hey, I'd like to buy a CD.

John Bever: Yes. Yes, indeed. So this brings us to one of the biggest issuers of these short term investments, the federal government and bonds. So a bond is actually a loan. And so you could loan your money to the U. S. government, you could loan your money to your state, you could loan your money to your local government.

Those would be municipal bonds to the state and your local governments. They're also corporate bonds where you're loaning money to the corporation. So a bond is nothing more than a loan. That bond comes with an interest rate. That interest rate may be fixed or it may be a variable rate. So if you think interest rates are going to move up, you might want to buy one of those that has a variable rate with it.

Taxation. Again, it depends on what type of an account you hold it in, but if you hold these in a non-qualified account, you'll be paying tax on the interest as it is paid from the bond. Not accumulated, but paid. So there's something in our industry with bonds that you take a look on your little statement, you see a little something about accrued interest.

That accrued interest is interest that the bond owes you. But that has not yet been paid. Accrued interest is not taxable year by year with one exception I'll mention in a moment. But that interest is taxed as it is paid out and that is paid into the brokerage account or into the mutual fund if the bond is held by a mutual fund.

Now generally, federal government and agency bonds are generally exempt from state and local taxes, whereas municipal bonds are generally free from federal tax. It state taxation does vary state by state, and there are some municipal bonds that actually are not free from federal taxation. We won't go into the details of that for this particular discussion, maybe in a later broadcast.

So we also need to think about the maturity or the duration of this bond. So again, I referred to this earlier that the longer the period of time that the bond is going to be out there until it's due, that duration of the bond until it matures, the more variability you can have in the price of the bond, because these bonds are priced on a daily basis.

And that pricing is a market value adjustment. This is actually one of the things that can get banks into trouble. If they have a portfolio of longer term bonds and all of a sudden interest rates go up, the value of those bonds can actually go down. And that's actually what happened in the 2023 situation with Signature Bank and First Republic Bank and some of the other banks.  They all experienced it to some degree. It's just how they manage the situation.

So let's talk about OID (original issue discount), which is the accrued interest on a bond that pays no interest, what's called a zero coupon bond. So a zero coupon bond is a bond that doesn't pay out any current interest. You buy that bond at a discount, a deep discount and that bond will grow over time until it eventually matures.  And that maturity value is on the date that it matures, and you get the full value of the bond. Bonds are issued in a... face amount of 1, 000 each. So if you buy a brand new bond, that is not a zero coupon bond, then you're going to buy that bond for a thousand dollars and it will mature at a thousand dollars.

But if you buy a zero coupon bond, you'll buy that bond for less than a thousand dollars and how much less depends on the length of time until it matures and the interest rate on that particular bond. Now here's an interesting thing. If interest rates go negative. Which they actually did in the 2000s, if interest rates go negative, you can actually have a zero coupon bond that you pay more than a thousand dollars for, and it'll mature at a thousand.

Jim, can you think of any situation where someone might want to do that, pay more and get back less?

Jim Uren: It's hard to imagine. It's hard to imagine other than if they were worried about their mattress not being safe.

John Bever: And that's the only case, right? Why would you want to do it otherwise?  But there were some situations in some other countries where there was maybe a little bit of concern about not getting all the money back or in a severe deflationary environment, but typically that's not an issue.

Jim Uren: If you want to loan me money, John, I'll give you back less later.

John Bever: Okay. You know what? We'll talk about that later. Yeah. Yeah. So Treasury, this brings us to the U.S. government. It, believe me, it is safe. No matter what you hear about the U.S. government right now, the U.S. government is safe with your money.

And one of the reasons is because it has an unlimited ability to print money. So we're not going talk about the value of that money, but in terms of the safety of getting your money back that you put into a government bond, that is absolutely safe. So treasurydirect.gov is a website that you can go to actually buy treasury bonds directly.  You can also buy EE bonds there and I-bonds.

I remember the day, I don't know if you had a Jim, where you would actually get a paper EE bond. And when it matures, you go to the bank and you turn it into the bank and they give you double back on your original investment with the EE Bonds.

You know what, those aren't available anymore. Now when you buy these, you have to buy them electronically. They're digital and they are online at treasurydirect.gov. So a EE bond has a fixed interest rate, which is announced at the time that you buy the bond. You can find this rate on that website.

