Cash Allocation 5 Years Before Starting Social Security

[RoadRunner7]

I’ve heard varying opinions on how to create a Cash and asset allocation that works for early retirement, so I would like your opinion.

Here is my example:

Early Retirement 5 years before starting Social Security etc. With all expenses, plus some fun money and including health care, will need 80k per year over these 5 years.

Would you keep 5 year’s worth of 80 x 5 = 400k in high interest Money Markets, CD’s and short term bond funds since this will most likely all be used up in this 5 year window?

Or would you just put away 5 year’s worth of your estimated Social Security in short term accounts and take out what you need yearly from your investment portfolio, with say an extra 2 - 3 years of Cash in CD’s and High Interest money market accounts in case of a market down turn that will always be there?


Our any other thoughts that I'm missing.


Thanks for your feedback

[FI_RElater]

Quote:

Originally Posted by RoadRunner7 I’ve heard varying opinions on how to create a Cash and asset allocation that works for early retirement, so I would like your opinion. Here is my example: Early Retirement 5 years before starting Social Security etc. With all expenses, plus some fun money and including health care, will need 80k per year over these 5 years. Would you keep 5 year’s worth of 80 x 5 = 400k in high interest Money Markets, CD’s and short term bond funds since this will most likely all be used up in this 5 year window? Or would you just put away 5 year’s worth of your estimated Social Security in short term accounts and take out what you need yearly from your investment portfolio, with say an extra 2 - 3 years of Cash in CD’s and High Interest money market accounts in case of a market down turn that will always be there? Our any other thoughts that I'm missing. Thanks for your feedback

If you have no other source of income, then I would use CD ladder, Treasuries (right now better in short term), and money market....and not use bond funds as they can loose money in the short term (and have done so recently, although ultrashort funds shouldn’t). You need the funds to have ironclad stability, don’t want them to drop (SWAN). Doing this means that the short term moves of the market have less influence on your ability to flourish in the shorter term to SS.


while we also have a pension, we have a rolling CD ladder (up to three years, beyond doesn’t give enough extra returns for the risk, so years 4/5 get added to these and are reinvested in another upon maturity so as to reach the intended timeframe) also have treasuries for short term (better short term rates and no state tax) with only a small part in money market.
we’ve only pulled less than 2% (less than 1% this year) and are doing Roth conversions so need extra cash in taxable for paying taxes on conversions.
(as a fallback if the markets drop precipitously, I can always start SS earlier than originally planned).

[RoadRunner7]

Thanks

[COcheesehead]

I am two years out from FIRE when I will be 57 and I have about 4 years worth of my retirement budget (all inclusive of expenses and fun money) in an investment grade muni bond ladder in my taxable account. I will probably have 6+ years of funds in the ladder when I retire.
Very little cash since the bonds mature frequently. I am not a fan of bond funds so I do not use them. They are not as predictable or precise as individual bonds.

[mickeyd]

There is nothing like a huge load of cash sitting in a MMF. The flexibility and options that it gives you is irreplaceable.

[Cut-Throat]

Quote:

Originally Posted by RoadRunner7 Or would you just put away 5 year’s worth of your estimated Social Security in short term accounts and take out what you need yearly from your investment portfolio, with say an extra 2 - 3 years of Cash in CD’s and High Interest money market accounts in case of a market down turn that will always be there? Our any other thoughts that I'm missing. Thanks for your feedback

What I did was pull out some funds from my Investments that would fund the equivalent amount of estimated Social Security and put it in a Money Market Fund. For myself this was 8 years worth.. From Age 62 to Age 70 (the age I will delay S.S. to) ... I am 67 currently.



The rest of my income needs were met by my Withdrawal Method of VPW, which I continue to use today. When S.S. kicks in 3 years from now, my 'S.S. Savings Account' will be depleted... The VPW of my Investment Accounts will continue...

[big-papa]

There's an alternative view embedded in a recent bogleheads thread.
Warning - if you're not into spreadsheet math and NPV calculations, this probably isn't for you.

It's not a new idea, but the thought is to consider your portfolio to be the actual portfolio you have today + the NPV of all future income streams (SS, Pension, part time work, a one time inheritance, cash from a house-downsizing that isn't used to buy another house, big wedding for your kid you will pay for, etc.). You must recalculate this each year and any withdrawal math is done on the portfolio + NPV amount.

If using something like VPW, it generally results in higher withdrawals earlier on tends to smooth things out over time without the big jump that might happen when SS starts. Now the main posters on this thread considered only a fixed AA in their examples. Because during the bridging time you are withdrawing more from your portfolio than you would have otherwise, there are some flags they put in the example spreadsheet where you could monitor the trajectory of your actual portfolio value to give you some notice if it looks like it might be prematurely depleted before SS kicks in.

https://www.bogleheads.org/forum/viewtopic.php?t=263790

Big-Papa

[pb4uski]

I chose not to pre-fund SS in my asset allocation. I retired at 56 and had 10 years to go to my FRA at 66... the SS gap would have represented 23% of our portfolio at retirement and that much cash would have been a drag on portfolio returns.

