How much cushion for a bear market?

[Alex in Virginia]

Hello, alll...

Can we agree that cashing out stocks at a loss in a bear market (or anytime?) to fund living expenses is not the best way to go? If we can agree, then how much cushion is enough cushion to get by a bear market without cashing in stocks?

I have set aside 3 years of living expenses in cash instruments (savings accounts & cds) and another 3 years in investment-grade (A-) bonds in a taxable account. The bonds are in a rolling ladder so that 1/3 each mature 4, 5 and 6 years from now (so that I can capture back the face value each year to cover those living expenses).

All of that I consider to be "separate" from my tax-deferred retirement funding portfolio.

Sound like enough? What is your bear market cushion like?

Thanks!

Alex in Virginia

 

[REWahoo]

If history is of any help: Average Duration of Previous Bear Markets - Seeking Alpha

 

[bUU]

For completeness... The Jun '08 - Mar '09 Bear Market, with loss of 57% of value, according to the Wilshire 5000 Index, a loss that was effectively erased by April 2012.

 

[Midpack]

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...

 

[nun]

Three years cash and three years in quality corporate bonds sounds ample. But I would ask what is the term of those bonds, it's probably best to stay away from long terms, and also why are you holding those bonds in a taxable account. I'd exchange the bonds for a broad stock index equity fund and then adjust your tax deferred AA to compensate. You have access to those bonds by simply selling taxable equities and transferring the same amount from bonds to equities in your tax deferred accounts.

 

[karluk]

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.

 

[Animorph]

3 years cash and 3 years bonds is pretty good. However, there was a study (I'll have to find it sometime, I think from Dr. Pfau) that said any cash position is a drag on your portfolio if it's just part of your AA. I suspect it is a little better if you actually spend the cash and bonds down during a bear market without replenishing them until they're exhausted. Are you ready to go through a big market drop using up your cash and not touching (but maybe even adding to) your equities? I did that in 2007-2010, but I didn't seem to have a lot of company.

I think with cash/bonds for this purpose you are insuring against a big market decline early in retirement. If the big drop happens later on, you would probably be better off with equity growth until then, at which point your portfolio is big enough to withstand the drop. Providing you didn't spend it before then.

 

[W2R]

Hello, alll...

Can we agree that cashing out stocks at a loss in a bear market (or anytime?) to fund living expenses is not the best way to go? If we can agree, then how much cushion is enough cushion to get by a bear market without cashing in stocks?

I have set aside 3 years of living expenses in cash instruments (savings accounts & cds) and another 3 years in investment-grade (A-) bonds in a taxable account. The bonds are in a rolling ladder so that 1/3 each mature 4, 5 and 6 years from now (so that I can capture back the face value each year to cover those living expenses).

All of that I consider to be "separate" from my tax-deferred retirement funding portfolio.

Sound like enough? What is your bear market cushion like?

Thanks!

Alex in Virginia

I have about 3-4 years in cash. Also my TSP is invested in "G Fund", a government bond fund which is guaranteed not to drop in share value, so it is similar to cash.

I guess we are all thinking about the possibility of a bear market, after the stunning leaps upwards in the market lately. It can't go up forever.

 

[Major Tom]

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.

 

[MichaelB]

Hello, alll...

Can we agree that cashing out stocks at a loss in a bear market (or anytime?) to fund living expenses is not the best way to go? If we can agree, then how much cushion is enough cushion to get by a bear market without cashing in stocks?

Alex, the only thing we can all agree on in this forum is that we can't agree on anything.

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.

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.

 

[Bikerdude]

If I assume a 50% drop in interest & dividends my CD's would last about 10 yrs. I would then consider selling I-bonds, then short term bonds. I don't plan on having to sell equities in this lifetime, however, I could be wrong.

 

[mpeirce]

I have a three year CD ladder that's there to tide me over a bear market. It's in a local bank currently paying 1.25% on 3 year CDs. I also keep from 1/2 to 1 year of money in a high yield savings account that I draw on monthly (my monthly "paycheck").

