Cash buffer vs. rebalancing

[Oz investor]

i class cash as money in normal ( and holding ) accounts and in inverse index ETFs ( as i will be selling them when in reasonable profit )

 

[Closet_Gamer]

+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

The simplicity of the 2.x% + 1% = 3.x% view had honestly not occurred to me.

Kudos.

How do you think about the occasional massive declines in dividends that accompany bears like the 2008 - 2009?

S&P 500 yields dropped ~24% from 2008-2011, only fully recovering in 2012. Today they are 50% higher than they were in 2008.

S&P 500 Dividend by Year

During that same window the whole bond market got pushed lower for short period of time but then recovered. Using Vanguards whole market ETF as a proxy:

https://finance.yahoo.com/quote/BND/

So over the medium term dividends obviously recovered plus a bunch, but during the crunch -- where the cash bucket theory would have bridged the pain and helped avoid selling shares at low prices to sustain income -- the dividend reduction was significant.

Is the right solution during that window to sell bonds, and eat additional bond principle while waiting for the dividends to recover?

Even more so if you have the courage to actively rebalance into equities at those lows.

 

[ERD50]

The simplicity of the 2.x% + 1% = 3.x% view had honestly not occurred to me.

Kudos.

How do you think about the occasional massive declines in dividends that accompany bears like the 2008 - 2009?
....

So over the medium term dividends obviously recovered plus a bunch, but during the crunch -- where the cash bucket theory would have bridged the pain and helped avoid selling shares at low prices to sustain income -- the dividend reduction was significant.

Is the right solution during that window to sell bonds, and eat additional bond principle while waiting for the dividends to recover?

Even more so if you have the courage to actively rebalance into equities at those lows.

I guess we can never know until we see a specific scenario, and then only in hind-sight. So sure, bond values may go down some, divs may go down some, but I still feel confident that the odds are that over a long retirement period, the many years of added gains from keeping the cash invested will outweigh any possible losses from a few years where we might pull a few % from principal at a sub-optimal time.

No way to know for sure, but the 'keep it simple' in me says just pick an AA and stick with it and enjoy life.

-ERD50

 

[Chuckanut]

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.

Good point on defining 'hurt'. It will vary from person to person.

FWIW, I actually managed to put some extra cash into the market during the crash of 2008/2009. Not enough to earn the label 'courageous' by any means. I had a CD coming due and decided I should practice what I preach and 'buy low'. And, I was working in a secure job with a regular paycheck coming in every month. At that time, I was planning on working for another 12 years. Had I known I would be retired within six years, I wonder what I would have done.

 

[googily]

There have been discussions lately about the low yields right now of bond funds and how the Vanguard prime money market is almost matching it for yield, with some people electing to move into VMMXX for the time being. Wondering about this in terms of this "cash bucket" discussion.

 

[OldShooter]

There have been discussions lately about the low yields right now of bond funds and how the Vanguard prime money market is almost matching it for yield, with some people electing to move into VMMXX for the time being. Wondering about this in terms of this "cash bucket" discussion.

Many years' experience has taught me that the more I play with my food, the less food I have. I am probably in the minority here, but I do not chase basis points. I am content to take a little risk, so all our ready "cash" is in SAMBX, which has been paying around 4%. That has been our choice for three or four years now. Changes occasionally happen when we take our annual look at the portfolio, but almost never outside that review.

 

[rayvt]

all our ready "cash" is in SAMBX

Initial Minimum Investment $100,000
Oof!

Morningstar says SAMBX is slightly lower return than OOSAX, with similar quality and risk profile. You just need to use a broker that waives the load, which Vanguard does.

 

[OldShooter]

... Morningstar says SAMBX is slightly lower return than OOSAX, with similar quality and risk profile. ...

At double the fee and 50% higher turnover? No thanks. Nothing predicts good long-term fund performance better than low fees.

TANSTAAFL; if the return is similar then the quality and risk are higher.

 

[Lsbcal]

In most "normal" market declines that occur due to recessions, bonds have positive returns helping to cushion the equity falloff. But there could be an inflationary market decline (like the 70's) where a cash bucket would be the better alternative to intermediate bonds.


