How much cash to set aside if interest/dividend more than cover annual expenses?

[Prague]

Our plan is to set aside cash for three year worth of expenses to avoid selling stocks in a downturn market. We figure probability wise, three year would be sufficient in general. Our total annual expenses are about 100K but our current investments in our taxable accounts generate about 110K per year, mostly come in the form of monthly or quarterly dividend/interest. So does that mean we only need to set aside two years worth of cash to meet our goal of three year or we do not need any cash set aside since the income stream comes in on a regular basis? Knowing that in a downturn market, dividend could be cut, but our 100K/yr expense includes discretionary spending which I assume that we could cut back if needed.

I am curious how everyone does this as for most ERs, we would be relying on passive income stream to cover our expenses. Having worked our whole lives and most of our effort is spent on saving and now has more questions on spending as we plan for our retirement.

 

[jebmke]

We ditched our emergency fund decades ago - well before early retirement. My cash balance normally is < 1 month of expenses.

 

[ShokWaveRider]

We have 3 years in MM.

 

[scrabbler1]

Our plan is to set aside cash for three year worth of expenses to avoid selling stocks in a downturn market. We figure probability wise, three year would be sufficient in general. Our total annual expenses are about 100K but our current investments in our taxable accounts generate about 110K per year, mostly come in the form of monthly or quarterly dividend/interest. So does that mean we only need to set aside two years worth of cash to meet our goal of three year or we do not need any cash set aside since the income stream comes in on a regular basis? Knowing that in a downturn market, dividend could be cut, but our 100K/yr expense includes discretionary spending which I assume that we could cut back if needed.

I am curious how everyone does this as for most ERs, we would be relying on passive income stream to cover our expenses. Having worked our whole lives and most of our effort is spent on saving and now has more questions on spending as we plan for our retirement.

I use monthly and quarterly dividends to supply me with regular income streams to cover my expenses in ER. I keep very little cash in my local bank's checking account, just enough to meet minimum balance requirements (and avoid monthly fees) along with a small buffer or cushion to cover any smaller, unforeseen expenses. The checking account earns aero interest, so I don't want to keep any large amounts of money in there earning zilch. I have some other bond funds earning interest I can use as a second-tier emergency fund should a larger, unforeseen expense arise.

Most of the dividend income are monthly bond fund dividends. But some of it are quarterly dividends from a stock fund. Those are a little more volatile, but I don't count on the full amount to pay my bills. It's more of a supplement whose arrival roughly coincides with similar spikes in my expenses such as auto insurance and income taxes.

I have never had to sell the underlying stocks just to meet my expenses. The only time I have sold stocks other than for rebalancing was when I bought a new car 11 years ago (I was still working at the time, and in 2007 the market was high).

 

[Prague]

We ditched our emergency fund decades ago - well before early retirement. My cash balance normally is < 1 month of expenses.

I am curious how you would handle the situation if an unexpected expense or larger than normal expense comes up when you keep that little in cash. Do you just wait till you need to dip into selling?

 

[Prague]

@scrabbler1 - Thank you for the detailed reply! I think our situation would be the same to use monthly/quarterly dividend/interest to cover our expenses. It sounds that you never had to "dip" into selling to cover unexpected expenses except one time. Would that just be careful planning that you are doing? I guess part of our uncertainty is that I think our life styles will be different during ER years compared to the working years and it would be rather strange not coming paychecks coming in twice a month and just the passive income which we in the past just plowing back into savings/investments.

 

[scrabbler1]

@scrabbler1 - Thank you for the detailed reply! I think our situation would be the same to use monthly/quarterly dividend/interest to cover our expenses. It sounds that you never had to "dip" into selling to cover unexpected expenses except one time. Would that just be careful planning that you are doing? I guess part of our uncertainty is that I think our life styles will be different during ER years compared to the working years and it would be rather strange not coming paychecks coming in twice a month and just the passive income which we in the past just plowing back into savings/investments.

