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Old 01-24-2013, 06:57 PM   #21
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Alex, the only thing we can all agree on in this forum is that we can't agree on anything.

I recall a thread about a year ago (can't find it) that referred to a study or white paper done elsewhere. The conclusion was that a cash buffer detracted from overall performance and was no help to the portfolio during a downturn.

In addition to be current year budget we keep one additional year and additional funds to pay for major repairs and expected or potential large expenditures.
funny i just posted this in another thread.

Sustainable Withdrawal Rates: The Historical Evidence on Buffer Zone Strategies
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Old 01-24-2013, 07:29 PM   #22
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I scanned the paper. On a gut level, it's hard (for me) to accept the paper's conclusion. Even though the paper is obviously soundly done, on an emotional level I'm not sure I would or could be without a substantial cash reserve cushion. Maybe it comes down to that: one's comfort level or peace of mind.

I'll study the paper more closely, but it may still all come down to that peace-of-mind consideration.

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Old 01-24-2013, 09:00 PM   #23
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I think the buffer strategy in that paper was kind of strange, as we noted in the other thread:

"If the investment portfolio goes up the second year after going down the first year, the retiree takes the annual withdrawal from the investment portfolio, and also liquidates enough of the investment portfolio to bring the cash position back up to its original value."

So there is a big market crash, you live off your buffer for the year, and then the market goes back up a little without being close to fully recovered. You're supposed to take your yearly expenses plus at least another year to fill your cash buffer. I'd rather wait for a better recovery. That might make the buffer look a little better. And better than a constant portfolio percentage (other than 0%).
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Old 01-24-2013, 10:09 PM   #24
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I think the buffer strategy in that paper was kind of strange, as we noted in the other thread:

"If the investment portfolio goes up the second year after going down the first year, the retiree takes the annual withdrawal from the investment portfolio, and also liquidates enough of the investment portfolio to bring the cash position back up to its original value."

So there is a big market crash, you live off your buffer for the year, and then the market goes back up a little without being close to fully recovered. You're supposed to take your yearly expenses plus at least another year to fill your cash buffer. I'd rather wait for a better recovery. That might make the buffer look a little better. And better than a constant portfolio percentage (other than 0%).
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Old 01-25-2013, 05:56 AM   #25
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I carry 5 years expenses in cash, CD's and stable value funds. I know it's a portfolio drag but I also have never lost sleep through the various downturns going back to '87. Sticking to 45/40/15 AA.
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Old 01-25-2013, 06:07 AM   #26
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I plan on keeping at least two years worth of living costs in cash or near cash at all times. Anything above that is a war chest for any opportunities the market throws my way.
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Old 01-25-2013, 06:28 AM   #27
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As mentioned a few times before in other threads, I have nearly 100% of my investments in CDs, munis or equivalent. I only started to buy deferred annuities in the last few months. I will learn more about equities when I FIRE.
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I carry 5 years expenses in cash, CD's and stable value funds. I know it's a portfolio drag but I also have never lost sleep through the various downturns going back to '87. Sticking to 45/40/15 AA.
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Old 01-25-2013, 08:59 AM   #28
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Depends on how much floor income you have from pensions/annuities/Soc Sec to begin with. If you have enough floor income to cover your projected annual spending, arguably you don't need any more than a typical emergency fund, standard recommendation used to be 3-6 months (longer for some since the 2008 meltdown?).

If your income comes entirely from your portfolio, 3 years seems to be a common recommendation from many sources, to avoid selling assets at/near a bottom. OTOH, while I'm not a proponent of the Lucia's (3) Buckets of Money approach, IIRC their short term bucket is 5-7 years. You can Google and read up on that if you like.

And if you're income sources are mixed, presumably something in between...
The paper calls this "Risk Capacity"; I'd never heard that term before but, I like it. It seems to be a measure of how much 'spending flexibility' you have. If you have more flexibility, presumably to cut discretionary expenses, you're less likely to sell equities low.

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I wonder if there is some kind of analysis of the ideal amount of cash to hold? Even if your cash holdings are low enough that you have to occasionally sell at, or near, a bottom, the benefit of having that extra money in equities during up markets would be of benefit.

Until recently, I was holding about 4 years of living expenses in cash, but have now moved to having just 2 years in cash. With dividends, I can go for about 2 1/2 years before having to sell equities. My thinking is that I am not trying to completely avoid ever having to sell in a down market. I'd just like to steer clear of having to do it most of the time.
This adjustment from 4yrs cash to 2.5yrs cash seems to be an example of "Risk Capacity."

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I scanned the paper. On a gut level, it's hard (for me) to accept the paper's conclusion. Even though the paper is obviously soundly done, on an emotional level I'm not sure I would or could be without a substantial cash reserve cushion. Maybe it comes down to that: one's comfort level or peace of mind.