My bet is on the "normal" market decline. So I have a 60/40 portfolio with a good helping of short term bonds for spending. At the start of the year nowadays I plan on moving the RMD's to a cash account for spending.

 

[mrfeh]

At double the fee and 50% higher turnover? No thanks. Nothing predicts good long-term fund performance better than low fees.

TANSTAAFL; if the return is similar then the quality and risk are higher.

We hold SAMBX also. But be prepared for it to lose value in a recession; that's the trade off for higher dividends during good times.

 

[mrfeh]

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.

Oh, I should add - when I say "cash", I mean short term investments: CDs, I Bonds and short term bond funds. Not actual cash.

 

[Oz investor]

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.

i consider my ' cash ' as parked ( in a relatively safe place ) rather than invested ( those inverse index funds should be very liquid in a major downturn , they are not about yields but about getting cash quickly into my trading accounts .. i expect savings accounts to be restricted during a bad downturn )

 

[OldShooter]

We hold SAMBX also. But be prepared for it to lose value in a recession; that's the trade off for higher dividends during good times.

Yup. That's the tradeoff. In 2008 it took a 25% hit but recovered within a year. We're willing to take a ride like that. Even if we have to sell some during a big dip, we have made enough money in the past few years compared to MM or T-bills that we will still be ahead. It definitely is not an investment for everyone, however. The rule about never buying something you don't understand definitely applies.

 

[Henry Lili]

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 )

Beautifully said.

 

[TwoByFour]

In most "normal" market declines that occur due to recessions, bonds have positive returns helping to cushion the equity falloff. But there could be an inflationary market decline (like the 70's) where a cash bucket would be the better alternative to intermediate bonds.


My bet is on the "normal" market decline. So I have a 60/40 portfolio with a good helping of short term bonds for spending. At the start of the year nowadays I plan on moving the RMD's to a cash account for spending.

I have a 60/40 AA also but the FI part is mostly a TIPS ladder with the rungs 1-year apart. I am never more than 1 year from getting full, inflation adjusted par value from any of those TIPS. Cash fills in for more immediate needs. Inflation scares me more than bear markets - loss due to inflation is permanent. Loss due to a bear has always recovered.

 

[CRLLS]

I never quite bought into the "cash" bucket theory. 1st, it is off the table for any real gains. Then, in times of need, it depletes almost as much as the market downturns. Then when things start to get better, one must steal from the gains to replenish the cash bucket.

It seems that this study supports that concept. The hard part is when things do go south, can I, will I, be able to ride it out. I did during the 2008 correction. Now, in the start of my decumulation phase, I wonder how I'll hold out. Time will tell.

 

[Lsbcal]

I have a 60/40 AA also but the FI part is mostly a TIPS ladder with the rungs 1-year apart. I am never more than 1 year from getting full, inflation adjusted par value from any of those TIPS. Cash fills in for more immediate needs. Inflation scares me more than bear markets - loss due to inflation is permanent. Loss due to a bear has always recovered.

I'm just not so sure about your last sentence. I am 70 and a 10 year bear market would not be something I want to go through even if it recovers after that. Not saying this will happen, just that it could. The 2008-2009 bear market was more like a 1.5 year one. Now the 1930's were quite another animal.

So I consider the equities risky in any 10 year time frame. Good to have a plan B.

 

[RobbieB]

I love cash! More cash means more dough to blow -

 

[TwoByFour]

I'm just not so sure about your last sentence. I am 70 and a 10 year bear market would not be something I want to go through even if it recovers after that. Not saying this will happen, just that it could. The 2008-2009 bear market was more like a 1.5 year one. Now the 1930's were quite another animal.

So I consider the equities risky in any 10 year time frame. Good to have a plan B.

None of us want to go through a 10 year bear. But I can weather it OK. Our withdrawal rate is about 3.4% and since our fixed income is all inflation tracking, we can live off nothing but FI for almost 12 years. We could not do that if a big chunk of our assets were cash. Inflation would whittle it down. That was my point.

 

[GravitySucks]

The simplicity of the 2.x% + 1% = 3.x% view had honestly not occurred to me.

Kudos.