And there are I-bonds, which are inflation protected bonds that give you a variable rate of interest depending on the inflation rate. And this interest rate is determined or set every six months. So when you buy one of these I-bonds, you're going to get that rate for your six months, and then you're going to roll over to a new rate that has been announced.  Those announcement dates are May 1st and November 1st.

You can also buy Treasury Bonds direct either at the original auction or in the secondary market where you're actually buying those bonds from other, individuals, other entities. I don't know if maybe you can even buy them from the Federal Reserve Bank.  I don't know how that works, but you could buy them and put them in that account and manage it yourself, which is very convenient at treasurydirect.gov.

Interest rates do vary quite a bit. Right now in the current situation, the EE bonds are actually paying substantially less than the I-bond inflation bonds. That will probably correct itself in the next couple of years.

Lastly, there are mutual funds and exchange traded funds, and these typically are going to own bonds of all different stripes and sizes and conditions.  Even those that are called debentures and subordinated debentures, secured, unsecured. So there's a lot out there.

In fact, there are many more issues of bonds around the world than there are stocks internationally. The international bond market makes up about 30 percent of the bond market. Domestically here in the U. S. our market makes up about 70 percent of the bonds worldwide.

Now these mutual funds can have a diversification of bond type or a very specific narrow set of bond type.  These funds might have a targeted maturity date that they're looking for with these bonds. They might have a wide variety and have flexibility for the bond manager to determine what might be best at the time. There's something that's called average duration, which is just simply the average maturity of all of those bonds that are in the portfolio at that point in time.

So that average duration is important. That's one of the things we look at that determines how much volatility in price there might be in that particular bond fund. So there are some additional risks that are brought to bear in these funds, even if you have Treasury bonds in there.

And one of those risks is the interest rate risk.  Again, when interest rates move up and down, bond prices move the opposite in the fixed rate bonds. You also can have credit risk when you step outside the realm of Treasury bonds. That credit risk is, are you going to get paid back the money that you loaned the entity? Typically, that credit risk is very low with municipalities.

Of course, it increases with corporations and it can get to the point where you actually might be buying a bond for a corporation that's about to go bankrupt. You might pay it. Pay pennies on the dollar and bet that you're going to make money because the company is going to at least somewhat stay in business and be able to pay you back more.  But typically those would not be used and are not advisable for any short term money at all.

Jim Uren: Yes. Yeah. Cause that brings up the point that just because it's a bond doesn't necessarily mean it's safe. We tend to think that's the case, but no, there are some bonds that are riskier than stocks.  And as you said, not a good option for your emergency money that you need to be there if you have that emergency

John Bever: That's right. And one of the ways that you can just get a feel for what the risk might be in that bond fund is simply what the interest rate is on the, fund.  What they're paying out in distributions on the interest.  And so typically the more conservative the fund, the lower the interest rate.  The more aggressive the fund, the higher the interest rate.

Again, generally speaking.  There are times where we have an inverted yield curve where short term rates are actually higher than long term rates, which we are experiencing at present.

Jim Uren: Now some of these,

John Bever: Go ahead.

Jim Uren: Oh, as you say, yeah, usually the higher that yield, the higher the risk, right?

John Bever: Yes. Yes.

Jim Uren: And so it this always reminds me of, remember George Carlin had that routine, how we changed the names. It's no longer a, it's no longer a “garbage dump.”  It's a “landfill.”  And so they're now “high yield bonds” as opposed to what used to be called “junk bonds.”

John Bever: Exactly. Yes.

Jim Uren: Same thing, but now we call them high yield bonds, meaning we'll focus on the yield as opposed to the risk.

John Bever: That's right. And some of these funds now they call them credit funds. They don't even want to call them high yields funds. They're called credit funds. Does that sound better?

Okay. Be careful with names. Yep. So some of these mutual funds and exchange traded funds actually come in a specific term. Okay. Where it's going to mature. The fund is going to mature at a particular point in time. This is particularly popular with the exchange traded funds, and those can be very useful because they trade almost like a regular bond or think about a CD that has a maturity date.

Now, again, these funds are going to be diversified with a whole portfolio of bonds, but they'll all come due within a certain period of time and they can come in very short term options such as one to two years.  And they can actually extend out as much as 10 years and they are available in treasuries, available in corporates and available in municipals.

