Revisiting “When Should the Game Change” and “How I Changed My Money Game”
About ten months ago, I wrote a post, How I Changed My Money Game, in which I discussed how changes in my life’s circumstances led me to alter how I manage my finances. This post was a follow-up to a July 2022 post, When Should the Game Change?, describing how each person can examine his circumstances, goals/objectives, and risk tolerance to choose an asset allocation and portfolio management style designed to be congruent with his parameters. Before continuing with reading this post, it would be helpful to read/reread those two prior posts in the order that I wrote them:
July 2022: When Should the Game Change?
July 2024: How I Changed My Money Game
As described in How I Changed My Money Game, I bifurcated my assets into two buckets: the first consists of a Growth Stock Portfolio aimed at maximizing capital appreciation, and the second bucket is designed for a) income to support my lifestyle, b) shelter, and c) capital preservation.
I also refer to Bucket 2 my safe bucket as its purpose is to cover all of my financial needs, regardless of how markets fluctuations may impact Bucket 1 in the short term. While large drawdowns, high volatility, and high risk may be acceptable for the Growth Stock Portfolio, they are unacceptable for Bucket 2. Given my stated purpose for Bucket 2, I’ve expanded my thinking to include identifying and mitigating risks associated with Bucket 2’s assets.
Bucket 2: Rethinking Its Composition
Some time has passed since I first began to segregate funds away from the growth portfolio into a separate Bucket 2. Around the Fall of 2023, I began siphoning additional cash from the Growth Stock Portfolio into Bucket 2, and this process continues with periodic transfers from the Growth Stock Portfolio to Bucket 2. In late 2024, I used a portion of Bucket 2’s cash to purchase a residence, resulting in a transfer of Bucket 2 cash to Bucket 2 real estate (i.e., shelter, not real estate for investment income purposes). The purpose of Bucket 2’s remaining cash is to provide a regular income stream to cover living expenses. It’s my preference to have sufficient cash in Bucket 2 to generate enough income such that assets within Bucket 1 or 2 don’t need to be sold to cover living expenses. Note: others may prefer some asset sales to fund their living expenses, with the 4% rule being one method. There isn’t one right approach.
As an investor, analyst, and stock picker, I’ve developed a second nature for identifying the risks and pitfalls (in addition to the upside potential) when considering an investment. Given that the cash in Bucket 2 is intended to provide an income stream to fund my lifestyle in perpetuity, I must consider all of the risks, including loss of principal, loss of purchasing power, reduction in yield (i.e., future cash flow from interest and dividends), and some other risks. The interest rate on cash — note: when I refer to cash in this post, “cash” refers to a liquid money market fund currently yielding about 4.25% — has moved down together with the reductions in the Fed Funds Rate (FFR). As the Fed raised interest rates from 0% to 5.25% (between March 2022 and July 2023) to combat inflation, it created an environment in which investors could earn attractive yields for simply holding cash.
Because unemployment remained low and inflation dropped, the Fed subsequently lowered (between September 2024 and January 2025) the FFR to 4.25%, where it stands now. The level of an interest rate is an important consideration when deciding where to invest cash for fixed-income purposes.
In summary, the so-called cash in Bucket 2 doesn’t necessarily need to be cash but rather can be invested in various fixed-income investments. The remainder of this post will be a discussion about the various risks when investing cash for fixed-income purposes. A future post will cover specific actions I’ve taken to mitigate the risks by constructing my tailored Fixed-Income Portfolio.
Interest Rate Risk
Interest rate risk refers to how future changes in interest rates can affect an investor’s yield. Below is a chart of the FFR since 2020. Note: the Fed has a 0.25% range for the FFR so when the Fed lowered the FFR to 0.25% in March 2020 the FFR was actually in the range between 0% and 0.25%. The chart below shows the upper bound of this range for each data point, meaning that the FFR is currently 4.25-4.50%.
The FFR is important because it is the primary factor determining short-term yields on money denominated in U.S. dollars. To be more specific, the FFR is set by the U.S. Federal Reserve’s Open Market Committee, which meets eight times each year. The FFR is the rate that banks charge each other on overnight loans of reserve balances held at the Federal Reserve.
Other borrowers will typically pay a higher interest rate (for short duration loans) than these banks. A fixed-income investor is lending out dollars in exchange for a yield (i.e., a future stream of interest and/or dividend payments) and the eventual return of invested capital at maturity.
The best yield that a fixed-income investor can obtain on a very short duration (note: duration is the time period for which a fixed income investment is locked in or locked up; this can typically range between one month to 30 years) is closely correlated to the FFR.
