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Selling in a Down Market
Old 07-12-2013, 05:42 PM   #1
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Selling in a Down Market

When folks dread "selling in a down market," I wonder if that's as bad as it sounds.

I suppose it depends on how much of your portfolio you MUST sell each year to support your budget. After SS, pension, divs and interest, we generally don't have to sell anything out of our 50/45/5 FIRE portfolio. But, lets say we had to sell about 2% of the portfolio every year to supplement SS, pension, divs and interest.

First I'd look at the 45% bond portion to see if there was something maturing or, despite equities being down, some bond or shares of a bond fund worth selling. If not I'd go to the equity portion and look for tax loss harvesting possibilities. Or some equity that is up nicely even if the overall equity portion of the FIRE portfolio is down. If there was no alternative worth doing, I'd sell the broad market position and take the loss.

If the equity portion of the portfolio was down, say, 20%, that means I'd be selling 4% of my equities while they were 20% down. Not something that would be my first choice, but not a disaster IMO.

Unless it's a prolonged down market in equities and simultaneous with the fixed portion also being down, it just doesn't seem like protecting yourself from a year or two of "selling into a down market" is necessarily worthwhile. Especially when balanced with the opportunity cost of holding extra cash when cash investments are paying at historic lows.

An exception might be a year where you plan to spend significantly above your usual budget, say for a new car or a house remodel. For that, I'd begin accumulating cash in advance.

Maybe I need to rethink this and establish a cash fund to cover the next few years? Comments?


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Old 07-12-2013, 06:05 PM   #2
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Originally Posted by youbet View Post
When folks dread "selling in a down market," I wonder if that's as bad as it sounds.

I suppose it depends on how much of your portfolio you MUST sell each year to support your budget. After SS, pension, divs and interest, we generally don't have to sell anything out of our 50/45/5 FIRE portfolio. But, lets say we had to sell about 2% of the portfolio every year to supplement SS, pension, divs and interest.

First I'd look at the 45% bond portion to see if there was something maturing or, despite equities being down, some bond or shares of a bond fund worth selling. If not I'd go to the equity portion and look for tax loss harvesting possibilities. Or some equity that is up nicely even if the overall equity portion of the FIRE portfolio is down. If there was alternative worth doing, I'd sell the broad market position and take the loss.

If the equity portion of the portfolio was down, say, 20%, that means I'd be selling 4% of my equities while they were 20% down. Not something that would be my first choice, but not a disaster IMO.

Unless it's a prolonged down market in equities and simultaneous with the fixed portion also being down, it just doesn't seem like protecting yourself from a year or two of "selling into a down market" is necessarily worthwhile. Especially when balanced with the opportunity cost of holding extra cash when cash investments are paying at historic lows.

An exception might be a year where you plan to spend significantly above your usual budget, say for a new car or a house remodel. For that, I'd begin accumulating cash in advance.

Maybe I need to rethink this and establish a cash fund to cover the next few years? Comments?


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You lay out the issues very well. I have not tried to think this through, so no useful insights. Let us know how this develops as you continue looking.

As a matter of habit, unless I consider values very good, I tend to hold a couple hundred k in cash anyway,(including CDs) so I guess the issue may not come up for me barring some real disaster.

Ha
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Old 07-12-2013, 06:27 PM   #3
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I think you have it right.

I've tried modeling this in the past, my models weren't really good enough that I felt like sharing them, but they do seem to tell me that it isn't that big a deal, for the reasons you mention. In a major downturn you would expect (well, at least I would!) that the fixed portion of the portfolio would not have dropped as much as the equity side. If you use your withdraws to help rebalance, the money you draw won't be down as much as the total portfolio.

For a lump sum spend like a car, I think you could play it either way. If the market is down, pull from fixed. But setting aside the cash seems prudent also.

On the flip side, my same crude models seem to tell me that adjusting spending in the face of a downturn doesn't help much either. Just on the surface, if your portfolio is down 40% or more (and that is what we see on the fails and near-fails in FIRECALC), changing spending from 4% to 2% for a few years is small potatoes. It helps, but that may be a big hit to lifestyle, and it probably only gains you a year or two before you fail.

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Old 07-12-2013, 06:37 PM   #4
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I tend to hold a couple hundred k in cash anyway,(including CDs) so I guess the issue may not come up for me barring some real disaster.

Ha
I typically have similar amounts in cash or near-cash as well. It's not intended as "cash for the next two years expenses" but rather liquidity in the portfolio to allow for trading, rebalancing, evil market timing and such. And part of the 45% bond allocation invariably falls into the "near-cash" category. If I withdrew some of it for current expenses, that would save me from "selling in a down market" but might be an inconvenient development in regards to portfolio management flexibility. It would depend on what I had going on at the time. Through my first 7 years of FIRE, including getting through 2008 - 09, it hasn't been an issue.

The "cash" I'm referring to in the original post is cash specifically held aside to cover 1 -2 - 3 years of future expenses to avoid "selling in a down market." Cash that would otherwise be part of your FIRE investment AA.

