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AA and cash reserves
Old 10-29-2018, 09:38 PM   #1
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AA and cash reserves

I'm curious--I've been reading about methods to mitigate SOR risk and one of the methods cited seems to be to keep 3 yrs expenses in cash. Makes a ton of sense until I realized that using the proverbial 25x expenses, this is ~12% cash. Even more if you ER and are waiting for SS to kick in and cover some of those expenses. This seems like a big chunk of a portfolio sitting in cash with respect to asset allocation.

I'm sure I'm missing something basic... Is this actually in bonds vs cash? Are people just using minimal SHTF expenses to keep in cash?
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Old 10-29-2018, 09:51 PM   #2
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"Cash" should be considered part of your Fixed Income allocation. If you decide on 60/40, and have 3 years cash (e.g., 12%) then you are 60% equity, 28% bonds, 12% cash.

But cash drag is real - historical studies generally use bonds which out-perform cash in the long run.
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Old 10-29-2018, 09:53 PM   #3
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A 60/40 portfolio has 10 years of expenses in bonds @ 4% WR. That's as complicated as I am planning to get.
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Old 10-29-2018, 09:56 PM   #4
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Originally Posted by tb001 View Post
I'm curious--I've been reading about methods to mitigate SOR risk and one of the methods cited seems to be to keep 3 yrs expenses in cash. Makes a ton of sense until I realized that using the proverbial 25x expenses, this is ~12% cash. Even more if you ER and are waiting for SS to kick in and cover some of those expenses. This seems like a big chunk of a portfolio sitting in cash with respect to asset allocation.

I'm sure I'm missing something basic... Is this actually in bonds vs cash? Are people just using minimal SHTF expenses to keep in cash?
Everyone is different depending on other income sources.

I keep one year is my rewards checking(2.07%)
I keep one year in my Vanguard Money Market (2.05%)
I keep 10 years in bonds
I keep the rest in US and Foreign Index stock funds.

I am retired for a little over 2 years and will not draw SS until 01-2021.

I do what lets me sleep at night.

VW
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Old 10-29-2018, 09:59 PM   #5
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But cash drag is real - historical studies generally use bonds which out-perform cash in the long run.
This is exactly my concern. It mitigates SOR risk, but when we run the numbers, the cycles that fail are all those that started in the 60s--very illuminating. Trying to figure out a happy medium.
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Old 10-29-2018, 11:24 PM   #6
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12% “cash” is reasonable if you are getting >2% using high yield CDs or short term bonds. Not hard to do right now and it makes me more comfortable keeping 70% in equities.
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Old 10-30-2018, 06:37 AM   #7
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I use the lower rungs on my bond ladder as “cash” knowing that in 3,6,9,12,24 etc, months I will have maturing bonds at x amount. It keeps the cash flowing and the yield above a typical “cash” account.
I keep just enough cash in checking to pay one month’s expenses, plus a small buffer.
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Old 10-30-2018, 07:30 AM   #8
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Don't forget about dividends. If your WR is 4%, and the portfolio produces 2% dividends, then you only need cash to cover the 2% gap. At 25X, you'd need a 6% cash allocation to cover 3 years of spending not covered by dividends.
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Old 10-30-2018, 07:59 AM   #9
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I use the lower rungs on my bond ladder as “cash” knowing that in 3,6,9,12,24 etc, months I will have maturing bonds at x amount. It keeps the cash flowing and the yield above a typical “cash” account.
I keep just enough cash in checking to pay one month’s expenses, plus a small buffer.
I don't have a bond ladder, but I have a steady income stream from monthly and quarterly dividends originating from my bond and stock funds.

Like you, I keep just enough cash in my local bank's checking account to pay my expenses while keeping a small buffer in case I have some small, unforeseen expenses.