I'll study the paper more closely, but it may still all come down to that peace-of-mind consideration.

Alex in Virginia
Me too.

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I carry 5 years expenses in cash, CD's and stable value funds. I know it's a portfolio drag but I also have never lost sleep through the various downturns going back to '87. Sticking to 45/40/15 AA.
I think this 'peace of mind' factor is of value, even though it's difficult to quantify. For many people, it's what enables them to stick with their AA through bear markets. Note that this study is based on that assumption: "static asset allocation strategy" (ie: no AA changes in down markets).

I just read The Four Pillars last month, and Bernstein talked about the importance of living within your risk tolerance so that you won't panic, as many do, and sell low. In fact, he said it's so important that he recommended that young investors start with LESS risk than they think they can tolerate, and work their way up the risk ladder as time, and bear markets, pass; a concept that's counter to most of what's written about young investor AA. The purpose is to ensure they don't make the serious mistake of selling low.

In fact, the study says pretty much the same thing about the psychological value in the Conclusion section of the study.

Although the results from this study show that a static asset allocation strategy is superior to a buffer zone strategy at minimizing longevity risk, the use of a buffer zone may be merited if it will impact one’s investment portfolio choice. To elaborate, it may provide a psychological mechanism to induce clients to accept stock exposure. With the one exception of comparing a pure bond asset allocation to a bond and buffer zone strategy, it is clear that buffer zone strategies are much superior to a long-term bond portfolio strategy.


So, for me, in 'the real world' a buffer strategy can have substantial value for many who want to FIRE.
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Old 01-25-2013, 09:03 AM   #29
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It would then seem that a 6-year cushion against being forced to sell stocks before the market has recovered is a reasonably good bet. Yes?
Seems excessive.

At the risk of repeating, I take it you have little or no floor income from pensions, annuities and/or Soc Security...makes a difference WRT the size of a cushion.
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Old 01-25-2013, 09:43 AM   #30
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Seems excessive. If you wait until the market recovers fully, you might as well have stayed in for the duration.
In theory if you did this you would have sold equities at a loss.


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At the risk of repeating, I take it you have little or no floor income from pensions, annuities and/or Soc Security...makes a difference WRT the size of a cushion.
This is true, in my case I can go 10 yrs. because a pension, SS, 1/2 my dividends and interest provide over 80% of my income leaving only 20% to be replaced by cash.
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Old 01-25-2013, 09:58 AM   #31
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In theory if you did this you would have sold equities at a loss.
You're right, I didn't think that through very well did I. Post above edited, thanks.
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Old 01-25-2013, 01:43 PM   #32
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It would then seem that a 6-year cushion against being forced to sell stocks before the market has recovered is a reasonably good bet. Yes?
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Seems excessive.

At the risk of repeating, I take it you have little or no floor income from pensions, annuities and/or Soc Security...makes a difference WRT the size of a cushion.

Sorry. Let me be more clear. The 6-year cushion I refer to above is a 6-year cushion to cover the deficit above and beyond my floor income.

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Old 01-25-2013, 02:04 PM   #33
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If the stock allocation in the portfolio is modest enough, I'm not convinced that any cushion at all is needed. Take a $1,000,000 portfolio evenly divided between stocks and bonds. After a 50% market drop in stocks, the portfolio would be $500,000 bonds and $250,000 stocks. This would trigger a rebalancing to get back to 50/50 stocks and bonds, resulting in selling $125,000 in bonds to purchase the same amount in stocks. That's a large enough net purchase of stocks that it would most likely exceed any sales required to fund retirement expenses. So a properly managed balanced portfolio would be a net purchaser of stocks during even severe bear markets and not need a cash cushion.

Of course all this changes if you are expecting a financial Armageddon where both stocks and bonds get hammered equally.
Good point.
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Old 01-25-2013, 02:10 PM   #34
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I think the buffer strategy in that paper was kind of strange, as we noted in the other thread:

"If the investment portfolio goes up the second year after going down the first year, the retiree takes the annual withdrawal from the investment portfolio, and also liquidates enough of the investment portfolio to bring the cash position back up to its original value."

So there is a big market crash, you live off your buffer for the year, and then the market goes back up a little without being close to fully recovered. You're supposed to take your yearly expenses plus at least another year to fill your cash buffer. I'd rather wait for a better recovery. That might make the buffer look a little better. And better than a constant portfolio percentage (other than 0%).
I think that any buffer strategy has to deal with the question "When do I refill the buffer?".

If I've got a three year buffer and I've used it up, but stocks have more-or-less recovered, do I jump in and sell enough stocks to refill my 3 year buffer? If not, what rule am I going to use?