To answer your question I put in bold, I had plenty of money in the muni bond funds to pay for the car, as I kept more in them while I was working and in a bigger tax bracket. I chose to sell some shares of stock instead because it enabled me to capture some cap gains. The car purchase was somewhat unexpected because my aging car was in decent shape until some things quickly went wrong and I had to replace it a little sooner than expected.

If you expect your ER lifestyle to be quite different from when you were working (unlike me), then you might want to keep a bigger buffer or cushion in your checking account. Not sure how much bigger that would be, only you can figure that out. But keeping 2-3 years of expenses tied up along with having the steady income stream(s) might be a little extreme.

 

[SumDay]

We have 4 years in MM. We can, so we do. Helps me sleep too.

 

[COcheesehead]

I am laddering out bonds for the first 4 years of retirement, starting in January of 2021. When I started this process a year or so ago, the yields were pretty small, but now things are getting interesting. The yields on 2 and 3 year muni's are even looking good.
I have a bunch coming to maturity between now and year end that I will hunt for the best deals on. Maturities of 2023 or early seem to be the sweet spot right now.

 

[DeborahB]

i like to have 6-12 mo. expenses in cash. My COL isn’t too bad and some stocks will still kick off dividends in a downturn. I think it’s important to remember that you won’t have NO income in a bad economy. And buying opportunities will show up. A year’s money will cover unexpected expenses along with the money that will still come in.

 

[DeborahB]

I am laddering out bonds for the first 4 years of retirement, starting in January of 2021. When I started this process a year or so ago, the yields were pretty small, but now things are getting interesting. The yields on 2 and 3 year muni's are even looking good.
I have a bunch coming to maturity between now and year end that I will hunt for the best deals on. Maturities of 2023 or early seem to be the sweet spot right now.

What kind of yields are you getting? I’ve been avoiding bonds for a long time.

 

[Dtail]

We have about 4 yrs in MM/short term CD's, but that mainly is for ACA income management, not really as a sub for equities in a down market.

 

[sengsational]

I pull one year's worth of cash in December. But my AA includes a decade or more of spending in a stable value fund. I don't think 3 years is enough. It remains to be seen how aggressively I'll rebalance, but there is no way I'm selling equities in the downturn.

 

[Mr. Tightwad]

Most of you play it very safe,,,I keep 4-12 months in cash. As I accumulate to the 12 month amount, I start deciding what my next stock purchase will be. I make my purchase, go back to 4 months expenses, and repeat.

 

[kgtest]

Pay as little interest while realizing maximum gains from maximum opportunities with lowest costs possible.



For me, that's 3months living expenses in cash. But I am not FIREd yet. Even when I am, I will only keep 3months of cash in a stable value/MM account.

Of course I would re-evaluate this as needed or annually. I am not as conservative as most around here though. My DW fights me on this, I am constantly having to discuss the lost opportunities of being out of the market with her.



There are situations where I would increase my cash, like if I wanted 20% down for a rental property. I would probably try and put less down if possible though. I'm not in the business of all cash offers right now so wouldn't need too much maybe 30k total. I don't know why anyone would hold too much cash, as you are losing out to inflation in the long run.

 

[ERD50]

... Our total annual expenses are about 100K but our current investments in our taxable accounts generate about 110K per year, mostly come in the form of monthly or quarterly dividend/interest. ...

Based on that, I really see no reason for you to hold nay more cash than what you might need in your checking account for cash flow purposes, to meet your bills. I like to keep enough buffer so that an unexpected bill doesn't require action, and that I don't need to worry about an overdraft. I'm comfortable with ~ 2~3 months worth. I hold no other cash.

... I am curious how everyone does this as for most ERs, we would be relying on passive income stream to cover our expenses. Having worked our whole lives and most of our effort is spent on saving and now has more questions on spending as we plan for our retirement.