When I have excess dividends from the mutual funds beyond the desired buffer, I invest it somewhere because I hate the idea of having any sizable amount of money earning zilch. Sometimes, I have to carry forward excess dividends a few months to cover larger, lumpier expenses. But that's standard operating procedure to pay my bills.
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Old 10-30-2018, 08:55 AM   #10
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A 60/40 portfolio has 10 years of expenses in bonds @ 4% WR. That's as complicated as I am planning to get.
It's even better than that. You'll be getting dividends from both stocks and fixed side, probably ~ 2.5% average? So even at 4% WR (and if you are worried about SOR risk, you'll likely be more conservative than that), you are really only drawing 1.5% from the portfolio on average. If you take that from fixed, it's more like 27 years before you need to sell off stocks!

That's an oversimplification, because the portfolio and div payout changes with time and withdraws, but it should get the basic point across. I guess it would be interesting to actually map that out with some of the 'killer' retirements years (1966?).

No need for a cash buffer, IMO, other than for smooth cash flow to pay bills.

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..... But cash drag is real ....
+1

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Old 10-30-2018, 08:56 AM   #11
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Big fan of cash here. Brokered CDs are paying decent rates (3% for 2-yr, 3.2% 3-yr). Occasional specials (recent NASA FCU) are even above that.

For us, it's our "sleep well at night" strategy as that cash generates a fair amount of monthly income. I still have ~30% of our Portfolio in equities and that causes me enough pain to not sleep well at night when we've had falling equity prices like we have pretty much all month.

I'm sure I'm in the extreme minority here, but we're essentially 30/10/60. And that's just fine by me with no W-2 income coming in after this year for either of us. (Note bonds are intentionally low given the rising rate environment we're in..even our favorite PIMCO funds and VBTLX are not doing great this year, not unexpectedly and VBTLX has done an anemic 1.85% average return over the last 5. No thanks).

I do realize the impact of inflation and have that modeled in our plan, but frankly don't have enough years left on the planet for it to matter. We'll still be "fine" and the 30% equity bucket provides some growth for out years.
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Old 10-30-2018, 09:16 AM   #12
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.... I still have ~30% of our Portfolio in equities and that causes me enough pain to not sleep well at night when we've had falling equity prices like we have pretty much all month.

I'm sure I'm in the extreme minority here, but we're essentially 30/10/60. ....

I do realize the impact of inflation and have that modeled in our plan, but frankly don't have enough years left on the planet for it to matter. We'll still be "fine" and the 30% equity bucket provides some growth for out years.
That's fine if you are still on the 100% success path that I saw in your first post.

But I would like to point out to others, that getting equities down to 30% in a 30 year portfolio has historically been less safe than a portfolio with a higher equity balance.

That can be countered with a larger portfolio (lower WR).

-ERD50
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Old 10-30-2018, 09:24 AM   #13
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That's fine if you are still on the 100% success path that I saw in your first post.

But I would like to point out to others, that getting equities down to 30% in a 30 year portfolio has historically been less safe than a portfolio with a higher equity balance.

That can be countered with a larger portfolio (lower WR).

-ERD50
All depends on your expenses and how you are covering them. With a Liability Matching approach, taking added risk with larger equity % is not needed and becomes upside.

I'm not looking to "leave a legacy" or leave $$ to family. First priority is capital preservation and paying the bills. I've mapped it out till we're 90+ and am good with 30%. If the market does crater to a point equities become cheap, I may wade in further and do another 10% or so..but even at 30% the October 18 drop is enough to prove to myself that even those levels is more than I'm entirely comfortable with.

With as much as I've stressed OUT the past month I can only imagine those people near or in retirement with 70, 80 or even higher percentage equities. Whatever works for you, but that wouldn't be us..I'd be likely to jump off a bridge if we were that exposed..and the "it always comes back" while true depends on your timeframe and how much longer on the planet you have left. We're getting to the point where we may not have enough runway to recover from a deep and protracted bear market..
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Old 10-30-2018, 09:30 AM   #14
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Thanks all, for the input. I hadn’t appreciated the dividends aspect, which certainly lowers the need significantly, though I assume those can get hefty cuts in a bad market. Also with CDs and savings rates climbing higher, this helps as well.