All right. Jim, when it comes to their short term money, people can become quite worried over the safety of those, funds have, you experienced any of that with any of your clients? Any questions that have come up about this?

Jim Uren: Yeah, certainly. This is always a concern. People are concerned the last 20, 25 years.  There's certainly been a lot in the news.  Even as of late, concerns about banking failures and other concerns we might have.

What do you think, John, what should we be thinking about when it comes to these risks?

John Bever: Yeah. And with these risks, it's easy to poke fun at the banks, right? We've talked about them, maybe paying lower interest rates. Oh, there's bank failures and you want to be careful. We have to be careful with this because really banks play in a very important role and banks are extremely safe because of the FDIC insurance protection.

Yeah. Above the FDIC insurance protection, then you have to really take a look at the quality of the bank.  But imagine where we would be without banks, right? And it's that old phrase, money makes the world go around. We need the banks to actually get that movement of the money. So they play an extremely important role.

And so this is an important part of the discussion because people do at times become quite concerned about the safety of their money in the banking system. Again, there is a difference between the banking system and the bond system. In bonds we have additional risks we have to take a look at, but in the banking system there's quite a bit of safety.

And there have been several banking crises and failures over the years, including back to 1907. And what happened in 1907 is there was actually excess speculation that the banks got involved in, and that excess speculation did result in real losses because there was no FDIC insurance protection in 1907.

So quiz, how many bank failures have there been so far in this century since 2000 Jim?  Any guesses?

Jim Uren: None. I have no idea. That's a good question.

John Bever: So audience lock in your answer. So here we go. According to the FDIC, now this is from 2001, from the FDIC 2001 to the middle of 2023, there have been 564 bank failures.

Jim Uren: Wow. Wow.

John Bever: Now, of course, we think of the Great Depression as one of the worst, right? That was actually the worst of the 29th century and far beyond anything that we see in the, excuse me, in the 20th century, anything that we've seen in the 21st century.  And we all think of the movie, It's a Wonderful Life, and George Bailey and everything that happened there.

That was actually a run on the bank. The money was there except for the $8,000, right, that that Mr. Potter got involved in and hiding that money. But apart from that the money was there. It's just as George said, “The money's in your house and it's in your house and it's in your house.”

And so what it was everybody wanted their money back at the same time. And that's typically what leads to the bank failure. So these are nothing new. There are systems in place to deal with them. And it's interesting to note that there's been no major us bank failure after the great depression until 1984.

And those from Chicago might remember this. It was Continental Illinois here in Chicago that failed in 1984.  Pretty large failure at the time. And then after that, we had the savings and loan crisis of the 1980s. And then of course we also had the most recent situation here with the financial crisis in 2008.

So there, these things tend to come in waves and there have actually been three waves that have had this bunching together of these bank failures, typically we look at maybe about five to ten closures is what we would have in a typical year.

The Federal Reserve has gotten a little bit more involved in trying to stem the tide of these failures.  And that's because they can provide liquidity to a bank that may be experiencing a run. But sometimes they actually just come to the rescue. And this happened in 1998. This is the first time that the Federal Reserve actually did this and actually rescued a bank that was actually several banks that were going to fail.

There was a major hedge fund called Long Term Capital Management that was put together by a bunch of PhDs that had a “could not lose” currency trading system. And guess what? It lost.  There was a black swan event and they ended up with losses that they never anticipated they could have ever had. It worked out to be an 80-billion-dollar loss for the banking system, but the Federal Reserve did step to the plate in order to rescue that situation and then change some of the rules.

The 2008 financial crisis saw the failure, the largest failure to date, and that was Washington Mutual. That was a $300 billion loss. But you know what, Jim? Every one of the depositors that was up to the FDIC insurance limit was made whole, even those depositors over the FDIC insurance limit. Not much we have to worry about in the banking system.

All right. Let's go back to this FDIC insurance limit that is there at $250,000. Remember, this is per person, per ownership category and per institution. So if I have two individual accounts, two non-qualified accounts in my name at two different branches of the same bank, because it's institutional, those have to be combined for my $250,000 protection.

But, if I have those two accounts at two different banks, each account is protected up to $250,000. At the same bank, I can have an IRA, a Roth IRA, a $250,000 protection limit from the FDIC. All right. Bottom line, banks are very, safe.

