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As little as six months ago, capturing an essentially risk-free 5% yield on your cash was the easiest thing in the world. In fact, not long ago I argued about why taking the 5% yield and walking away from risk assets for a little while might be a prudent choice. Or how retirement savers can take advantage of these yields and adhere to the “4% withdrawal rule” while still growing their portfolio!

But 75 basis points of Fed rate cuts later and the calculus has changed. No longer can you just throw your money in T-bills and cash those dividend checks. With the Fed Funds futures market still pricing in three more cuts by the end of 2025, T-bill yields are moving lower and faster in anticipation.

The going 3-month T-bill rate has dropped from 5.4% to 4.5%. That means if you’re looking to hang on to a 5% portfolio yield, you’ll need to make adjustments to your portfolio and add some risk in the process, whether that’s pushing into different asset classes, lower credit qualities or longer durations.

When I first published my 5% Target Yield Portfolio, the construction process was simple. It focused mostly on ultra-low duration Treasuries with just a bit of corporate bond exposure for diversification.

It consisted of three ETFs - the iShares Treasury Floating Rate Bond ETF (TFLO), the iShares Floating Rate Bond ETF (FLOT) and the iShares AAA-A Rated Corporate Bond ETF (QLTA).

The use of TFLO was pretty straightforward. It contains essentially no duration and no credit risk. With a yield at the time of 5.25%, it easily could have been a portfolio of one and accomplished the goal.

FLOT keeps duration risk at nothing, but the overall weighted credit quality drops somewhere in the A-rated to AA-rated range. The addition of nearly 60 basis points of additional yield in exchange for a minor amount of additional risk makes sense.

QLTA is a higher quality corporate bond fund that adds some duration back into the mix. Its yield is currently below the 5% threshold, but the inverted yield curve won’t exist forever. Its 5% allocation won’t move the needle much, but it does provide a little extra total return potential.

Note: I recently updated my rankings for the ultra-short term bond ETF category if you’re looking for other higher yield, low risk income options. It can be found HERE.

This portfolio combination works very well in terms of eliminating most risk.

Putting aside the historical returns, which are less relevant to today’s environment specifically, volatility is incredibly low. The maximum drawdown of just 0.5% demonstrates that share price downside is very limited and can be more than offset by the yield being generated.

This was a bigger issuer in 2022 when the Fed was raising rates at an aggressive pace. Drawdown risk has much higher and with yields already at or near zero, there was little room for error. Today, however, the safety cushion is large and risk has returned to historically normal levels.

In order to adjust to today’s new lower rate environment on the short end of the curve, it’s time to adjust, but not in a major way.

Here’s how the yields have shifted over the past couple months.

• TFLO: 5.25% ☞ 4.69%

• FLOT: 5.84% ☞ 5.46%

• QLTA: 4.56% ☞ 4.76%

The floating rate ETFs have predictably seen their rates decline with Treasuries dipping more than corporates. The longer duration QLTA has seen its yield go up, which is consistent with the overall bear steepener that’s been occurring in the bond market.

Since TFLO’s yield has dropped well below the 5% benchmark, it’s no longer appropriate to carry an 85% allocation to it within this portfolio. One option I did consider here was the Invesco Variable Rate Investment Grade ETF (VRIG). It’s got the near-zero duration, splits its portfolio relatively evenly between government, corporate & securitized issues and has 85-90% of assets in the AAA-A credit ratings. But it’s about 80% more volatile than FLOT and its Treasury position overlaps that of TFLO.

So we stick with what we have!

That brings us to the updated allocation for the portfolio.

The 85/10 split between TFLO and FLOT moves to 45/50. Obviously, the shift from Treasury bills to floating rate corporates will add a degree of risk, but not so significantly that it substantially alters the profile.

The standard deviation of returns for the portfolio climbs from 0.7% to 1.2%, which puts it roughly on par with the volatility level of a 12-month Treasury bill.

The max drawdown, historically at least, goes from 0.5% with the old allocation to 2.2%. That might become a more important consideration in the future if rates begin to rise again if inflation becomes a bigger threat.

Final Thoughts

This may be just the first of many revisions to this model portfolio.

If the Fed makes three more rate cuts over the next 12-14 months, it will be difficult to achieve a 5% fixed income yield without significantly ramping up the risk. Then we’d probably need to minimally start considering intermediate-term durations, heavier allocations to the BBB-rated tier and maybe even things, such as CLOs and senior loans. This may be as low risk as it gets for a while.

For the time being, however, the 5% yield is still achievable without taking on major risk. The pivot from Treasuries to corporates is a minor step today, but it may turn into a bigger step in the near future.