And RetireSoon, I get it. I’ve always been a big fan of cash until I actually ran the numbers and realized that historically, that was a much less conservative option. It’s counterintuitive, but the data support higher equity allocation...as long as you don’t panic I suppose! Know thyself...

Eta, RS, we cross posted, but looks like we’re thibkibg along the same lines
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Old 10-30-2018, 11:46 AM   #15
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All depends on your expenses and how you are covering them. With a Liability Matching approach, taking added risk with larger equity % is not needed and becomes upside.

I'm not looking to "leave a legacy" or leave $$ to family. First priority is capital preservation and paying the bills. I've mapped it out till we're 90+ and am good with 30%. If the market does crater to a point equities become cheap, I may wade in further and do another 10% or so..but even at 30% the October 18 drop is enough to prove to myself that even those levels is more than I'm entirely comfortable with.

With as much as I've stressed OUT the past month I can only imagine those people near or in retirement with 70, 80 or even higher percentage equities. Whatever works for you, but that wouldn't be us..I'd be likely to jump off a bridge if we were that exposed..and the "it always comes back" while true depends on your timeframe and how much longer on the planet you have left. We're getting to the point where we may not have enough runway to recover from a deep and protracted bear market..
Portfolios that are heavy in fixed income have only traded risk, not avoided it - inflation risk for market volatility. Inflation erodes value permanently. Equities have always recovered.

My AA is just about 62% equities and I am not nervous at all. I have barely even looked at it. Market volatility is expected; it will recover. Retired 5 years now.
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Old 10-30-2018, 12:07 PM   #16
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No need for a cash buffer, IMO, other than for smooth cash flow to pay bills.

-ERD50
Agreed. A prudent, well diversified FIRE portfolio really doesn't need a significant cash buffer to avoid selling beaten down equities in a SHTF market. Just going back to the recent Great Recession, I was 2 years into FIRE and had not started SS or pension, yet never sold a beaten down equity to get cash for expenses. As you said, div + int + maturing bonds + a little bond fund selling got us through in fine shape. We went into the period with a typical 60/40 AA dominated by index funds on the equity side and a blend of individual bonds and actively managed funds on the fixed side.

Note: I'm talking spending cash here as opposed to trading cash.
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Old 10-30-2018, 12:12 PM   #17
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Portfolios that are heavy in fixed income have only traded risk, not avoided it - inflation risk for market volatility. Inflation erodes value permanently. Equities have always recovered.
Exactly! Folks sometimes fail to take note that the worse FireCalc failures are not from the Great Depression or other equity crashes but rather from periods that started with high inflation. As you correctly point out, equities have so far always recovered. Inflation, so far, has never recovered.
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Old 10-30-2018, 12:20 PM   #18
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I use the lower rungs on my bond ladder as “cash” knowing that in 3,6,9,12,24 etc, months I will have maturing bonds at x amount. It keeps the cash flowing and the yield above a typical “cash” account.
I keep just enough cash in checking to pay one month’s expenses, plus a small buffer.


Hmmm. I use the higher rungs (e.g. >2yrs)on my CD ladder as “Bonds”.
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Old 10-30-2018, 12:27 PM   #19
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I note that semantics and the meaning of "cash" is having a huge impact on this discussion. For example, the approx 40% fixed portion of my portfolio contains some instruments which others are calling "cash."

My point is that there is a difference between holding several years of expenses in true cash (pass book, checking account, back of the sock drawer, etc.) and holding CD's, short maturity bonds, low duration bond funds, etc.

I suspect some of the folks who say they are holding a lot of cash aren't holding any more than some of the folks who say they aren't but have diversified portfolios with a significant fixed component, say 40%. For example, I feel I hold very little cash. Yet, I have some CD's, a hefty TIP bond about to come due and a short duration tax-free bond fund.

Perhaps the lotsa cash vs. little cash folks aren't as far apart as it seems at first glance?
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Old 10-30-2018, 12:36 PM   #20
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To me, CDs are effectively "cash" - especially if laddered as that provides additional liquidity. Others treat them as bonds. YMMV.
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