The only thing that I did was to establish a cash component to our portfolio where we had none before... went from 60/40/0 just before retirement to 60/35/5 in retirment. The 5 in cash is in an online savings account that earns about 2% currently.

I have an automatic transfer from the online savings account to our local credit union account that I use to pay our bills... my monthly "paycheck"... once I rebalance, the cash is sufficient to provide 24 months worth of monthly "paychecks".

If one wanted to fund the SS gap, I think the best way to go would be a CD ladder.

[VanWinkle]

Quote:

Originally Posted by pb4uski I chose not to pre-fund SS in my asset allocation. I retired at 56 and had 10 years to go to my FRA at 66... the SS gap would have represented 23% of our portfolio at retirement and that much cash would have been a drag on portfolio returns. The only thing that I did was to establish a cash component to our portfolio where we had none before... went from 60/40/0 just before retirement to 60/35/5 in retirment. The 5 in cash is in an online savings account that earns about 2% currently. I have an automatic transfer from the online savings account to our local credit union account that I use to pay our bills... my monthly "paycheck"... once I rebalance, the cash is sufficient to provide 24 months worth of monthly "paychecks". If one wanted to fund the SS gap, I think the best way to go would be a CD ladder.

I use the same plan as you pb except I split the 5% between 2.07% high yield checking and Vanguard Federal MM fund. I also agree a cd ladder would work best if you decide to dedicate a larger sum to the pre SS years.

[audreyh1]

When we retired SS was so far out we didn’t really count it, so never pre-funded or anything. Now even waiting until 70 it won’t be a large part of our income at all, so just living off (withdrawing from) our investments in an AA and SS will just be an increase in annual income - most of it going to pay for Medicare and additional taxes.

[jollystomper]

Quote:

Originally Posted by RoadRunner7 Would you keep 5 year’s worth of 80 x 5 = 400k in high interest Money Markets, CD’s and short term bond funds since this will most likely all be used up in this 5 year window?

This is exactly the approach we took. I know it will impact my overall portfolio returns, but I am willing to make the tradeoff for the the "sleep well at night factor regardless" factor.

Based on our planned living expenses we estimated the amount we would need beyond our pension to support our desired lifestyle. I am 60 so went it with between 6-7 years of that amount, based on taking SS as late as my FRA. The money is currently earning between 2% and 2.23% in a few high yield savings and money market accounts. I will probably start looking more closely at CDs for some of this in January.


However, I am going to be flexible with this and monitor our progress. If it turns out we overestimated our needs (which six months into retirement appears to be the case), I may cut down on the amount in cash and put some of it into equities. Also, I am looking at withdrawals from my 401K before age 70 to avoid massive RMDs, and that might also cause me to put more of the cash back into equities, based on our desired AA.

It is not the most optimal approach to maximize returns... but one we can live with.

[RoadRunner7]

I've been studying the VPW method over at Bogleheads and downloaded the spreadsheet. It seems to make sense for us. So could one just factor in the S.S. needed over the next 5 years and just use the VPW withdrawal method starting these first 5 years before reaching the point where we start S.S.


In other words, we need 80k per year. 40k is the S.S. estimate.
Take out 40k x 5 = 200k and just withdraw the rest based on the percentage on the VPW Spreadsheet. (Which actually would be much more than 80k per year)


Would you keep 3 years in Cash as safety Cash?


Thanks Again for all your great insight (still learning)

[RoadRunner7]

Quote:

Originally Posted by Cut-Throat That is exactly what I did.... Starting at age 62, I set aside 8 years of S.S. (since I was dealying to age 70) in a High Interest Savings Account and then made my VPW Withdrawals from the resulting balance of the portfolio...... Great piece of mind. Since I worked with the developer of VPW, I was able to make suggestions on the design of the VPW tool, such as backtesting against Stock and Bond Markets, Inflation Adjustments etc.

Thanks...Would you suggest having some Cash to help out in market downturns to add in when needed? I was thinking 3 years would be a good safe number, but hey I'm still learning. So 40 x 3 = 120k as safe Cash.

[RunningBum]

As Big Papa said in post 7, you could calculate a NPV of SS, and include that in your VPW spreadsheet. Either use formulas or just look at what an annuity would cost you to provide the same income starting in the future. It's the simplest way I came up with. It also works whenever you take SS between 62 and 70, so you don't have to start SS at 62 just because you only set aside that much cash. You can choose to take 62 if it makes sense for your situation, or delay, and continue to use a NPV for SS. I factor in a 25% cut to SS in case it happens.

[Cut-Throat]

Quote:

Originally Posted by RoadRunner7 Thanks...Would you suggest having some Cash to help out in market downturns to add in when needed? I was thinking 3 years would be a good safe number, but hey I'm still learning. So 40 x 3 = 120k as safe Cash.

Well, VPW reacts to 'Market Downturns', you pull out less from the Market during down years and more during up years....