I have a question for the audience to think about for a moment. What would you use for your situation? Which one of these options would you select? Jim, as you put these together for clients, as you think about short term accounts, what are some of the things that you like to use?

Jim Uren: Yeah. So again it, depends on the client situation and part of it comes down to how much risk the client wants to take.

Certainly one of the things that has gotten a lot of attention lately are the I-bonds. There's pros and cons to just about every decision you make. Typically with an I-bond in a more normal interest rate environment, you're typically not going to get the same rate of return. You can typically do a little bit higher yield through alternatives.

However, the other advantage of the I-bond, of course, is that you're not taking on any inflation risk. In other words, if we have unexpected inflation, the I-bond, part of the return you get on that is they compensate you for inflation. So if inflation jumps 4% in a year, particularly if we weren't expecting it, the value of your bond goes up by 4%. Having some emergency money in an I-bond means you don't ever have to worry about losing money to inflation. It's always going to, in a sense, preserve your purchasing power. So I like to tell clients it's not a great wealth creation tool. It's a decent wealth preservation tool.

You're not going to get rich investing in I-bonds, but for some part of your emergency money, I like it because we don't have to worry about unexpected inflation. For example, like we've seen in 2022. That inflation unfortunately meant a lot of the money in our checking accounts just didn't buy the same amount of bread and milk as it did even a year or two earlier.  So that's a good option.

And like you said, the banks, we joke a lot about the banks, but if we had to live in a world like It's a Wonderful Life with runs on the bank…Cause the truth is there's not a single bank that could survive. Everyone's showing up on the same day requesting their money back.  They just don't have it. It is that's how they make money. They take the money I put in my checking account and they loan it to you, John, to buy a house. And, but that's where the FDIC is so helpful is that we don't have to worry about having a rumor of a bank run. And cause that used to be, it was, it just took a rumor, didn't even have to be true. And that bank was gone and now people are out their money. So that strong banking system that we have is certainly very critical. Part of why I think we've been so successful as a country.

John Bever: Yeah, and it's interesting you mentioned run. One of the things that we just recently had this year was a flash run because of digital presence in social media.

Literally within 24 hours, there were hundreds of millions of dollars that were being extracted from a bank because of something that was mentioned on social media. And so those runs can happen very quickly these days. And that's why the FDIC stands ready, as you mentioned, very quickly to resolve some of these situations.

Now you mentioned emergency money, Jim, what are some of the guidelines you use for determining how much money to have in the emergency portion?

Jim Uren: Yeah. So again, it depends certainly as one enters retirement we like to see that money a little bit higher. The rule of thumb is often typically three to six months of living expenses, certainly for an emergency portion.

I like to see closer to that six months in terms of what their retirement income would be. But even in retirement, typically your portfolio, we still have a chunk of that in safer investments, shorter term bonds, CDs, things like that. So that we've, we're confident in those years that if the market goes down, we still can pull money out of your portfolio to cover your living expenses over the next few years.

So that that is really important. And of course. As you're preparing for retirement, it can fluctuate based on the job you have, how much emergency money. I've got clients, maybe they're both tenured school teachers and the chance of losing a job is pretty small. They've got other risks certainly they may not need to have as much emergency money as let's say, if you've got a client who's in sales and their salary goes way up or way down, depending on what the economy is doing, they might need a lot more.  A lot more savings to be sure.

John Bever: Exactly. Yeah. So let's put this all together. So in the year you retire, there's some things you want to look at. So the first thing is there's five categories of income that you want to write down. Okay. Five primary income sources. The first one is pension. Not everybody has a pension.  Some people have two or three pensions. So pensions is one category.

Second category is Social Security. Third category is any part-time income. You may be retired, but maybe have a side gig, or you still have a part-time job you're going to keep, or maybe even part-time consulting with your existing company.  And some of this income can be regular. Some of it can be irregular. So write that down.

And then there's also your investment income. So if you have rental properties or rental equipment that would certainly be part of that after your costs, dividends and interest. So there are four, but there's a fifth area.

And that fifth area of income is going to be withdrawals from your portfolio. Now this may be separate from your dividends and interest if you have the dividends and interest paid directly to your checking account. So how do we figure out what that fifth category is? The withdrawals from the portfolio you figure out those four categories and you figure out your expenses and you find out what that shortfall is and that shortfall you might think of as annual or you might think of as monthly, but make sure you include everything that you spend money on in one year.

