Cash cushion and Asset Allocation

[walkinwood]

Hello,

I hear a lot of people on the board say that they have a cash cushion of x number of years spending. The purpose being to draw down on the cushion instead of selling equities in down years.

I have a question for those who use a cash cushion. Is that cash considered part of your asset allocation? Or do treat it separately.

To be clear, let me give an example. If you have $1M, a cash cushion of 100K, 450K in bonds and 450K in equities, would you say you have an asset allocation of 50/50 (equities/bonds) or would you say 45/55 (Equities/Bonds+cash)?

Thanks.

 

[REWahoo]

The cash cushion/bucket should be considered part of your asset allocation as in your second example above: 45/55.

 

[bbbamI]

What REWahoo said.

 

[audreyh1]

I keep them separate. I don't care how things "should" be - this system works better for me.

I have 2 to 3 years (can drop to 1 year if needed) cash cushion in a separate account from my retirement portfolio. I refer to this as my "short term funds".

I also have cash in my retirement portfolio, but this cash is there for rebalancing and overall asset allocation and paying portfolio taxes, NOT for my short term cash needs.

For me, keeping them independent works better psychologically. I can view severe market fluctuations with equanimity, and rebalance my portfolio during bear markets because I know that none of these actions affect my short term available funds and that by the time I need to replenish my short term funds in a year or two, things will have likely recovered somewhat. Also, when I rebalance the portfolio I pay no attention to my short term funds account.

The "short term funds" cash cushion actually started out as a special "travel fund" for the first couple of years of retirement, but this happened to coincide with the 2000-2002 bear market, and having this cash cushion helped so much psychologically that I made it a permanent part of my strategy. It makes it so much easier to enjoy the present no matter what insanity the markets are going through.

Audrey

 

[REWahoo]

I keep them separate. I don't care how things "should" be - this system works better for me.

Heck, if I were homeless I might feel the same way.

 

[2B]

I treat my cash/fixed income as part of my normal asset allocation. This is 40% of my total assets. Depending on my spending pattern this could last 20 years or 7. Obviously, a 7 year spending pattern would only continue if equity gains were available to routinely rebalance and replenish the money spent. Poor equity returns would cause spending to drop (less for traveling and extras) and gear spending for the 20 year model.

Cash is never to be moved into equities in a declining market. I'm sure this creates a rip in the space time continuom inherent in FIRECalc's assumptions but I've decided that it is better to be safe than very, very sorry later.

Cash and fixed income investments are always very conservative to "guarantee" it being there when needed. I only use US government backed securities which might include CDs, Tbond or TIPS. I don't do mutual funds due to principle drift.

 

[Alan]

My cash cushion is part of my overall allocation. I am currently 40/50/10 (Stocks/Bonds/Cash) And I have ~5 years of cushion in that 10%.

And it also is counted in the overall portfolio performance

 

[rs0460a]

Here's what I do....

In my/DW's simple 60/40 portfolio, my "cash bucket" is a portion of the 40%. Since I'm retired, but "pre-SS", that 40% has a larger amount of cash (held in short term - e.g. MM funds).

When I start drawing SS, that 40% (if I keep 60/40) will contain less cash/more "bond type" holdings.

Anyway, that's my "scheme"...

- Ron

 

[d]

what Audrey said (except for the travel funds part) , though she said it better than i could

 

[bigla]

I am with Audrey. I keep it separate from my overall allocation - just works better for me.
Larry

 

[Bikerdude]

Considering my current total balance of funds I'm 50/35/15. Cash includes MM, CD's and I-bonds. With interest and dividends paid to cash I could go 17 years without selling (bonds and equities) anything.

 

[friar1610]

My default AA is 47.5% stocks; 47.5% fixed income and 5% cash.

I say "fixed income" vs. "bonds" because nobody has yet convinced me that CD's are really any different than bonds (for those of us who want to hold them to maturity.) So, I consider my CD holdings to be "fixed income" vs. "cash".