Yields on longer-duration fixed income assets, while influenced by the FFR (i.e., the short-term interest rate), are determined by market factors — largely collective investors’ expectations of future changes to interest rates and other factors. During normal times (most of the time), the longer the duration, the higher the interest rate yield. However, when the yield curve gets inverted, yields on short-duration bonds (e.g., 2-year) are actually higher than yields on long-duration bonds (e.g., 10-year). Below is a table showing currently (as of 23May 2025) available yields on very safe U.S. dollar-denominated debt.
| Investment | Yield |
|---|---|
| Short-term Govt Bond Money Market Fund | 4-4.25% |
| CD (3 month) | 4.3% |
| US Treasury (3 month) | 4.3% |
| CD (1 year) | 4.3% (4.25% call protected) |
| CD (5 year) | 4.6% (4.25% call protected) |
| U.S. Treasury (5 year) | 4.0% |
| Municipal Bonds Aaa/AAA (5 year) | 4.0% (no Federal tax on income) |
| Corporate Bonds Aaa/AAA (5 year) | 4.3% |
| U.S. Treasury (10 year) | 4.45% |
| U.S. Treasury (30 year) | 5.0% |
The following is a summary of what has happened with interest rates over the past 15 years. During the 2010s, there was a long period of tame inflation and very loose monetary policy. During this time, stocks did well, it was cheap to borrow money, and it was challenging to make any return in bonds. In 2020, the pandemic prompted governments to lock down society, which essentially froze much economic activity and massively disrupted the network of global supply chains that had been established in the decades prior.
To prevent a likely global depression, the world’s central banks, in lock-step, cut rates to essentially zero (shown as 0.25% in the FFR graph above) from what were already historically low rates. In addition, fiscal spending by many governments was massively increased to prevent permanent financial destruction of businesses as well as households on the low end of the economic spectrum. The lockdowns 1) increased demand and spending on physical goods, 2) reduced spending on services, and 3) froze supply chains, reducing the supply of physical goods. The eventual and large inflation spike was not immediate, but when it occurred, monetary policymakers deemed it transitory. It now seems clear that inflation was indeed transitory. However, the duration of the transitory period was much longer than central banks expected. Thus, to prevent inflation from permanently taking root (a long period of transitory inflation can lead to persistent inflation, which would be a huge problem), the Fed was forced to sharply raise the FFR. The effects of the central banks’ policy changes on interest rates (rapid easing in the Spring of 2020 and rapid hiking from March 2022 through July 2023) were the following:
1) Ultra-low rates were available during 2022, with rates at 50-year lows. Those who locked in long-duration loans essentially got almost free money. However, those who borrowed at these rates on their residences to this day have a very strong financial incentive to remain in those homes, which is still causing distortions in the supply and demand dynamic of the residential real estate market.
2) Very high interest rates were available starting and peaking in mid-2023 until the Fall of 2024, with rates for risk-free fixed income rising to levels not seen in decades. Investors could get very good yields by holding cash or buying bonds, but the yield curve inversion (see #3 below) made it psychologically challenging to buy long-duration fixed-income investments because short-duration fixed-income investments offered higher yields. Also, good yields on cash and bonds reduce the incentive to buy more risky assets such as stocks.
3) Yield curve inversion (where the interest rate available on short-duration is higher than on long-duration) peaked in early July 2023, with the steepest inversion in 42 years (see the table below this paragraph). The inversion creates a disincentive to buy long-duration fixed-income, so investors tend to stay in shorter-duration fixed-income to get a higher yield today. However, as interest rates fall, the opportunity to lock in long-term yield on fixed income begins to fade. Also, as short-term rates fall due to central banks’ loosening monetary policies, the yield curve can begin to un-invert which can help keep long duration rates higher for longer (as rates are dropping). Higher long-duration rates for longer have some effects on the housing market and on investor behavior. Persistently high mortgage rates will further extend the time that homeowners will stay put in their current homes due to the differential between the ultra-low mortgages that they locked in during 2021 and the currently available and much higher mortgage rates; this keeps the supply of homes for sale on the market low. Also, as interest rates fall, investors will seek better yields and become increasingly incentivized to move capital from cash and short-duration bonds into more risky assets.
-This section is turning out to be longer than I intended, but I thought additional context and explanation could be useful for people weighing whether preemptive actions to mitigate interest rate risk should be warranted. We know that interest rates have come down from the peak but are still relatively high compared to rates that were available during the past two decades. Will rates continue to fall, stay flat, or go back up? No one can know for sure, but I’m willing to bet that short-duration interest rates are likely to be lower in a year. If that happens, then reinvesting any short-duration fixed-income investments will result in lower yields in the future. To protect against interest rate risk, one could lock in yields on longer-duration fixed-income products today.
Loss of Purchasing Power Risk
Inflation is the primary cause of a loss in purchasing power. Inflation was relatively tame from the 1980s until the steep yet short-lived spike in the post-pandemic period (see chart below). As mentioned above, the pandemic-triggered fiscal and monetary policy changes triggered large disruptions that are now still dissipating. Inflation has fallen back down to reasonable levels and continues to fall toward the Fed’s 2% target. However, new, recent policy changes, namely tariffs, have threatened to unleash a new bout of inflation.