Be careful about asking what "everyone does". They may not be in the same situation as you, and they might not be making a great choice either.

As I said, with an income stream greater than expenses, you just really have no need for much cash. If you did have a big expense, selling something is fine. You can worry about selling on a dip, but most of the time the market is up. There is no reason to let the fear of the chance of selling on a dip keep you from keeping your money working for you. Some discussion here:

http://www.early-retirement.org/forums/f28/djia-800-a-94149.html#post2123072

A conservative investor who would hold cash would also likely have a conservative WR and a conservative AA. Say an ~ 3.5% WR and an ~ 50/50 AA portfolio likely to be kicking off ~ 2.5% in divs. So if the market tanks, the investor only needs to draw ~ 1% from the portfolio. That 1% would be from fixed income in order to maintain their AA. This could obviously go on for many, many years before you would touch equities. By that time, they've probably recovered.

Nope, history says that cash doesn't provide a safety net, it is a drag and reduces your long term safety. I sleep better knowing I have my money working for me.

-ERD50

 

[COcheesehead]

What kind of yields are you getting? I’ve been avoiding bonds for a long time.

I have been buying muni's in the 3.8% to 4.4% range, 2-4 year duration. 5% ish coupon. In my tax bracket that equates to 5%+ equivalent for high investment grade bonds. A bunch are state specific as well so double tax free.

 

[HI Bill]

Cash dividends or stock dividends? If you're cashing out stock dividends and the stock value has decreased, you're essentially spending 'principal'. For stock dividends, additional stocks are added, and the unit price goes down. Best not to sell proceeds from stock dividends in a down market.

When ETFs and mutual funds issue dividends, do the stock issuers issue more shares, or actual cash?

 

[nash031]

Most of you play it very safe,,,I keep 4-12 months in cash. As I accumulate to the 12 month amount, I start deciding what my next stock purchase will be. I make my purchase, go back to 4 months expenses, and repeat.

I think you are still accumulating, like me, and not retired like many who are espousing keeping 3+ years. For us, something on the order of 4-6-12 months makes sense. For "them", having more makes more sense so they don't have to sell into a downturn.

 

[Prague]

Cash dividends or stock dividends? If you're cashing out stock dividends and the stock value has decreased, you're essentially spending 'principal'. For stock dividends, additional stocks are added, and the unit price goes down. Best not to sell proceeds from stock dividends in a down market.

When ETFs and mutual funds issue dividends, do the stock issuers issue more shares, or actual cash?

Dividends are issued in the form of cash.

 

[jebmke]

I am curious how you would handle the situation if an unexpected expense or larger than normal expense comes up when you keep that little in cash. Do you just wait till you need to dip into selling?

Every month I do a cash forecast for the next month. If existing cash + dividends aren't enough to cover it, I sell something. In the past I more or less tried to avoid making a taxable sale if I was roughly in our allocation band. Now I am letting things ride and will probably never sell equity again. If I need money, I'll sell bonds.

 

[Mr. Tightwad]

I think you are still accumulating, like me, and not retired like many who are espousing keeping 3+ years. For us, something on the order of 4-6-12 months makes sense. For "them", having more makes more sense so they don't have to sell into a downturn.

I've been retired for 11 years. I get everything you're saying. Just having 4 years of cash when you have your expenses covered seems way overboard.

I know, disaster could strike at anytime.

What I meant about my accumulating, is that I spend about 2500 a month, and make 7500 in retirement, so it just keeps adding up.

 

[scrabbler1]

I am curious how you would handle the situation if an unexpected expense or larger than normal expense comes up when you keep that little in cash. Do you just wait till you need to dip into selling?

At the start of the year, I create an approximate running total of cash inflows and outflows from my local bank's checking account, like a projected checkbook register. I note each month's low point which occurs after the last payment of the month and before the next monthly dividend income. Because the dividend payments coming in always exceed the expenses going out, each month's low point tends to rise throughout the year. When that low point exceeds my minimum desired buffer, or cushion, I can take that excess amount and invest it somewhere else.

