Cash & Fixed Income

Cash

Cash is your most liquid asset and your first line of defense. This category includes money in your checking and savings accounts, uninvested funds in brokerages, and physical currency. While cash won't generate long-term returns, its primary purpose is security and accessibility rather than growth.

Regular Spending

This is the capital you need to manage your day-to-day life: rent or mortgage, utility bills, groceries, etc. The goal of this cash is transactional efficiency, ensuring you never bounce a check, miss a payment, or incur overdraft fees while living your normal life.

Emergency Savings

Beyond your daily expenses, cash acts as your safety net. It is recommend to keep 3 to 6 months' worth of essential living expenses in savings. For example, if your monthly budget is $5,000, your emergency fund should sit between $15,000 and $30,000. This buffer is critical, as it ensures that an unexpected job loss, major home repair, or sudden medical bill won't force you to sell your long-term investments while the market is down.

Account Strategy

• Physical Cash: Keep whatever feels comfortable for you, whether that's $20, $100, or nothing at all.

• Checking Account: Keep just enough to cover everything that you will be charged for in the next month, plus a comfortable buffer. This includes rent/mortgage, utilities, and debit card purchases.

• Savings Account: This is the emergency fund, so 3-6 months worth of expenses, and ideally, you're using a High-Yield Savings Account (HYSA).

• Uninvested Funds in Brokerage: Avoid having uninvested funds in all investment accounts, preferably having all dividends automatically reinvested.

Fixed Income

This category primarily consists of bonds, which are essentially lending money to an entity (typically a government or corporation) in exchange for regular interest payments and the return of your principal at a later date. Bonds are generally much less volatile than stocks and provide more consistent returns, making them an excellent tool for balancing the unpredictability of stocks. They are graded from AAA to D, with bonds at BBB or higher being considered "investment" grade and widely considered to fall into the bond portion of your portfolio.

This category primarily consists of bonds. When you buy a bond, you are essentially lending money to a government or corporation in exchange for regular interest payments and the return of your principal at a specific later date. Bonds are generally much less volatile than stocks and provide more consistent returns, making them an excellent tool for balancing unpredictability of the stock market. They are graded on a scale from AAA to D, with bonds rated BBB or higher being considered investment grade and typically form the defensive part of your portfolio.

Risk and Correlation

When building a portfolio, it is crucial to understand correlation, how closely two assets move in relation to each other. For most investors, the primary reason to hold fixed income isn't to increase returns, but to own an asset that is uncorrelated with the stock market. You want your bonds to go up when your stocks go down; if your portfolio moves in the exact same direction, you don't actually have a safety net.

On the safest side of the spectrum, where capital preservation is the main goal, investors opt for Treasury bills (T-bills) and certificates of deposit (CDs). Because these are backed by the U.S. government or FDIC insurance, they basically carry zero default risk are have little to no correlation with equities. Their correlation can even become negative, as investors often panic and flock to the safety of Treasuries during recessions. The catch is that they have the lower yields than other forms of fixed income.

The other end of the spectrum features high-yield "junk" bonds and emerging market bonds. These offer significantly higher payouts to compensate for their elevated risk of default. Crucially, they are highly correlated with the stock market, so they tend to lose value right alongside your equities during a recession, albeit to a lesser degree. While the higher yields are tempting, their lack of a diversification benefit will hurt your portfolio when you need it the most.

In the middle are investment grade corporate bonds, which offer slightly higher yields than Treasurie sbut carry some default risk. They will hold up well during mild downturns, but can still stop alongside stocks during more severe events.

Beyond default risk, investors must also consider duration risk (sensitivity to interest rates). Long-term bonds hold their yield, but go down when rates rise and up when rates fall, while short-term bonds hold their price value, but their yields go up or down with interest rates.

To build a true defensive parachute for your portfolio, your core holding should be U.S. Treasuries. Trying to bridge the gap between stock volatility and low Treasury yields with riskier bonds is often a trap. Any higher-yielding strategy must be well-understood and should never outweigh your core safe holdings.

Individual Bonds vs Bond Funds

Individual bonds pay a fixed interest rate and return your principal on a specific maturity date. This provides absolute predictability, but it limits diversification and can be expensive if you need to sell the bond early.

Meanwhile, bond funds are managed portfolios where bonds are constantly bought and sold to maintain a target timeframe. This gives you instant diversification, high liquidity, and a smooth monthly income. However, because the fund never actually "matures," its share price will fluctuate with interest rates, meaning your principal value can temporarily drop.