How do you think about the occasional massive declines in dividends that accompany bears like the 2008 - 2009?

S&P 500 yields dropped ~24% from 2008-2011, only fully recovering in 2012. Today they are 50% higher than they were in 2008.

S&P 500 Dividend by Year

During that same window the whole bond market got pushed lower for short period of time but then recovered. Using Vanguards whole market ETF as a proxy:

https://finance.yahoo.com/quote/BND/

So over the medium term dividends obviously recovered plus a bunch, but during the crunch -- where the cash bucket theory would have bridged the pain and helped avoid selling shares at low prices to sustain income -- the dividend reduction was significant.

Is the right solution during that window to sell bonds, and eat additional bond principle while waiting for the dividends to recover?

Even more so if you have the courage to actively rebalance into equities at those lows.

Thanks for the dividend table. I remember dividend cuts happened, but rarely see it mentioned here and was to lazy to look for the info.
In the other side of the coin a good amount of my current budget items went for fire sale prices at the time. DW got a used Caddy she always wanted for 1/2 the 07 price. We stayed for 3 weeks in a nice ocean view studio motel for less than $750. That's less than current weekly rate.
So lower dividends, maybe lower expenses.

 

[OldShooter]

... Inflation scares me more than bear markets - loss due to inflation is permanent. Loss due to a bear has always recovered.

+1

 

[Oz investor]

inflation is a major concern for me as well , hopefully i can keep ahead of inflation , but history suggests that will be a very hard task .

however a market dip is something i MIGHT be able to take advantage of .

as i was well aware of the dividends being reduced in harsh times , but runaway inflation would slash spending power

 

[rayvt]

We hold SAMBX also. But be prepared for it to lose value in a recession; that's the trade off for higher dividends during good times.

My primary thought about SAMBX was that $100,000 minimum investment. Didn't bother to look further, but I suspect that there are other similar funds that have lower minimums.

I've always wondered about these high minimum funds----can you play a game by opening for $100K and then withdrawing $90K, if you only want to put $10K in it?

Both SAMBX and OOFAX have average credit quality of B.
B = Non-investment grade = junk bonds. Morningstar puts them in lower left quadrant, which is "low credit quality".

Seems to me that junk bond investments are more "investment" type investments than a safe harbor for your cash. Reaching for yield is risky.

 

[mrfeh]

My primary thought about SAMBX was that $100,000 minimum investment. Didn't bother to look further, but I suspect that there are other similar funds that have lower minimums.

I've always wondered about these high minimum funds----can you play a game by opening for $100K and then withdrawing $90K, if you only want to put $10K in it?

Both SAMBX and OOFAX have average credit quality of B.
B = Non-investment grade = junk bonds. Morningstar puts them in lower left quadrant, which is "low credit quality".

Seems to me that junk bond investments are more "investment" type investments than a safe harbor for your cash. Reaching for yield is risky.

We bought it 5 years ago when total bond was returning <2%. I was willing to take the risk, and it has worked out.

That said, it is less than 10% of our fixed income holdings. And now that dividends for total bond are improving, there's a good chance we'll dump SAMBX, especially if it looks like a recession is imminent.

 

[scrabbler1]

I guess we can never know until we see a specific scenario, and then only in hind-sight. So sure, bond values may go down some, divs may go down some, but I still feel confident that the odds are that over a long retirement period, the many years of added gains from keeping the cash invested will outweigh any possible losses from a few years where we might pull a few % from principal at a sub-optimal time.

No way to know for sure, but the 'keep it simple' in me says just pick an AA and stick with it and enjoy life.

-ERD50

I agree. I hate the idea of tying up any significant blob of money in cash where it earns nearly nothing. The closest thing I have to cash in terms of stability and liquidity is the ~$40k I have in an intermediate-term muni bond fund which earns about 2.5%, mostly tax-free, and ha checkwriting privileges.

My ER portfolio generates a steady, reliable income stream consisting of 12 monthly payments (from a bond fund) and 4 quarterly payments (from a stock fund), enough to pay my bills with a reasonable cushion, or surplus, to cover any small, unforeseen expenses. Any remaining surpluses over time get reinvested somewhere.