That said, within my 47.5% fixed income I have a mix of the following:
- mutual funds invested strictly in Vanguard Total Bond Market Index. Most of this money is inside of tax-advantaged Rollover IRA's, but there's a wee bit in taxable funds.
- a few TIPS (the bonds themselves, not funds) inside of tax-advantaged retirement funds.
- a chunk of I-Bonds which I was fortunate enough to buy back when they paid 3.5%+ an inflation adjustment. By definition, they are after-tax holdings (although you don't pay tax until you redeem them.)
- a couple of Treasuries outside of tax-advantaged accounts.
- a 5 year ladder of CD's paying various rates of interest.

All of the "cash" is in either:
- Vanguard Prime MMF or
- Credit Union Money Market Accounts.

I won't go longer than 5 years for either CDs or Treasuries. The bond fund is an intermediate which close to that.

If anyone has a persuasive argument as to why I shouldn't consider CD's to be equivalent to bonds, I'd be happy to hear from them.

 

[Gardnr]

Hello,

I hear a lot of people on the board say that they have a cash cushion of x number of years spending. The purpose being to draw down on the cushion instead of selling equities in down years.

I have a question for those who use a cash cushion. Is that cash considered part of your asset allocation? Or do treat it separately.

To be clear, let me give an example. If you have $1M, a cash cushion of 100K, 450K in bonds and 450K in equities, would you say you have an asset allocation of 50/50 (equities/bonds) or would you say 45/55 (Equities/Bonds+cash)?

Thanks.

When I RE I plan to use the Buckets of Money strategy which gives the cash cushion you refer to. That "cash" will be part of my asset allocation.

To me the beauty of this strategy is that it guides you to the asset allocation that you want to hold. Normally it will give you anywhere from a 60/40 stocks/FI to a 70/30 if you're more aggressive and hold fewer years of "cash cushion." That just happens to coincide with the suggested AA per Bernstein (60/40) and others.

I really like this because it gives me some more rationale for the AA and doesn't feel so arbitrary.

One thing I'm still debating is whether to keep separate a lump of cash I'll call my Emergency Fund; somewhere around 15-20K.

Many ways to skin this cat.

 

[Gardnr]

If anyone has a persuasive argument as to why I shouldn't consider CD's to be equivalent to bonds, I'd be happy to hear from them.

Nope, I agree. Essentially the same, as long as we're not talking about junk bonds, or even higher quality corporates, I suppose.

 

[Alan]

If anyone has a persuasive argument as to why I shouldn't consider CD's to be equivalent to bonds, I'd be happy to hear from them.

I'd say they were very similar but you have credit risk with bonds (loaner could default) and CD's are insured by the FDIC.

 

[audreyh1]

LOL! I may BE homeless, but I don't FEEL homeless. Oh wait - I'm houseless, not homeless. My home just happens to have wheels and usually I have to rent a spot to park it - at least for overnight.

Tonight I'm sitting here watching the crazy financial unwinding happening on CNBC and speculating on a potentially VERY nasty panicky market for at least a couple of days. Oh wait - I got cash to carry me through 2010! Ahhhh - nice feeling! If the markets tanks another 15 to 20% in the next 6 months, I can just rebalance the portfolio again and otherwise not worry about the portfolio until 2010.

Audrey

 

[REWahoo]

Oh wait - I got cash to carry me through 2010!

Yep, tonight the important thing isn't whether you are homeless or houseless. What you don't want to be is cashless...

 

[youbet]

My cash cushion is part of my overall allocation. I am currently 40/50/10 (Stocks/Bonds/Cash) And I have ~5 years of cushion in that 10%.

And it also is counted in the overall portfolio performance

This implies you currently have 50 years of expenses in your portfolio assuming your portfolio keeps up with inflation. Yet, you're still working. I assume there's some reward for this such as medical benefits or pension.

100% agree with counting all cash in calculating overall portfolio performance. Otherwise, you're just fooling yourself.

 

[youbet]

For me, keeping them independent works better psychologically.

You and I have arm wrestled this subject before but I completely agree with your view when you state it this way. My three years of cash is handled as part of my total portfolio yet it gives me exactly the benefits your cash gives you. Why? Because it's how I'm comfortable pushing the numbers around.......one spreadsheet...... and in the end, cash is cash. Whether one thinks of their total portfolio as an aggregation of two or more separate buckets or as one big bucket with subdivisions called allocations, it's all the same.