I don't always have a cushion every month, as sometimes I need to carry forward surpluses to pay for any larger, lumpier expenses. Sometimes, I need to dip into the cushion when any smaller, unforeseen expenses arise in a given month. Sometimes, I will cut back or eliminate any of those occasional excess cash reinvestments.

In some more extreme cases, I can divert some small dividend reinvestments from my two smaller bond ("slush") funds to my local bank's checking account. This can happen when one of those unforeseen expenses arise just after I made one of my excess dividends reinvestment. Or I miscalculated somewhere, which has happened (rarely).

The two muni bond funds (slush funds) are there to handle anything too large for the general cash surpluses can't handle. It's rare that anything that big suddenly comes in. When I was in the hospital 3 years ago, the battle between the hospital and my insurance company took 4 months before it finally got resolved and the hospital sent me a bill for my share. I had been building up cash that whole time, preserving the excess cash surpluses so I didn't have to sell anything or got to my muni bond fund (like I thought I was going to do). Even another unexpected but smaller expense around the same time didn't wreck my system, as I designed it to handle these things.

 

[youbet]

Our plan is to set aside cash for three year worth of expenses to avoid selling stocks in a downturn market. We figure probability wise, three year would be sufficient in general. Our total annual expenses are about 100K but our current investments in our taxable accounts generate about 110K per year, mostly come in the form of monthly or quarterly dividend/interest. So does that mean we only need to set aside two years worth of cash to meet our goal of three year or we do not need any cash set aside since the income stream comes in on a regular basis? Knowing that in a downturn market, dividend could be cut, but our 100K/yr expense includes discretionary spending which I assume that we could cut back if needed.

I am curious how everyone does this as for most ERs, we would be relying on passive income stream to cover our expenses. Having worked our whole lives and most of our effort is spent on saving and now has more questions on spending as we plan for our retirement.

Clearly you're extremely, extremely conservative in this regard. Depending on your specific AA, the chances you'd need to sell diminished equities to cover expenses in a down market is close to nil. So, it's your choice. You'll bear the pain of reduced returns from carrying excessive "what if a down market happens" cash and you'll gain approximately zero protection from "selling equities in a down market."

What is your current AA? Are you sure that in a down equity market you'd have to sell diminished equities? That is, there would be absolutely nothing else in your portfolio you could tap?

DW and I were fully retired at the onset of the Great Recession (that enough of a "down market for ya?) and had an approximate 60/40 AA. DW had a pension which covered about one third of our expenses and I had zero. By taking our divs + interest and spending some bonds that matured, we were never even close to needing to sell diminished equities. And we did not cut spending a penny.

I think the need for holding cash to cover expenses in a so-called "down market" is highly overstated for folks with diversified portfolios....... Now, having said that, if you have an extremely high equity AA paying low dividend levels, that might be another story. Why don't you share some details with us in that regard?

Edit: I should add, if you're a nervous Nelly (and I don't mean that in a derogatory way - we all are who we are), and having cash available to avoid any portfolio maneuvering when making major purchases or in so-called "down markets," helps your peace of mind, then keep the cash. The dollars lost to the expense of holding cash would be well spent if they help you sleep at night!

While I keep a bit of emergency cash on hand and have access to credit (which in 12+ yrs of FIRE I've never needed), I actually enjoy cruising the portfolio looking for harvest opportunities when the need for "spendin' money" arises!

 

[youbet]

We have about 4 yrs in MM/short term CD's, but that mainly is for ACA income management, not really as a sub for equities in a down market.

Good point Dtail! It's important to differentiate between cash held pending trade opportunities or rebalancing and cash held for future spending. Two completely different things.

I think what OP is talking about is cash being held for spending and which is not to be touched outside of spending needs during times when absolutely nothing else in your diversified portfolio is a candidate for harvesting.