Some folks seem to be doing this, some not.
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Old 07-12-2013, 07:26 PM   #5
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I think you have it right.
If I could get DW to say that once, just once, even joking, I'd being the happiest man in the world.......
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I've tried modeling this in the past, my models weren't really good enough that I felt like sharing them
Me too. It's a struggle to build in the opportunity cost of holding cash.
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On the flip side, my same crude models seem to tell me that adjusting spending in the face of a downturn doesn't help much either. Just on the surface, if your portfolio is down 40% or more (and that is what we see on the fails and near-fails in FIRECALC), changing spending from 4% to 2% for a few years is small potatoes. It helps, but that may be a big hit to lifestyle, and it probably only gains you a year or two before you fail.
+1
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Old 07-12-2013, 09:38 PM   #6
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I haven't tried modeling my method either. At least one study, discussed here before, has shown that holding even just one year in cash is a drag on portfolio performance. As far as I'm concerned, so are bonds.

So I'm "100% equities", which is actually 2% cash for liquidity reasons, although I've also been less than that. I've got a simple retirement portfolio projection where I sell enough equities at the start of each year to cover expenses. If the portfolio value hits that start of the year value early, I sell early and I'm covered for that year's expenses. Hopefully that can smooth things out a bit, though it will depend on how optimistic my market growth assumptions are. If I run out of cash it'll be month by month equity sales, hoping to delay as much as possible.
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Old 07-12-2013, 11:56 PM   #7
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I typically have similar amounts in cash or near-cash as well. It's not intended as "cash for the next two years expenses" but rather liquidity in the portfolio to allow for trading, rebalancing, evil market timing and such. And part of the 45% bond allocation invariably falls into the "near-cash" category. If I withdrew some of it for current expenses, that would save me from "selling in a down market" but might be an inconvenient development in regards to portfolio management flexibility. It would depend on what I had going on at the time. Through my first 7 years of FIRE, including getting through 2008 - 09, it hasn't been an issue.

The "cash" I'm referring to in the original post is cash specifically held aside to cover 1 -2 - 3 years of future expenses to avoid "selling in a down market." Cash that would otherwise be part of your FIRE investment AA.

Some folks seem to be doing this, some not.
Yes, I see. I don't compartmentalize or bucketize. To me cash is cash. I would only invest most of it in stocks if PE10 were 5 or 6. So I may be holding it mainly for investment reasons, but it would also buy a lot of groceries if necessary. I get SS, and my portfolio throws off a fair amount of cash. I live in a mortgage free reasonably well managed condo; I am not likely to need huge amounts of cash for life spending.

Ha
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Old 07-13-2013, 04:24 PM   #8
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I try to keep it simple. First, I don't hold cash so if I want to eat, I have to sell something (dividends and interest in taxable do defray some expenses). My equity target is 40% +/- 5pts so as long as equity is below 45% I sell bonds to eat.
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Old 07-13-2013, 07:14 PM   #9
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I agree youbet with S&P yielding 2% and total bond market at 2.5% the most of your portfolio you should have to liquidity a year is 1.5-2% (ignoring inflation here but I suspect during a real bad market most retirees pass on giving themselves an inflation raise).

Even during 2008 with -40% S&P the effects aren't devastating, and realistically during 2008 you AA had shifted enough that you would have sold your bonds not stocks.
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Old 07-14-2013, 08:34 AM   #10
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....Maybe I need to rethink this and establish a cash fund to cover the next few years? Comments?..
I have struggled a bit with this over the 18 months that I have been retired.

When I was working, I had a 60/40/0 AA and no real emergency fund but was unconcerned because I had a steady paycheck coming in and could always sell some taxable investments if I needed to.

When I first retired, I carved out a second bucket that had a couple years of living expenses that was separate from my 60/40 nestegg so my overall AA was ~56/38/6 in cash.

More recently, I decided it was simpler just to have my liquidity be a part of my 40% fixed income allocation so I'm currently 60/34/6. It helps that I'm more scared of interest rate risk than equity risk so I'm more comfortable being heavier in equities and lighter in bonds.

The 6% is for "normal" living expenses. If I have some special items coming up in the near future (like for example planning to replace a vehicle), I'll "carve out" the special items before assessing my AA so the 60/34/6 is after reducing the cash position of my nestegg for any special items.
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Old 07-14-2013, 10:05 AM   #11
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I have struggled a bit with this over the 18 months that I have been retired.
Yeah, I've been thinking about it too, obviously, and hence the thread. I've been FIRE'd 7 yrs. There were no liquidity issues the first couple of years since I received a severance package and had accumulated some cash since things were obviously troublesome with my MegaCorp employer. But as I spent a chunk of my new-found leisure time studying retirement investing and got most of my cash invested, I began to wonder how I'd handle day to day expenses if we had a big downturn.
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When I was working, I had a 60/40/0 AA and no real emergency fund but was unconcerned because I had a steady paycheck coming in and could always sell some taxable investments if I needed to.
I think pensions and SS partially (depending on how much of your budget they cover) create the same scenario. DW's mid-sized pension and my SS cover, roughly, half of our day-to-day expenses. The other half is easily covered by a 2% portfolio withdrawal. 2% happens to be my approximate average div + int yield. So far, there's never been a need to actually put in a sell order to get cash for day to day expenses. Taking the divs and int in cash does create a bit of a rebalancing issue however. I need to sell high asset classes and redirect the proceeds to low asset classes to rebalance instead of just redirecting divs and int.
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More recently, I decided it was simpler just to have my liquidity be a part of my 40% fixed income allocation
Agreed. My fixed allocation always seems to contain a chunk of "near-cash" such as soon-to-mature
CD's or bonds, short term bond funds, etc.

