Rethinking my Cash Allocation

[kyounge1956]

At retirement, I plan to sell my current residence and move to a less-expensive part of the state. Until recently, I've always supposed my house here would sell for quite a lot more than it would cost to replace there, and I planned to add a cash allocation to my portfolio out of the excess proceeds.

Recently, I've had a real-estate reality check. I knew prices were down, but I didn't know how much until my recent refi, when my house appraised for only about 3/4 of what it appraised for on the previous refi in 2006. Shortly after that, an identical unit kitty-corner from mine went on the market with an asking price of only 65% of the 2006 appraisal . I called the listing agent to investigate, and she said it had sold but wouldn't disclose the price, since the sale hadn't closed yet. But in this market, I'm sure it wouldn't have sold for more than the asking price. By the time I pay for expenses of sale and a few repairs to the house that will probably be required before it's fit to put on the market, it looks like the "excess proceeds" that I was counting on to fill up a cash bucket at retirement will have completely evaporated. (Silver lining: I can probably still hit my retirement target date of May 2013)

That leaves me wondering if I should change the allocation in my portfolio. I could put some of my Roth contributions into a money market fund or short term Treasuries, or I could add a "Cash Accumulator" (basically a CD inside the retirement plan) or the mysterious Stable Value fund to my 457 account at w@rk. The Stable Value fund has higher returns than the other cash or cash-like options in the plan, but I've never been able to find out exactly what it is. I asked the deferred-comp custodian's on-site rep about it, and he couldn't either. There is no prospectus available. It's a black box, you put money in and get it back later with, currently, about 3% return.

The immediate purpose of the cash bucket is to make up any shortfall between my pension and living expenses between retirement and starting to draw SS, probably at full retirement age, about 9 years into retirement. (FIRECalc said $45K would meet this need in all time periods, and in most time periods I'd have more than $35K of it left when I start to draw SS)

How do you decide how much of your portfolio to keep in cash? Or do you consider cash reserves a separate category from your portfolio?

 

[easysurfer]

I consider my cash reserve separate and hold enough to last me about two years.

I also keep some cash in my portfolio just to balance out the amount I put in equities and bonds.

 

[Onward]

The Stable Value fund has higher returns than the other cash or cash-like options in the plan, but I've never been able to find out exactly what it is. I asked the deferred-comp custodian's on-site rep about it, and he couldn't either. There is no prospectus available.

 

[Nords]

How do you decide how much of your portfolio to keep in cash?

We keep two years' expenses (8%) in cash and replenish that every up year.

Of course we're counting on the vast majority of recessions to last for less than two years.

You might be in a different situation of forecasting a one-time need for a chunk of cash at a certain date. The conventional wisdom on that is CDs or zero-coupon bonds.

 

[Rustic23]

We keep about three years, but I don't replenish yearly. I am down to about a year and a half, so it is getting close to time to get off the pot.

 

[Koolau]

The Stable Value fund has higher returns than the other cash or cash-like options in the plan, but I've never been able to find out exactly what it is. I asked the deferred-comp custodian's on-site rep about it, and he couldn't either. There is no prospectus available. It's a black box, you put money in and get it back later with, currently, about 3% return.

What Is a 'Stable-Value' Investment? - Investing - Basics - SmartMoney.com

Here's a general explanation of SV funds. However, if your custodian can't tell you exactly how yours works, I think I would avoid it. Just my opinion and YMMV.

I was wondering if you might not recoup some of your paper loss on your home when you move to the "lower cost" place. IOW, you won't get as much from your current home as you had hoped, but a new place should be similarly "discounted", potentially leaving you with a significant cash bucket. Just a thought. Again, YMMV. Best of luck. Sounds like you have things under control in any case.

 

[jebmke]

Other than working capital (about a months worth of expenses in the bank) I don't hold any cash at all.

 

[kyounge1956]

What Is a 'Stable-Value' Investment? - Investing - Basics - SmartMoney.com

Here's a general explanation of SV funds. However, if your custodian can't tell you exactly how yours works, I think I would avoid it. Just my opinion and YMMV.

Thanks for the link. I used to have some of my 457 in the Stable Value fund and got out for that very reason. I notice in the link that SVFs are now sometimes available outside employer plans, but I'd need to think some more before using one. Besides the relatively high expense ratio, there are the penalties for early withdrawal. If all goes according to plan there will be about two years after retirement but before age 59-1/2. I don't anticipate running short the first two years but you never know. If I leave the reserve in my 457 I believe I can take it out any time after retiring provided I'm at least 55 years old when I pull the plug.

I was wondering if you might not recoup some of your paper loss on your home when you move to the "lower cost" place. IOW, you won't get as much from your current home as you had hoped, but a new place should be similarly "discounted", potentially leaving you with a significant cash bucket. Just a thought. Again, YMMV. Best of luck.

That is possible, but I don't think I can count on it. The "less expensive part of the state" is Gray's Harbor County. The area is somewhat economically depressed and has been for years, but they have just gotten something of a boost from a big contract making (I think) pontoons for a rebuild of one of the bridges across Lake Washington, so prices there may not have been hit as hard as they have been here.

Sounds like you have things under control in any case.

Boy, I hope so. There are so many things to think about and decide I wonder how I can possibly get them all right. But maybe I don't need to do everything perfectly. Maybe "close enough" is close enough.

 

[FIREd]

I keep about 5 years worth of expenses in cash or cash equivalents (CDs, i-bonds, money market funds, savings accounts, etc...). I consider it part of my portfolio.

