Cash buffer vs. rebalancing

[Chuckanut]

I have often wondered if having a cash buffer (perhaps 3-5 years) in the event of a huge bear market was worth earnings one gives up.

This article in today's WSJ indicates that it may be better to set one's AA and then rebalance while staring into the teeth of the Bear market.

Sorry this is behind a pay wall.

https://www.wsj.com/articles/retiri...rns-1537522201?mod=searchresults&page=1&pos=3

Here is the relevant paragraph:

According to recent research, which looked at 140 combinations of investment strategies, withdrawal rates, and buffer-zone sizes over successive 30-year periods from 1926 to 2009, investors came out ahead with cash-buffer strategies in only three instances. In contrast, with rebalanced portfolios, they came out ahead in 70 simulations, said co-author David Nanigian, associate professor of finance in the Mihaylo College of Business and Economics at California State University, Fullerton. In the remaining 67 combinations, the strategies performed the same, he said.

[-]If I can find the study online I will post a link.[/-]

Here is the link to the study:

https://www.onefpa.org/journal/Page...rical Evidence on Buffer Zone Strategies.aspx

 

[Floridatennisplayer]

It is a part of my plan.

 

[Fedup]

I understand this better after I read the article. The implementation state will take time.

 

[Oz investor]

with prudent flexibility or without

might be an interesting extra question

for example i am taking profits at sensible opportunities , but sensible buying opportunities are much harder to find , so by default i am increasing my cash buffer ( in an 'at call account ' )

certainly should promote extra thought in some members

 

[TwoByFour]

Are you saying you spend down the cash when the market crashes? How does that differ from spending down from the fixed-income part of your assets when the market is down? After all, a down market will push the AA out of whack towards too much FI, so when rebalancing you sell some FI and use part (or all) of that money to fund your withdrawals. And for many of us, part of our FI is cash, so whether we sell a bond or spend cash is really immaterial, the point is still that you are not selling equities that are under water which I believe is the point of a cash buffer scheme. Or is it something else?

 

[LOL!]

There are quite a few studies which show a cash buffer hurts an investor.

To my knowledge there are no studies which concluded a cash buffer did one any good except psychologically.

We don't keep any more cash around than enough to pay the next month's bills.

 

[Oz investor]

Are you saying you spend down the cash when the market crashes? How does that differ from spending down from the fixed-income part of your assets when the market is down? After all, a down market will push the AA out of whack towards too much FI, so when rebalancing you sell some FI and use part (or all) of that money to fund your withdrawals. And for many of us, part of our FI is cash, so whether we sell a bond or spend cash is really immaterial, the point is still that you are not selling equities that are under water which I believe is the point of a cash buffer scheme. Or is it something else?

currently i have very little in interest-bearing securities , most current offering are junk debt ( unsecured and low priority ) with a fancy corporate name on top , in my locale

i have resorted to 'bond proxies ' ( property trusts ) to work around this

if the market corrects/retracts i will be looking to invest some of that cash buffer ( not just spend it )

although i have been forcibly retired , time will tell if i am truly financially independent ( in the mid-term ) currently dividend returns plus the disability pension are giving me a cash surplus ( as well as less options to spend cash )

but if the economy turns down and dividends reduce how will that go ?

already suggestions are being made on private specialist medical consultations so health-care costs could accelerate drastically .

my discretionary spending should stay flat until 2020 ( maybe even 2022 )

i like to take SOME profit out in a rising market ( and hopefully beat the rush , if sentiment turns )

 

[AginMS]

Kitces wrote a nice article about managing sequence of returns risk using a bucket vs rebalancing approach. He shows that rebalancing is a superior strategy if you can overcome the psychology of wanting to keep a stash of cash out of the market.

Here’s the link:
https://www.kitces.com/blog/managin...egies-vs-a-total-return-rebalancing-approach/

There was a good Bogleheads discussion of the article here:
https://www.bogleheads.org/forum/viewtopic.php?t=238979

 

[ERD50]

There are quite a few studies which show a cash buffer hurts an investor.

To my knowledge there are no studies which concluded a cash buffer did one any good except psychologically.

We don't keep any more cash around than enough to pay the next month's bills.

+1

It's hard to understand how anyone would think a cash buffer would be a benefit if they've actually thought about the numbers, instead of just thinking about it emotionally.

We invest in the market because we expect the market to go up on average, over the long run, over and above cash and fixed income. If we didn't have some degree of faith in this, we would not (should not? it is a choice) be in the market.

So why would we want a bunch of $ stuck in cash?

And consider a conservative w/d rate, say 3.x%, and a typical AA will provide ~ 2.x% in divs. So we only need to draw ~ 1% from principal. So a mildly conservative AA, say 60/40, means you can draw from fixed for ~ 40 years, before needing to sell any equities (that's an over-simplification, the fixed will be reduced each year with the withdrawal, but it illustrates the point).