I've never been able to figure out a rule that look substantially better than just regular rebalancing.
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Old 01-25-2013, 03:04 PM   #35
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If the stock allocation in the portfolio is modest enough, I'm not convinced that any cushion at all is needed. Take a $1,000,000 portfolio evenly divided between stocks and bonds. After a 50% market drop in stocks, the portfolio would be $500,000 bonds and $250,000 stocks. This would trigger a rebalancing to get back to 50/50 stocks and bonds, resulting in selling $125,000 in bonds to purchase the same amount in stocks. That's a large enough net purchase of stocks that it would most likely exceed any sales required to fund retirement expenses. So a properly managed balanced portfolio would be a net purchaser of stocks during even severe bear markets and not need a cash cushion.

Of course all this changes if you are expecting a financial Armageddon where both stocks and bonds get hammered equally.
As I recall my Corporate bond funds fell in 2008 and without cash I would have sold at a loss. Just curious, are you retired?
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Old 01-25-2013, 03:29 PM   #36
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I think that any buffer strategy has to deal with the question "When do I refill the buffer?".

If I've got a three year buffer and I've used it up, but stocks have more-or-less recovered, do I jump in and sell enough stocks to refill my 3 year buffer? If not, what rule am I going to use?

I've never been able to figure out a rule that look substantially better than just regular rebalancing.

I raise cash when my portfolio is doing better than projected (raise an extra year's cash or more if the portfolio value is a year or more ahead). I spend it all before touching equities, or reinvest some if I have extra in a bear market. When I run out of cash I sell equities month by month as needed for expenses. Starting from 2007 I've done all of that and have been happy with the result. Nominally 0% cash as an allocation.
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Old 01-25-2013, 04:20 PM   #37
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As I recall my Corporate bond funds fell in 2008 and without cash I would have sold at a loss. Just curious, are you retired?
It's very possible your corporate bond funds fell signficantly in 2008. You would have to share the names of the funds for us to judge the length and severity of the downturn in your bond investments. However, the following chart comparing VBTLX (total bond index) and VTSAX (total stock market index) fails to support your (apparent) contention that a properly diversified balanced portfolio would have done worse in 2008 than a similar portfolio with a big cash cushion. In particular, you would not have been selling VBTLX at a loss. VBTLX started 2008 with a NAV well above its average NAV from 2006 and 2007 and stayed at or above this average except for a minor dip in October and November. If you had withdrawn enough on the first of each month to pay for that month's living expenses, you would have been selling VBTLX at or above its average NAV every single month of 2008 except for October and November. That hardly constitutes the catastrophic fire sale of depreciated assets that you seem to fear.

There is no doubt that having a multi-year cash cushion is psychologically comforting. I have no problem at all with other people using one, if it makes them feel more financially secure. But as the scholarly articles cited earlier in this thread point out, investors can do just as well or better by foregoing a cash cushion in favor of regular rebalancing.

I will be retiring next month. I find these discussions very useful in putting together my own post-retirement financial plans. This particular thread has convinced me to forget about using a cash cushion, except maybe for when I'm aware of large purchases coming up in the next six months.

I admit that having a pension that pays the majority of our month-to-month expenses may make me more willing than most to forego a cash cushion.

VANGUARD TOTAL BOND MARKET INDE Fund Chart - Yahoo! Finance;
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Old 01-25-2013, 05:03 PM   #38
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Old 01-25-2013, 05:38 PM   #39
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As mentioned a few times before in other threads, I have nearly 100% of my investments in CDs, munis or equivalent. I only started to buy deferred annuities in the last few months. I will learn more about equities when I FIRE.
obgyn65- Your tactic is my goal - The old quote from Groucho Marx about treasury bonds not paying much interest - "they do if you own enough of them" is very relevant.
Also recent interviews from Bill Bernstein regarding the fact that once you've won the game quit playing.
Now that the masses may be coming back to equities I may slide from my 45/40/15 position to even more cash.
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Old 01-25-2013, 06:33 PM   #40
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It's very possible your corporate bond funds fell signficantly in 2008. You would have to share the names of the funds for us to judge the length and severity of the downturn in your bond investments.
VFICX. I agree funds with more treasuries did better.

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However, the following chart comparing VBTLX (total bond index) and VTSAX (total stock market index) fails to support your (apparent) contention that a properly diversified balanced portfolio would have done worse in 2008 than a similar portfolio with a big cash cushion.
My cash did better in 2008 than a balanced portfolio.

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That hardly constitutes the catastrophic fire sale of depreciated assets that you seem to fear.
I don't recall saying that.

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There is no doubt that having a multi-year cash cushion is psychologically comforting.
That and my Teddy bear.

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I will be retiring next month.
Congratulations! Good Luck.

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I admit that having a pension that pays the majority of our month-to-month expenses may make me more willing than most to forego a cash cushion.
I have that and a cash cushion.
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