But, if you are worried about a Market Downturn.... Chances are you probably have too high of an Allocation towards stocks.. My Allocation is 30% Stocks/70% Bonds, so my portfolio is not that volatile... The only Cash I have is from my Annual VPW Withdrawal, which I keep in a Spending Account..


So, if you Backtest your portfolio against Market History using the VPW tool, and you see that your VPW amount cannot meet expenses in Market History Withdrawals, then you need to alter your asset allocation towards Bonds, so that your portfolio won't be as Volatile.

[big-papa]

Quote:

Originally Posted by RoadRunner7 I've been studying the VPW method over at Bogleheads and downloaded the spreadsheet. It seems to make sense for us. So could one just factor in the S.S. needed over the next 5 years and just use the VPW withdrawal method starting these first 5 years before reaching the point where we start S.S. In other words, we need 80k per year. 40k is the S.S. estimate. Take out 40k x 5 = 200k and just withdraw the rest based on the percentage on the VPW Spreadsheet. (Which actually would be much more than 80k per year) Would you keep 3 years in Cash as safety Cash? Thanks Again for all your great insight (still learning)

That's one way to do it, but you'd need to make sure that the $200K is roughly keeping up with inflation since that's what SS will do. You are creating a bridge of cash that it set aside.

The alternative is to do what I posted in post #7 which is to calculate the value from which you are withdrawing as being the current value of your portfolio + the NPV of future SS payments. Call that value PortfolioPrime. Calculate the withdrawal $ amount from your portfolio using the value of PortfolioPrime with VPW. Each year recalculate the NPV of future SS payments and again add that to your actual portfolio to create a new PortfolioPrime value. Withdraw as prescribed by VPW. Rinse & Repeat.

Everybody is different on holding Cash as safety. I personally won't do it because between what would be sitting in my checking account at any given time, credit cards and the couple of days it takes to sell some shares of any mutual fund I have, I think I'm covered for just about anything and would prefer to have the opportunity for that money to grow over time.

[big-papa]

Quote:

Originally Posted by Cut-Throat Well, VPW reacts to 'Market Downturns', you pull out less from the Market during down years and more during up years.... But, if you are worried about a Market Downturn.... Chances are you probably have too high of an Allocation towards stocks.. My Allocation is 30% Stocks/70% Bonds, so my portfolio is not that volatile... The only Cash I have is from my Annual VPW Withdrawal, which I keep in a Spending Account.. So, if you Backtest your portfolio against Market History using the VPW tool, and you see that your VPW amount cannot meet expenses in Market History Withdrawals, then you need to alter your asset allocation towards Bonds, so that your portfolio won't be as Volatile.

Doing that will definitely reduce the volatility of nominal withdrawals, but it may not help as much when accounting for inflation. Depends on what constitutes the bond portion of the portfolio and how it might react to inflation.

[Cut-Throat]

Quote:

Originally Posted by big-papa Doing that will definitely reduce the volatility of nominal withdrawals, but it may not help as much when accounting for inflation. Depends on what constitutes the bond portion of the portfolio and how it might react to inflation.

VPW Back Testing will account for inflation also.... Just run the Backtest and if you don't like the result, change the portfolio asset allocation and/or increase the portfolio value (i.e. You didn't have enough money to retire) -- If you don't have enough money to retire and are depending on robust stock returns that are not affected by inflation, such as the 1970's, don't quit your day job.

[big-papa]

Quote:

Originally Posted by Cut-Throat VPW Back Testing will account for inflation also.... Just run the Backtest and if you don't like the result, change the portfolio asset allocation and/or increase the portfolio value (i.e. You didn't have enough money to retire) -- If you don't have enough money to retire and are depending on robust stock returns that are not affected by inflation, such as the 1970's, don't quit your day job.

I guess it's because once I figured out what VPW actually is, I decided to write my own, which lets me add my own assets like a Pseudo-TIPs series to help with an early 1970's situation, since the original VPW is pretty limited. And once you go there, you can do other things that the original author doesn't really care for.

[Cut-Throat]

Quote:

Originally Posted by big-papa I guess it's because once I figured out what VPW actually is, I decided to write my own, which lets me add my own assets like a Pseudo-TIPs series to help with an early 1970's situation, since the original VPW is pretty limited. And once you go there, you can do other things that the original author doesn't really care for.

Good for you! ..... I have enough 'cushion' in my portfolio that VPW is not limiting for myself in the Least... Again, for me personally, I would not have retired unless I had a lot discretionary income to overcome the nuances of various Bonds..


ETA: -- BTW, I worked with the Author during the early design phase of the VPW Tool.... He always took my suggestions and others when they fell within the boundaries he outlined in the initial Objectives. --- He's a very smart guy and if he did not 'care for' your suggestions, I am quite positive he had a Very good Reason for it. He is one of the most tolerant and flexible people I have met via the Forums.


Whenever I witnessed his refusal to adopt a suggestion or feature, it usually was someone that was trying to turn VPW into a 'complete retirement planner' or a 'Portfolio Manager' --- He only wanted VPW to address the 'Withdrawal Method'.....