When you come up with that figure, then calculate what three years of that's going to give you your three-year withdrawal amount from your portfolio. So now that you know what that withdrawal amount is that you're going to need for three years. Now you move on to the emergency account, which Jim mentioned.

Then the third thing that you're going to look at for this short term money is, Oh, that money that you need for the non-recurring bills. Those bills may come up every two or three or four or five years, or some of your short term goals. So Jim, what are some of these, what are some examples of some of these non-recurring bills or goals that people have in their retirement years?

Jim Uren: So probably the most common one is an automobile purchase, right? A car purchase you're going to need to get something every so many years.  Your car doesn't go forever and it's expected. And then some of the unexpected ones though can be a repair to your home that was completely out of the blue, unexpected.

Unfortunately, the other big one we see is dental bills, right? Boy, those can be enormous and completely catch you off guard. So it is important, as you said, John, to make sure that you're prepared. For these type of these type of non-recurring bills and goals.

John Bever: Yeah, and Medicare does not provide coverage for dental, does not provide coverage for vision, and does not provide coverage for hearing.

If you happen to be the unlucky person that's going to need all three of those in retirement, that can be pretty large amount.

Jim Uren: Yes.

John Bever: So once you put all those together, that gives you your short term fund that you need to set aside.

And now you start looking at the timing of when you're going to need that money.  Any money that you're going to need month by month. That's good money to keep very to you, not in your checking account necessarily, but at least in a money market where you can move that money once a month, maybe every three months, put the money in your checking that you're going to need.

And as you look out longer term, the money that you might need a year from now, or the money you might need two years from now, you can look at buying a termed investment.  That could be a CD with the maturity, a bond with the maturity. Or one of these exchange traded funds that comes due in a particular year. And that can help you have that money set aside. You don't worry about it. It's going to come due when you need that for the next chunk of cash that you're going to need.

It's a little more challenging though, when we're talking about emergency money, because emergency money, you may never need it for the rest of your life. But you might need it next month, right? So what do we do with that? That's where actually some of these bond mutual funds can actually be helpful where we let the bond manager choose the right mix of treasuries and corporates, but we can actually look at a targeted maturity.

Or a targeted time frame of bonds that they're buying. For example, there are short term bond funds that just target short term bonds. Bonds that come due in perhaps three months. Or bonds that come due in six months. Or bonds that might have an average maturity of the next year. So they might have a mix of very short term and maybe some two and three year term bonds in there.

And so those funds can be useful for that. Some people still like to have the money in a CD or a bond that they know this is going to come due a year from now. And I'm just going to roll it every year. And if I have to break it early, I have to break it early. Again, the penalties for early breakage on these short term bonds and CDs is really quite small, whether it be a market value adjustment or losing some of the interest.

That the I-bonds that you mentioned can be very useful for this because the I-bonds, when you buy an I-bond in your Treasury Direct account, you do have to hold that for one year and you have absolutely no access to it. You are persona non grata, you cannot get at that money. However, after a year, you have access to that bond.

Years one through five, if you break the bond before year five, you're going to give up three months worth of interest, but that's it. Just three months worth of interest, no loss of principal. And then after five years, that money's totally available. That can be an excellent way to set aside money for a car because at least you're going to have that inflation protection.

Jim, do you have any last thoughts on this or any cases that you've worked on recently that might give a little extra insight on putting together the short term money and emergency money for a portfolio?

Jim Uren: Just I would just add to what you're saying in that it's important to make sure that you have, as you alluded to, John, this gap between the income is coming in from like the pensions, the Social Security, et cetera, versus what you need.

And that's often, typically, of course, the biggest question that people have when they come see us is, “How do I make sure that portfolio lasts?,” to continue to fill in that gap and then making sure that when we do have the right short term money that it is accessible to us. And you had mentioned a little bit this idea of the bond ladder.

John Bever: Yes.

Jim Uren: Can you maybe just allude, explain that a little bit and what's the advantage of a bond ladder? You can do a similar thing with CDs.

John Bever: Yeah. So I want to leave the listeners with this visual picture. So picture a ladder and the ladder has rungs on it. And as you go up the ladder, you're increasing your risk of falling and hurting yourself.