 

[audreyh1]

I honestly don't think I could rebalance my investment portfolio if I included my short term fund. It would wreak havoc on my spreadsheet. The short term fund fluctuates too much during the drawdown.

My investment portfolio allocation target is 7% cash, 35% short-term to med-term bonds, and 58% equities. The role of the cash in the portfolio is to rebalance against bonds and equities. Of course, it also gives me additional cushion against prolonged losses in the other asset classes above and beyond my short-term funds, but is that is not the primary role.

Audrey

 

[youbet]

I honestly don't think I could rebalance my investment portfolio if I included my short term fund. It would wreak havoc on my spreadsheet. The short term fund fluctuates too much during the drawdown.

My investment portfolio allocation target is 7% cash, 35% short-term to med-term bonds, and 58% equities. The role of the cash in the portfolio is to rebalance against bonds and equities. Of course, it also gives me additional cushion against prolonged losses in the other asset classes above and beyond my short-term funds, but is that is not the primary role.

Audrey

Audrey,

If that pov of your portfolio works for you, fantastic! It's all about what you're comfortable and successful with.

My current AA is about 52/44/4. Despite withdrawals for living expenses, the cash allocation tends to slowly grow since interest + dividends exceeds cash withdrawals. I'm not seeing the fluctuation in cash that you mentioned you see from drawdowns. In fact, compared to the fluctuations in the equity portion this past year, fluctuations in the cash portion, even considering drawdown, are nothing.

I also don't think I'm as methodical in rebalancing as you are. I have a target that I'm, for better or for worse, comfortable with. I tweak from time to time to keep things in the ballpark of the target. That's it.

BTW, I'm exaggerating when I say ALL our assets are included in my one portfolio view of things....... DW, bless her heart, takes care of the day to day household expenses and has typically 3 or 4 months cash in the checkbook for that purpose. Every once in a while she gives me a little kick in the butt and I ET some money from the brokerage account to that checking acct. We have a rough budget so these little reminders aren't actually a surprise.

 

[dex]

I look at it similarly to Audrey - IRAs (no cash) and Taxable accounts.

How do people compute their cash needs?
1. Total Cash Needs - Estimated Dividends = net cash needed
2 Dividends re invested and not used to determine cash balance required

Currently, I have 2+ years of est. cash needs in a MM acct.

I will use #1 in the future - when I begin to receive SS @62

 

[Nords]

I have a question for those who use a cash cushion. Is that cash considered part of your asset allocation? Or do treat it separately.

We keep two years' expenses in cash-- a year in a money market and another year in a CD ladder that we run out as far as we can. (A five-year ladder would be great but the yield curve is more like three years right now.) Two years' expenses works out to... eight percent. So our ER portfolio is 92% equities and 8% cash.

We've been moving out of mutual funds for the last few years and taking the cash from that. Now we'll keep selling off individual stocks to replenish the money market. In a few years we'll have to start selling off ETF shares to replenish it. In a prolonged bear market we'd spend the maturing CDs, then break the rest of the CDs, and finally start moving into the equities.

We've left the ETF dividends to reinvest (which Fidelity does at no charge). Maybe a decade or so down the road we'll be able to just live off the dividends-- especially as empty nesters-- but for now the reinvesting is working fine.

 

[Rich_by_the_Bay]

A side note: some people consider short term federal bonds to be "near cash" depending on the context. I have about 6 years in cash but maybe a third of that is in such short term federal bonds (Vgd short term federal). For me, the real but very slight risk is worth the extra yield compared to MMF and CDs.

 

[youbet]

Agreed Rich. And taking that farther....... there is a grey area between true cash and true fixed investments in this context. For example, if you have several years of so-called "cash" set aside, I'd think of a CD that matures within a few months as being "as good as cash." Not only will it mature before you need it, it's also available as cash for a modest penalty.

Folks keeping several years of "cash" in a MM at 2.5% or so are really paying dearly in opportunity costs......