So with that, plus the dividends from my stocks, and some easy/modest belt tightening I figure I can go more than four years without touching my stock portfolio when (not if!) we hit the next rough patch.

I keep this amount of liquid assets since it seems best to me to keep my portfolio invested in stocks (i.e. mostly mutual funds) for the best long term performance - I plan on living off of it for the next 40 years.

I may be retired, but I'm still a long term investor.

 

[Animorph]

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.

I found the link to AA cash allocations, from Kitces:
Research Reveals Cash Reserve Strategies Don't Work... Unless You're A Good Market Timer? - kitces.com | Nerd's Eye View

 

[ERhoosier]

I found the link to AA cash allocations, from Kitces:
Research Reveals Cash Reserve Strategies Don't Work... Unless You're A Good Market Timer? - kitces.com | Nerd's Eye View

Interesting article, but doesn't this assume US will remain the dominant equity market it has been in the post-WWs era? I vivdly recall pundits in late 80's pushing heavy exposure to Japan since for years it had been delivering more consistent returns than US (fewer bears?) and was projected to become world's largest equity market (total assets) by 1992-3. Many were pushing to make yen the world's reserve currency. But things changed. Nikkei peaked ~39,000 in Dec 89, then lost ~3/4ths of its value over next 20+yrs.

Not saying the article's numbers are wrong nor predicting a US market crash of Nikkei proportions, but history cannot 100% predict future events. We only get 1 chance at this FIRE thing. Many sleep better at night knowing where their next 3 yrs living expenses are coming from.

 

[Bikerdude]

I found the link to AA cash allocations, from Kitces:
Research Reveals Cash Reserve Strategies Don't Work... Unless You're A Good Market Timer? - kitces.com | Nerd's Eye View

I agree with this quote and plan to follow it if possible. Is this not the purpose of a cash reserve.

"Some readers may take issue with the particular strategy the authors used to replenish cash reserves. Would it have been better to limit the sale from the portfolio from cash reserves until the portfolio recovered to its prior highs? "

I didn't read the supporting study but does anyone know what they considered cash?

 

[jebmke]

My cushion is my whole portfolio. If stocks go down, I will sell bonds and rebalance to food and stocks. I keep no cash except what I need to pay next month's credit card.

 

[heeyy_joe]

$100K liquid helps me sleep at night.

 

[ERD50]

I think you are missing the dividend yield from your calcs. Back of the envelope says with a typical 75/25 AA and 4% WR, the fixed portion alone could provide over six years of living expenses before touching your stocks. Now, factor in a likely 2% or more dividend yield, and that doubles that six years to ~ 12 (or a bit less - the divs would likely drop as you deplete the portfolio).

-ERD50

 

[Alex in Virginia]

If history is of any help: Average Duration of Previous Bear Markets - Seeking Alpha

Looking at the chart so kindly posted by REWahoo in post #2 of this thread, now I'm thinking it's not just how long bear markets have lasted, but more to the point how long it has taken those markets to recover.

If we take out the worst case of 1929-1932 as being totally outside the curve, then the longest it has taken for market recovery has been 8.8 years (from the 1937-1938 bear). Also taking out the best case 1990 bear as outside the curve, the shortest time has been 1.4 years. That gives a recovery midpoint of 5.1 years.

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?

Alex in Virginia

 

[Major Tom]

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?

Alex in Virginia

A portfolio contaning bonds (or similar) would take less time to recover, and this also ignores the long-term drag on a portfolio of containing such a large amount of cash as a cushion (i.e. money that isn't in equities). For these reasons, I disagree.

 

[mathjak107]

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

 

[Alex in Virginia]

funny i just posted this in another thread.

Sustainable Withdrawal Rates: The Historical Evidence on Buffer Zone Strategies

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

 

[Animorph]

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%).

 

[Bikerdude]

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%).

+1

 

[foxfirev5]

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.