During 2009, I fretted a bit over where spending cash would come from, but it turned out to be a non-issue. Despite the sharp drop in equities, there always seemed to be more than enough opportunities to liquidate something favorably.

I would note that:

Someone living 100% off their portfolio (real early retirement folks!) would have to plan more carefully than our household where a pension and SS cover about half of our budget.

Someone with fewer holdings would have a more difficult time. Say someone holding only TSM and TBM etf's. My portfolio has dozens of holdings since I like to tinker. The equity portion is dominated by a low cost TSM index fund, but there are lots of other smaller positions to consider if I need to sell something.
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Old 07-14-2013, 10:24 AM   #12
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I don't foresee any problems with this and do not have a complex portfolio. I do have enough cash at Vanguard to cover several years' expenses, and to be honest I am lucky enough to have sufficient dividend income to cover my living expenses. Not only that, but for many of us it is nearly instinctual to cut back on spending at times when the market has tanked.

A down market is a great time to buy, so in a down market I would probably choose to just live off part of my dividend income and use the cash at Vanguard plus the rest of my dividend income to essentially buy low by rebalancing.
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Old 07-14-2013, 10:27 AM   #13
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I agree youbet with S&P yielding 2% and total bond market at 2.5% the most of your portfolio you should have to liquidity a year is 1.5-2% (ignoring inflation here but I suspect during a real bad market most retirees pass on giving themselves an inflation raise).

Even during 2008 with -40% S&P the effects aren't devastating, and realistically during 2008 you AA had shifted enough that you would have sold your bonds not stocks.
Yes, I had not taken into account that the divs/interest are already providing much of the withdraw. Couple this with rebalancing and very little selling would be needed for a downturn that lasts a few years.

And keeping enough cash to get through a long downturn will likely hurt in the long run.

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Old 07-14-2013, 11:48 AM   #14
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Despite the sharp drop in equities, there always seemed to be more than enough opportunities to liquefy something favorably.
Unless you are using a blender, I think you mean liquidate.
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Old 07-14-2013, 12:13 PM   #15
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Unless you are using a blender, I think you mean liquidate.
Thanks. Fixed.
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Old 07-14-2013, 04:33 PM   #16
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Unless you are using a blender, I think you mean liquidate.
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Thanks. Fixed.
Aww, I liked the original. Reminded me of this:



How about, pssssst, Wellesley, will it blend?

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Old 07-14-2013, 06:56 PM   #17
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It seems to me that lots of folks hang tough when the market is down, but many don't rebalance into the things that have dropped. A target retirement fund or a balanced fund like Wellesley or Wellington will do that for them without them even knowing it.
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Old 07-14-2013, 07:04 PM   #18
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It seems to me that lots of folks hang tough when the market is down, but many don't rebalance into the things that have dropped. A target retirement fund or a balanced fund like Wellesley or Wellington will do that for them without them even knowing it.
+1

Owning these funds allows me to focus all my efforts on hanging tough - no need to release my grip while I rebalance.
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Old 07-15-2013, 06:37 AM   #19
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It seems to me that lots of folks hang tough when the market is down, but many don't rebalance into the things that have dropped. A target retirement fund or a balanced fund like Wellesley or Wellington will do that for them without them even knowing it.
+1
Pretty much our plan with an additional chunk of cash that will take us through a few years when added to the bits coming in from small pension, dividends, and SS. The cash is also there for some purchases if the price is right.

Cheers!
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Old 07-16-2013, 02:00 PM   #20
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+1
Pretty much our plan with an additional chunk of cash that will take us through a few years........!
And the discussion goes full circle.......!

Clearly, there are no rights and wrongs here. Each strategy has its pros and cons and will win out over different periods of time.

My original question concerned the issue of whether it was worth it to hold a chunk of cash, perhaps at a significant opportunity cost, for the purpose of financing the next year or two or three of day to day living expenses. I haven't been. Others commented that they don't either because (1) the chances of a down market so broad that nothing in a diversified portfolio is a decent sell candidate are small, (2) the fixed portion of a portfolio likely contains "near cash" and (3) even if a tiny percentage of a portfolio's equity holdings had to be liquidated while the market is down, the impact of that action is small.

Still, I recognize the comfort involved in holding some cash specifically set aside to buffer against the possibility of having to sell a holding while the market for that holding is down.

I seems to be a matter of individual styles of investing and comfort levels with the need to make decisions and take action in various market circumstances. I think I'll stay as I am, zero cash held specifically to fund close-in budget needs and to avoid "selling in a down market." But the logic of those who choose to hold cash for that purpose certainly is reasonable.

Great discussion. I appreciate it.
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