Okay. Same thing happens with the fixed income area, right? As we move up this ladder of maturity. So think of the rungs as maturity of when these bonds or CDs come due. As you move up the ladder, you're going to be increasing your risk some. So low to the ground, very low risk. Think about the money you need in the next three months.

That's the first rung of the ladder. Think about the money that you need three to six months. That's the next rung. Money up to a year. That's the next rung. Then maybe one year, two years, three years. You might have a very wide or big rung on there for a year when you're going to need to purchase a car, as Jim mentioned.

You can actually draw that ladder and put in the money that you're going to need at those different times, different points in time. So building a bond ladder, we mentioned that term, you probably read about it. That's all it is. It's just building your portfolio, your short term fixed income portfolio that is going to match that ladder of need with maturities.

So if you need $10,000 over the next three months, that stays in the money market. That's like on the ground, the money that you need three months from now might be $7,000. And so that's going to go on that rung and so on and so forth. And then you buy CDs or bonds or funds that match those maturities. Walk away with the bond ladder and put your money on those various rungs. And then you won't have any concerns about retirement. Now remember this every year, this picture changes, right? So the money that you need right now, 10 years from now, a year from now, you're going to need that in nine years and another year from then you're going to need it in eight years.

So this bond ladder is constantly shifting. As you drop something off the bottom, spend the money, maybe you have a little leftover. If you don't have anything left over, you still have to build one of those higher rungs. So make sure you're always looking at building those higher rungs. And one of the things that we love to do with people is to make sure that the money they're putting into those rungs for their emergency money, for their income, that they're not selling any of their stocks at a loss.

So as a result, we may recommend that people take a fairly large chunk and build five years of this bond ladder. After a market rally, and we may let that get a little short, make it down to two to three years if the market's in a declining situation where we don't want to sell at a loss. So it's a ladder, but it's a ladder that has a lot of flexibility with it.

Jim Uren: Yeah, it can be very dynamic and it's important to manage it well.

John Bever: Yes, indeed. We have a non-financial principle that is really important in retirement. It's this principle of gratitude. As we end each podcast, we want to share something that we are thankful for.

Jim, what is something that you're thankful for today?

Jim Uren: Yeah, so what comes to mind today is really technology as it relates to staying in touch with family I think we can talk to my parents and they can see the grandkids on video now, right? That was like science fiction years ago, and my wife tells the story of her grandmother was a missionary in Papua New Guinea. And they rarely got to talk to her life. And when they did, it was on the radio, right? And you had to say, “Over.” And, just boy, she talks about how different her relationship would be with their grandmother if she had the tools that we have. And we can just hop on that phone and then talk to the grandparents today.

And just unbelievable. So neat. How about you, John? What are you thankful for today?

John Bever: I was waiting for the “Over.” Over?

Jim Uren: Over.

John Bever: Roger. Roger. I don't know. What am I thankful for? I'm actually thankful for the seasons. I've got a daughter out in Los Angeles and I remember her first couple of years in school out there, she would come back and she loved coming back in the winter because there was winter, right?

There's no such thing as winter out there in LA. So I'm thankful for them because I do enjoy. I enjoy summer. I know we're in summer. I absolutely love it, but I also look forward to the fall and winter, as long as it's not too long. And then of course the breaking of winter with spring. So I'm very thankful for the seasons and living where I live right now.

Jim Uren: Wonderful. Thank you all for listening and tuning in for our show notes. You can go to phase3advisory.com/podcast. That's phase3advisory.com with the number three, /podcast . You'll see our transcript as well as links to some additional resources that you may find helpful.

Thank you so much for tuning in and we'll look forward to talking to you at our next podcast. Thanks so much. Bye-bye.

Jennifer Uren: The views expressed in this podcast are not necessarily the opinions of phase three advisory services and should not be construed directly or indirectly as an offer to buy or sell any securities or services mentioned herein, unless otherwise specified show guests are not securities licensed or affiliated with phase three advisory services or Osaic wealth.

Investing is subject to risks, including loss of principal invested. Past performance is not a guarantee of future results. No strategy can assure a profit nor protect against loss. Please note that individual situations can vary. Therefore, the information should only be relied upon when coordinated with individual professional advice.

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Phase III Advisory Services is located at 1110 Wesley Cook Road, Suite 265 in Buffalo Grove, Illinois, 60089. Our phone number is 847 520 5545. For additional information, visit our website at phase3advisory. com.