Forget buckets, forget cash buffer - that's what your AA is for. Keep it simple, enjoy life.

-ERD50

 

[Fedup]

I’m certainly guilty. I should join Cash hoarders anonymous.

 

[Oz investor]

+1

It's hard to understand how anyone would think a cash buffer would be a benefit if they've actually thought about the numbers, instead of just thinking about it emotionally.

We invest in the market because we expect the market to go up on average, over the long run, over and above cash and fixed income. If we didn't have some degree of faith in this, we would not (should not? it is a choice) be in the market.

So why would we want a bunch of $ stuck in cash?

And consider a conservative w/d rate, say 3.x%, and a typical AA will provide ~ 2.x% in divs. So we only need to draw ~ 1% from principal. So a mildly conservative AA, say 60/40, means you can draw from fixed for ~ 40 years, before needing to sell any equities (that's an over-simplification, the fixed will be reduced each year with the withdrawal, but it illustrates the point).

Forget buckets, forget cash buffer - that's what your AA is for. Keep it simple, enjoy life.

-ERD50

i am accumulating a cash buffer for two main reasons

first i am finding it hard to currently find sensible places to invest it

second my health-care costs could easily blow out

less relevant is i think the stock market is approaching a peak ( and should correct sooner rather than later )

also having a cash buffer will allow me to invest in other distressed markets ( say if property collapses )

i would rather my cash working but there has to be suitable returns for that risk taken ( and cash in the bank is not 100% safe either )

also plan A , is to resist drawing down on the investment portfolio only utilize the income it produces ( profits taken are re-invested where sensible opportunities occur )

 

[UnrealizedPotential]

I don't think this is a simple question. One thing I do is try and put myself in a position to where my portfolio throws off much more income than I need. I would go crazy trying to figure the best thing to do in all situations. So I just try and have plenty of income coming in and it makes it much easier to deal with all the tough questions that I don't know the answer to.


The other way I attack this is through my Asset Allocation. Right now I have a little over 40% bonds, 56% stocks and the rest is cash. If I can sleep at night that helps a lot.

 

[GrayHare]

I've liked the following Christine Benz "Ready Your Portfolio for Retirement" discussion of buckets, cash buffers, etc.

https://www.morningstar.com/videos/641676/ready-your-portfolio-for-retirement.html

 

[audreyh1]

There are quite a few studies which show a cash buffer hurts an investor.

To my knowledge there are no studies which concluded a cash buffer did one any good except psychologically.

We don't keep any more cash around than enough to pay the next month's bills.

“Hurt” is a matter of degree and timing.

A cash buffer may hurt an investor (or their heirs) slightly in the long-run since it slightly lowers long-term returns.

Once someone retires, they may not be as concerned with optimizing long term returns anymore so long as the retirement fund does not run out of money. Hopefully someone has already selected a reasonable withdrawal rate and AA that their chances of running out of money is very low.

Retirees, especially those living only on their investments, have to live with market volatility and balance getting through the short term as well. I don’t think a cash buffer causes serious harm and IMO slightly lower end of life assets don’t matter so much unless you are seeking to optimize what you pass along to heirs.

BTW OP, rebalancing while staring into the teeth of a bear market is a very psychologically difficult thing to do. This should not be taken lightly. For many folks in 2008/2009 the best they could manage was to hang in there and not sell, let alone rebalance and buy more stocks. Not to mention so many folks so scared they bailed. I believe that psychology plays a very large role in long-term investing, and you had better know yourself well and use whatever techniques will help you hang in there.

 

[TwoByFour]

i would rather my cash working but there has to be suitable returns for that risk taken ( and cash in the bank is not 100% safe either )

I used to approach the fixed income part of our portfolio as needing to generate a return but a couple of years ago I decided to completely partition risk so that all the market risk is on the equity side. Basically I dumped all the corporate bond funds we held and have been converting bond funds to bond ladders. Doing the latter removes interest rate risk since I will never sell a bond before its maturity. All of our bonds are now US Treasuries, from 2-year to 10-year, with a lot of TIPS.

To make up for the fact that the FI portion of our portfolio is not expected to do better than keep pace with inflation, I just tilted the AA a little more to equities. I like this configuration a lot, it is more robust in the face of a market crash and has good resiliency against inflation.

So a cash bucket is not needed in this scheme. If I get worried enough about an impending crash I might shift the AA back towards more FI.

 

[GrayHare]

When you've won the game, why continue to take unnecessary risks? Yes, maybe without cash I can die with a portfolio near the top of FIRECalc's projection range, but I won't need it.