The main effect of inflation is loss of purchasing power: more money will be required to purchase the same item in the future as it does today. Inflation is particularly nasty for most asset classes and a negative force for any economy, so combating inflation is a top priority of monetary policymakers in any advanced economy. Some hedges against inflation include real estate and gold. Inflation rates are not the same across countries because they are linked to money in each currency. High inflation in one country and low inflation in another country will affect the currency exchange rate between those two countries, assuming that the currencies aren’t pegged to each other. Thus, loss of purchasing power can occur through a currency depreciation, which would make imported goods and overseas travel more expensive. The fiscal and monetary policies of the United States affect the exchange rate of the U.S. dollar compared with other currencies.
Loss of Principal Risk
There are several ways principal can lose value. Default is the worst kind of loss of principal. Default occurs when a bond issuer (the entity that issued the note to the investor/creditor) no longer makes the coupon payments. Default can be either a temporary suspension, where payments are resumed later or a permanent financial disaster (e.g., bankruptcy) for the debtor, in which case the investor/creditor can lose their entire principal investment. In some cases, the terms of the loan can be renegotiated. The three credit agencies (in the United States) are S&P Global Ratings (S&P), Fitch Group, and Moody’s, and each provides ratings on specific bonds; these ratings are an excellent (but not fullproof) indication of the riskiness of debt.
A second way an investor can lose principal is through changes in interest rates after purchasing a bond. Since a bond’s interest rate and payments are typically fixed for the duration of the bond’s term, changes in the market interest rate will affect the principal’s current value. Market interest rate and the price of a previously issued bond are inversely correlated, and the longer the duration of the previously issued bond, the more susceptible the principal of that previously issued bond is to changes in the market interest rate. If a bond is held until maturity, then there is no realized loss of principal. However, an investor who receives a 2% in annual coupon payments for 30 years, for example, would not be happy if interest rates rose to 5% on 30-year bonds. This investor would have a choice: either continue holding the bond or sell it in the secondary market, thereby accepting a loss of principal (i.e., a capital loss). Conversely, investors who purchased bonds when interest rates were high could sell those bonds for a capital gain if interest rates were to fall.
Currency devaluation, which was mentioned above as a loss of purchasing power risk, could also be considered a loss of principal. Currency values tend to fluctuate relative to other currencies, but a country, assuming that it has a currency that is not pegged to another country’s currency, can permanently devalue its currency. One potential scenario under which this could occur is through printing money, thereby diluting the value of the currency. It’s important to closely watch the combination of a country’s debt level, its annual and projected future deficits, its reliance on demand for its future debt issuances, and the demand for its debt. These factors have recently come into greater focus and scrutiny (by the bond market) in the United States as the government’s administrative and legislative branches seem intent on passing a budget that doesn’t prioritize a lowering of the deficit. I may discuss this topic further in future posts.
Other Risks
When investors buy stocks or bonds, they want to know that the country in which the investments are located has a strong system of laws and rules, a capitalist-friendly economy and government, and a stable currency. Investors also strongly prefer to invest their capital in markets where their investments aren’t at risk due to unfair or arbitrary decisions by the government concerning specific companies or classes of investors (e.g., foreign investors). Personally, I’ve specifically avoided investing in Chinese companies and some countries due to such risks. The United States has historically been an excellent country for investors; however, recently, investors have become aware of rising risks to the value of the U.S. dollar and other risks.
GauchoRico Mitigates the Risks
In 2022, when I consciously created a separate Bucket 2 (Safe Bucket) which now includes residence(s) and cash, I didn’t think much about the risks, other than interest rate risk. Back then, short-term rates were at 5.25% (now down to about 4.25%), so I was content to park all of my cash in a short-term government bond money market fund, which is completely liquid and provides an interest rate very close to the FFR. I recently realized that there are a lot more risks I need to consider for my Bucket 2 assets. Again, the purpose of Bucket 2 is to provide shelter (a residence) and a stream of income to cover all of my current and future living expenses. Thus, I want Bucket 2 to provide a semi-fixed-income, and, therefore, Bucket 2 now includes a Fixed-Income Portfolio. Today, I am managing two distinct and separate portfolios, each with separate goals. The Growth Stock Portfolio’s goal is to maximize long-term CAGR (i.e., capital appreciation) while the Fixed-Income Portfolio’s goal is to provide income to cover all current and future living expenses. I’m new to fixed income investing, so managing the Fixed-Income Portfolio is also a new journey and a work in progress. I’ve already made a lot of changes to this Fixed-Income Portfolio to address the risks that I’ve brought up in this post. I will soon write a post about my Fixed Income Portfolio in which I’ll explain these changes and the reasons behind them. I also intend to periodically write portfolio updates for the Fixed-Income Portfolio. Finally, I’ve added a Fixed-Income category under the blog section of this website.
The opinions, thoughts, analyses, stock selections, portfolio allocations, and other content is freely shared by GauchoRico. This information should not be taken as recommendations or advice. GauchoRico does not make recommendations and does not offer financial advice. Each person/investor is responsible for making and owning their own decisions, financial and otherwise.