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This question assumes one has an appropriately sized emergency fund already established.

If I expect the equities market to decline in the next year or two - what specific circumstances would make holding cash (in a 1% savings account for example) preferable to purchasing bonds?

For the sake of analysis, the bonds purchased can be in the form of 5-year US treasury bond (currently at 1.83% PA.)

  • Could you be more specific? e.g. What kind of bonds would you contemplate purchasing? Say, long-term junk corporate bonds, short term government bonds, something else? – Chris W. Rea Jan 17 '17 at 20:47
  • How do you define cash? Is a bank account cash? Certificate of Deposit? Money Market account? – keshlam Jan 17 '17 at 22:23
  • @keshlam 1% savings account – Chris Jan 17 '17 at 22:34
  • @ChrisW.Rea For the sake of analysis, we can consider a 5-year US treasury bond. I updated the question with the additional info – Chris Jan 17 '17 at 22:38
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A bond can default, a pile of cash is just a pile of cash.

Bonds are usually slightly more risky than holding cash, so they give a slightly higher rate of return. Risky bonds give higher returns than safe bonds.

Keep in mind that estimating risk is fundamentally an attempt to predict the future. If conditions change enough to make default likely, there is a big downside to a "low risk" bond. Housing bonds were considered safe until large numbers of people took the unprecedented action of not repaying their mortgages. Municipal bonds are considered safe right now because how often do cities go bankrupt under the crippling weight of pension obligations? And so on.

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    Do you feel a treasury note has a greater than zero risk of default? – JoeTaxpayer Feb 17 '17 at 18:22
  • Not under any likely scenario I can conceive of. My main worry would be that the low rate of return is outpaced by inflation. Of course, a pile of idle cash has an even lower rate of return. – Jim W Feb 17 '17 at 20:50
  • T-bills give such a low return that it's almost pointless from my point of view, even with ridiculously high amounts of money. I don't remember off the top of my head, but to get a return that was in the thousands of dollars range, you'd have to invest tens of millions of dollars. I know that the much longer term US notes have higher returns, but who wants to hold on to something for decades to reap a few perentage points of return- that's a huge opportunity cost if something better comes along in that time. – Jim W Feb 17 '17 at 21:01
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There are a lot of reasons for holding large amounts of cash:

  1. For accidents-You never know when you will need money.Selling Bonds in the secondary market is an option but you never know what will be the coupon value when you will be selling the bond.

  2. Junk Bonds can Default on Principal amount or the Interest-If you are planning to buy junk bonds then, you must diversify them with the help of mutual funds specialized on junk bond schemes.Still, there are risks with junk bonds even after diversification.

  3. Same amounts of return in fixed deposit schemes-Why go for bonds if you can get the same amount of returns on fixed deposit schemes.(At least in India)

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If inflation increases greatly, then the bonds will lose value faster than cash. Also, cash can be used instantly, but a bond has to be sold before it can be used.

Also, your bond holdings are known to all the three-letter agencies, but if you have cash, only you know about it.

The problem with cash is that the government is making it harder and harder to deal in cash in the United States.

  • Care to explain your second paragraph? what are the pros and cons of having the TLA knowing your bond portfolio? Can you add a source to the second paragraph? – Mindwin Jan 18 '17 at 12:33
  • @Mindwin The full consequences of unknown governmental agencies knowing a person's treasury holdings is of course unknowable. However, just one example of a negative consequence: all interest on Treasuries is automatically reported to the IRS, so the IRS can estimate, if it does not already know, your treasury holdings. The higher your estimated assets, the greater the probability of being audited. – Five Bagger Jan 18 '17 at 12:55
  • So everyone in Fortune 500 is audited all the time, by following your reasoning... something does not add up. sources? – Mindwin Jan 18 '17 at 14:19
  • @Mindwin Thanks for the blanket smear. And, yes, people who have larger amounts of money do get audited much more frequently. Many people with over $100 million in assets get audited automatically every single year. The more money you have the higher likelihood of an audit. If you have a lot of known assets (like Treasury Bonds and Notes) and have low income, you will get audited. – Five Bagger Jan 18 '17 at 14:52
  • Downvoting this answer is not justified. The first paragraph is principally correct because when inflation increases, bond yield also increases simply because of inflation premium. As yields increase, bond value decrease. Some investors can't tolerate this drop in value even if they have a promise of receiving the principle. – Bee Dev Feb 8 '17 at 0:43

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