Bonds & Fixed Income Investments
Savings and Reserves, Once Again

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By imdajunkman
January 9, 2006

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"Savings" and "Reserves" might be two words for the same thing, or two different things. I just don't know at this point, for not haven given it any thought. My sense is that they are different, and I'm content to leave them undefined.

The reasons for creating Savings and Reserves will be summed below, where "Reasons" are suggested in the left column and "Sizes Needed" (to accomplish the task) are suggested to the right. But, first, a bunch of background:

"Sizes" can be stated in dollar amounts, or as a percentage of one's assets under management. I prefer the former. Years ago, I was reading the annual report of an international fund, and they were explaining the changes in their allocations. "This year we increased our exposure to India to 1.7% from last's year's 1.4%" And I fell out of my chair laughing.

"They are smart fellows', I said. "So this year I'm going to increase my allocation to India by that same 0.3%, too. Let's see. Do I have a spare $17.56 I can put to work?"

They, obviously, were dealing with a billion dollars or so and 0.3% of that becomes a significant amount of money when deployed in a third-world market. But those sums aren't characteristic of typical Savers, which suggests this story:

"A cabinet-maker works to the nearest 1/128th. A framer to the nearest 1/8th, but a boat builder to the nearest boat."

For most savers considering allocation amounts, working to the nearest 5% is going to be "Good Enough". But that does raise this problem. A 5% allocation to Savings in a $20,000 portfolio has a different impact and utility than a 5% allocation in a $200,000 (or bigger) portfolio. But let me lay out some more background, and then I'll get back to the dollars-versus-percentage argument.

Savings can be created in a lot of ways, not just purely financial ones. Examples from daily living abound, like deleting junk mail (paper or electronic) as soon as it is received, without ever opening it, so that it never piles up to become a thing about which later decisions had to be made. The "savings" is Time and Effort. But they matter as much (or more) than money.

But when the term "Savings" is used, "financial" savings is the default understanding, and the default vehicle is "insured term-deposits", where the "term" might be as short as one day (i.e., a money market checking account) or as long as "Forever". But I'd argue that 5 years really is a threshold, the crossing of which, begins to take on risks more characteristic of "Investments" than "Savings". (I can't prove that yet. It's just a gut feeling.)

OK, back to "sizing". There are a lot of insured term-deposits the would-be Saver could choose from. CD's is the one that comes to most people's mind. But T-Bills are a term-deposit, as are insured municipal bonds, as are all money market and banking accounts, etc. If there is reliable assurance that there will be no loss of nominal principal, then the vehicle can be considered a savings vehicle. Thus, I'd even consider short-maturity Agencies as savings vehicles. But the point at which Agencies becomes investments, instead, isn't something I'm sure about. My guess is five years. Beyond that time frame, you really are beginning to speculate about a whole bunch of things that are beyond the ken and intent of the typical Saver. You're beginning to speculate about credit risk, re-investment risk, etc., which aren't worries that are proper for a Saver to consider. Those are tasks Investors take upon themselves, but that Savers can avoid. That's the trade-off. If you're going to take on the risks, then you need to be compensated for doing so. If, OTOH, you choose to avoid the risks, then you have to pay the costs (by forfeiting potential reward.)

Yet more background: It is a fundamental belief of mine, based on anecdotal evidence, but not yet proved, that the return from savings vehicles will never, on average, overcome inflation risk. Therefore, the would-be Saver either has to pile up enough savings so that their sheer quantity can be drawn against as inflation erodes their purchasing power. (In other words, treat them as a depreciating asset). Or the person has to also become an Investor with respect to a portion of one's assets under management, choosing vehicles likely to carrying with them an inherent inflation premium, such as stocks are reputedly said to do. (Trading is a different gig. There profits and losses are nearly instantaneous compared to the time-frames characteristic of investing. Therefore, inflation risk isn't a consideration.)

And one last preliminary. Whatever you determine the universe of insured term-deposits to be, the 800-pound gorilla, the benchmark against which the returns from all other term deposits are going to be measured, is Treasuries, but especially the 4-, 13- and 26-weeks Bills, the 2- and 3-year Notes, and possibly the 5-year Note. (I'm not sure about that. But it seems to make more sense to permit it than to argue for its exclusion.) As I argued in another thread, however, if you choose the 4-week bill as your preferred maturity, you have to commit yourself to systematic buying. (Otherwise, you are likely to under-perform the results to be obtained from buying term-deposits whose interest rate is known is advance of their purchase, which is never the case with Treasuries of any maturity if you're bidding through the non-competitive process.) However, in terms of sizing Savings and Reserves, a 4-week ladder, one-rung deep, amounts to petty cash and has limited utility. One's savings work-horses (and more likely choices) are going to be longer ladders.

OK, now comes suggestions as to the Reasons for Savings and Reserves and some possible Sizes:

(1) Psychological Anchor, $13-26K
(2) Trading Grubstake, $26k
(3) Mad Money, $4-13k
(4) Targeted Objective, $13k-?
(5) Generic, Prudent Household Reserve, $13-26k
(6) Saving Done for the Discipline of Doing It, $13k

Note: Those sizes are sizes which meet the needs of each individual reason. Obviously, they are not to be summed as a total, because each amount could serve more than one reason. A single 13-week ladder seems to be the minimum. A single 26-week ladder is likely to be sufficient in most people's portfolios and lives. But that's for each person to decide.

Each person will amend some of Reasons and Sizes and add her own. But I think nearly everyone would agree that it doesn't make much sense to talk about sizes in terms of percentages of one's asset under management. There really is a dollar amount that is Enough, beyond which the money might be put to better use elsewhere. But just the same, there really is some minimum dollar amount that is both prudent and necessary if one of the chief goals of Savings is to be obtained, which is emotional stability in a hostile and unfriendly financial world.

POST SCRIPT: This is my last post in this forum, if not forever, then for a good long time. I rejoined after a several years' absence, because I wanted to work out some ideas. In the world of fast, hot money, Saving is a disparaged path. It is seen as old-fashioned, etc. I needed to rehabilitate it for myself. I grew up as a Saver, and I still consider myself a Saver, but "it gets no respect as Rodney Dangerfield might have said, and it's a tough, tough discipline to accept when the whole world seems to be making faster, bigger money.

I've made some of that bigger money, turning $20k into over $400k in just over 21 years. (That's investments, not real estate. There I'm up 500% on the modest, little cottage I have and where I'll live until I die.) So don't tell me it can't be done, that a "little guy" can't elbow his way into markets and hold his own. But that little guy needs all the help he can get, which is why I applaud Spitzer, which is why I fight the battles that I do.

But I've reached the point where I want to have a Life, not a Portfolio. So, I'm going to unwind some of the risks I've been taking on. But markets are my Zendo, so I'll be taking on a new challenge, programmed trading, just to see if I can do it. The effort will require a total absence of distractions, which means I convert all investments to savings, if not actually, then mentally, which is why I've been leaning on this savings stuff so hard.

If I'm going to be doing savings big time, I needed to understand what I was getting myself into in terms of costs and benefits. I see now that the financial costs are tolerable and the emotional rewards are tremendous. The effort to get a trading program going also means I need to shut down the sort of distraction that hanging out at the bond board can become. I don't like wrangling with immoral scoundrels or explaining myself to the endlessly lazy. (In both instances, the few there are know who they are.)

I wish my Fellow Fools the tranquility all of our lives deserve, as well as such Fortune as you might earn.

Charlie, ex-junkman, now Saver-Trader

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