 

[Dtail]

Sometimes it is relative what one calls "cash". Many folks have CD's as part of their non equity portfolio. One could state depending on the duration that it is cash or a bond fund substitute.

 

[Oz investor]

I used to approach the fixed income part of our portfolio as needing to generate a return but a couple of years ago I decided to completely partition risk so that all the market risk is on the equity side. Basically I dumped all the corporate bond funds we held and have been converting bond funds to bond ladders. Doing the latter removes interest rate risk since I will never sell a bond before its maturity. All of our bonds are now US Treasuries, from 2-year to 10-year, with a lot of TIPS.

To make up for the fact that the FI portion of our portfolio is not expected to do better than keep pace with inflation, I just tilted the AA a little more to equities. I like this configuration a lot, it is more robust in the face of a market crash and has good resiliency against inflation.

So a cash bucket is not needed in this scheme. If I get worried enough about an impending crash I might shift the AA back towards more FI.

i originally had a very nice portfolio in interest-bearing securities ( very nice yield v. acceptable risk ) but as the various (international ) QEs gained tractions those securities were redeemed or just simply matured ( and the replacement debt securities were clearly inferior , often completely unsecured and also reduced yields )

ideally i would like my portfolio to NOT lag inflation , the only way to potentially beat inflation is to demand high(er ) yields as an entry requirement in new investments .

unlike many members my future expenses are very uncertain , they could move markedly either way ) ( both near-term and mid-term )

i am looking at interest bearing securities regularly but am unwilling to simply buy this asset class simply because a theory says a certain percentage is ideal ( it has to be a sensible investment )

 

[DEC-1982]

I have a cash buffer. It helps me to sleep better than I would without it.

There are many studies showing that keeping a cash buffer pulls down your rate of return. As long as one is comfortable with that lower rate of return, there is nothing wrong with keeping that cash buffer.

 

[RunningBum]

Everybody has a cash buffer of some sort. That's not what this is about. The question is whether you use it to jump in the market when it's low.

 

[Oz investor]

Everybody has a cash buffer of some sort. That's not what this is about. The question is whether you use it to jump in the market when it's low.

for me , SOME of it undoubtedly
will it be 50% or 90% ( of the cash buffer ) ??
time will tell ,
i was very distracted during the GFC , so a distraction during the next downturn must be considered as well .

i am hoping to exploit the next big dip , but fate might decide otherwise

 

[Dtail]

Everybody has a cash buffer of some sort. That's not what this is about. The question is whether you use it to jump in the market when it's low.

For me the cash buffer is to manage ACA income, thus it stays outside the markets. Different for everyone I guess.

 

[pb4uski]

..... For many folks in 2008/2009 the best they could manage was to hang in there and not sell, let alone rebalance and buy more stocks. Not to mention so many folks so scared they bailed. I believe that psychology plays a very large role in long-term investing, and you had better know yourself well and use whatever techniques will help you hang in there.

That was me. I was like a deer in the headlights.... parallelized by the uncertainty. I stood pat but I could not muster the courage to sell bonds and buy more stocks... if I had I would be much richer today.

Back then I was working and had a secure job so the dough was rolling in every couple weeks. If it happens again, I'm not sure what I will have the courage to do.... I suspect that I would at least stand pat but possibly might buy more stocks.

I know a couple people who were older and retired who bailed from stocks and never bought back in.

 

[mrfeh]

I have often wondered if having a cash buffer (perhaps 3-5 years) in the event of a huge bear market was worth earnings one gives up.

This article in today's WSJ indicates that it may be better to set one's AA and then rebalance while staring into the teeth of the Bear market.

I agree completely.

However, not all situations are identical. We do carry about 3 years of expenses in cash, and that is because we are living solely off our taxable accounts for 7 years, until we can access our 401Ks and IRAs. For tax efficiency, our taxable accounts are 100% equities, which means they are especially susceptible to sequence of returns risk.

So, our cash buffer is a safety net against running our taxable accounts dry before we have access to other sources of money.

 

[OldShooter]

As someone pointed out, these discussions are fraught because "cash" is not defined. I like looking at our fixed income allocation as an available bucket, but some would argue that we hold no cash. Just a bunch of TIPS and a bunch of SAMBX, a bank loan fund that pays about 4%. As we need money to live on, we sell SAMBX. We really don't want to sell the TIPS, so if necessary and if the market has not tanked, we will replenish the bucket by selling equities. That decision is several years down the road.

What will we do in a market drop? I don't know. We have always been near 100% equities in past drops, so there were no decisions other than to sit tight. Now we are about 75% equities, so I guess there can be some decisions. Probably we will just sit tight, though. We are among the fortunate who have won the game, so there is no need to play aggressively any more.