For general long-term investing, go with bond funds, but if you know exactly when you will need the cash (like a down payment for a house), individual bonds or CDs are perfect.

Active vs Passive

Unlike the stock market, there is strong academic merit to active management in specific corners of the bond world. Because credit markets are less efficient, bonds with similar fundamentals can be priced differently. This allows skilled fund managers to exploit pricing gaps by buying underpriced bonds and aggressively analyzing corporate balance sheets to avoid defaults. While some managers also try to reposition their portfolios based on interest rate predictions, consistently timing rate shifts is notoriously difficult.

However, you must be careful when choosing an actively managed fund. Higher returns do not automatically equal higher risk-adjusted returns, and active funds come with higher expense ratios, increased trading costs, and manager risk. You must ensure the fund has higher risk-adjusted returns net of fees and not just artificially boosting yield by taking on extra credit risk.

Key Takeaway: Active managers generally only provide an advantage in complex, illiquid areas like high-yield or multi-sector credit. For defensive assets like pure Treasuries and TIPS, the markets are highly efficient, making low-cost passive index funds the superior choice.

Bond Portfolio

When building your bond portfolio, your primary goals are capital preservation and steady income generation. For most long-term portfolios, the optimal structure splits your bond allocation into three buckets. This combination ensures your safety net is highly diversified, resilient to both inflation and economic downturns, and capable of generating consistent returns.

Below are highly-rated bond funds to consider for each portion:

• Treasuries

  • Vanguard Intermediate-Term Treasury (VGIT)

  • Vanguard Long-Term Treasury (VGLT)

  • Schwab Intermediate-Term U.S. Treasury (SCHR)

  • Schwab Long-Term U.S. Treasury (SCHQ)

  • iShares U.S. Treasury Bond (GOVT)

• TIPS

  • Vanguard Short-Term Inflation-Protected Securities (VTIP)

  • iShares 0-5 Year TIPS Bond ETF (STIP)

• Yield

  • Janus Henderson AAA CLO (JAAA)

  • JPMorgan Core Plus Bond (JCPB)

  • Fidelity Total Bond (FBND)

  • PIMCO Active Bond (BOND)

  • PIMCO Multisector Bond Active (PYLD)

  • iShares Flexible Income Active (BINC)

  • VanEck Emerging Markets Bond (EMBX)

Target Allocation

A popular rule of thumb for asset allocation is to subtract your age from 120 to determine your stock percentage, allocating the remainder to bonds. For example, if you are 30 years old: 120 - 30 = 90% in stocks, leaving 10% allocated to bonds. You can adjust this baseline up or down depending on your personal risk tolerance.

For the bonds themselves, the simplest approach is 100% in an intermediate Treasury fund (VGIT). For a more robust defense against both recessions and inflation, you can split your core between long-term Treasuries (VGLT) and short-term TIPS (VTIP). Finally, if you want to boost your income, a high-quality yield fund like JAAA fits well alongside VTIP, provided it remains a non-core holding. Try out my interactive Portfolio Builder tool to get a tailored breakdown and target percentages of each of these funds.

Asset Location

Unlike stock dividends, the interest generated from most bonds is taxed at the same rate as your salary. Due to this and their lower returns, placing the right bonds in the right accounts is important.

• Pre-Tax Accounts (Traditional 401(k) / Traditional IRA): For the most part, this is the best place to hold bonds, especially yield-seeking funds and TIPS. Both pre-tax and post-tax accounts shield you from the tax hit of payouts, but pre-tax is especially good for assets with lower growth due to withdrawals being taxed as income.

• Post-Tax Account (Roth 401k, Roth IRA, HSA): While these accounts do protect you from the taxes from payouts, you should prioritize having your high-growth assets (like stocks) in these accounts.

• Taxable Brokerage Account: You will pay income tax on the yields, so it's not great to hold bonds in taxable brokerage accounts. US Treasuries and TIPS are exempt from state taxes, but corporate and other high-yield bonds are not. If your tax bracket is high enough, you should consider investing in municipal bond funds (VTEB or MUB), which are exempt from federal taxes.

Typically, you should have a traditional 401(k) and a Roth IRA, so this means you should keep most of your bonds in your 401k. However, many employer plans offer terrible investment options, so it may be better to choose a low-fee stock index fund in a Roth 401(k), while holding high-quality bond funds in your traditional IRA.