 

[kyounge1956]

Follow up question

Lots of E-R members keep a few years' worth of expenses in cash. Do you figure the amount based on your total budget, or just the part you need to derive from your investments? Suppose your annual budget is $50K, you have $40K of non-portfolio income (SS and/or pension), and you want to keep 3 years of expenses in cash. Is "three years in cash" $150K, or $30K?

 

[Sconie]

I keep a year of expenses in cash and don't consider it part of my portfolio.

 

[REWahoo]

Suppose your annual budget is $50K, you have $40K of non-portfolio income (SS and/or pension), and you want to keep 3 years of expenses in cash. Is "three years in cash" $150K, or $30K?

$30K - but I'd probably keep a total of $50K or so as an additional emergency fund.

Keeping $150K in your example would, in my opinion, unnecessarily reduce the long-term performance of your portfolio, especially with the dismal return we are currently seeing from cash investments. When interest rates improve this might not be the case but I would still not keep what amounts to 15x my annual need in cash.

 

[rescueme]

Suppose your annual budget is $50K, you have $40K of non-portfolio income (SS and/or pension), and you want to keep 3 years of expenses in cash. Is "three years in cash" $150K, or $30K?

I would say $30k, and it depends on where you maintain your cash. For DW/me, who have the majority of our retirement investments in tax-deferred funds, we would have $30k + 15% tax, or a gross amount of $35,294.12 (e.g. $30k / .85 - the inverse of 15% = $30k net). For those that also need to count on paying state tax, you will have to add to your federal tax estimate (I don't pay state/local tax on retirement income).

In our case, we each maintain a 3-4 year "gross tax" position in tax deferred MM funds. While the argument could be made that we have "too much" in cash, we are a bit risk adverse and been through many market downturns in the last 30 years of investing. Our way of doing it certainly helps our "sleep factor".

The second point (for us) is while we currently have a lot in cash, it's a temporary situation and that amount will be greatly reduced as two pensions (defined benefit plan) along with our respective SS income come into play over the next 7 years. Assuming we live long enough to collect all those income sources, our held cash will be very little.

Everybody has their own way of managing their retirement income. For us, this works and meets the idea of "in retirement, cash flow is everything"...

As far as cash as part of our joint AA target? We consider it on the bond side. In other words, our current E-R AA target is set at 50/50; 50% being equity funds, 50% being bond/cash. I know that some will split it into a three part AA; whatever works in your world. As far as funding to keep it within our target range? On years where a holding shows considerable profit (either equity or bonds), I'll sell off a bit of "profit" and add it to our "cash bucket". As an example, we sold off some GNMA last year due to the great return. On years where everything takes a dive (such as 2008), we don't sell anything and just add any distributions to cash.

Over the last 30 years, we've only had three overall down years in our investment "history" (2001-02, 2008); that's why we feel comfortable with our 3-4 year cash holding target. A bit conservative, but then, so are we.

 

[Danmar]

We have about 2 years worth of spending in cash. Seems to be a conservative rule of thumb. Replenish regularly. I like the line" In retirement cash flow is everything" Don't have any FI as pension takes it's place.

 

[audreyh1]

Lots of E-R members keep a few years' worth of expenses in cash. Do you figure the amount based on your total budget, or just the part you need to derive from your investments? Suppose your annual budget is $50K, you have $40K of non-portfolio income (SS and/or pension), and you want to keep 3 years of expenses in cash. Is "three years in cash" $150K, or $30K?

The latter, but like Rewahoo points out, with a cash buffer that low, you might want more as an emergency fund.

For those of us who don't have non-portfolio income, the cash buffer is big enough that it can do double-duty as an emergency fund even though you would have to replenish it at some point. Still - you have the flexibility of extra cash on hand if suddenly needed.

Audrey

 

[audreyh1]

How do you decide how much of your portfolio to keep in cash? Or do you consider cash reserves a separate category from your portfolio?

I have a "short-term funds" account that is basically a cash reserve for 1.5-3 years of expenses. This is separate from the portfolio. I don't have to worry about short-term market fluctuations with this money.

I ALSO have cash as an asset class in my portfolio. That is mainly there for rebalancing if equities go way down like has happened twice in the past decade.

But being a two belts and suspenders type, I don't like to see my cash plus bonds (the fixed income portion) in my portfolio drop below 10 years expenses so that I can weather a decade long bear market if necessary. This just means that when I rebalance, selling bonds+cash to buy equity funds, I don't go below that threshold. In the recent nasty bear market this actually made it psychologically possible to rebalance under very scary conditions. It was still hard to do, but I did it knowing how cautious my approach was. And I got a nice payback a couple of years later.

Audrey

 

[Spanky]

Schwab has a couple of good articles on this topic.
How much cash do you advise investors to hold in their portfolios?
Managing Your Portfolio Q&A: We Answer Your Questions
Building an Emergency Fund: Building an Emergency Fund

 

[Meadbh]

There was a time when I held no more than 5% cash and cash equivalents. Currently, I, like the OP, am planning a move. While I am not retiring yet, the way I am paid will change; in future I will be paid exclusively from my corporation. So I have built a reserve of cash and GICs in the corporation sufficient to pay me for ~3 years, including taxes. I too will be selling a home. The market here is healthy and there will be no capital gains tax to pay, but I don't want to make any assumptions. Worst case scenario, I will not have to dip into equities.

 

[Nords]

Lots of E-R members keep a few years' worth of expenses in cash. Do you figure the amount based on your total budget, or just the part you need to derive from your investments? Suppose your annual budget is $50K, you have $40K of non-portfolio income (SS and/or pension), and you want to keep 3 years of expenses in cash. Is "three years in cash" $150K, or $30K?

Three years = $30K.

I guess the full statement would be "three years' cash of the gap in expenses after pension income"