Our plan is to set aside cash for three year worth of expenses to avoid selling stocks in a downturn market. We figure probability wise, three year would be sufficient in general. Our total annual expenses are about 100K but our current investments in our taxable accounts generate about 110K per year, mostly come in the form of monthly or quarterly dividend/interest. So does that mean we only need to set aside two years worth of cash to meet our goal of three year or we do not need any cash set aside since the income stream comes in on a regular basis? Knowing that in a downturn market, dividend could be cut, but our 100K/yr expense includes discretionary spending which I assume that we could cut back if needed.
I am curious how everyone does this as for most ERs, we would be relying on passive income stream to cover our expenses. Having worked our whole lives and most of our effort is spent on saving and now has more questions on spending as we plan for our retirement.
Clearly you're extremely, extremely conservative in this regard. Depending on your specific AA, the chances you'd need to sell diminished equities to cover expenses in a down market is close to nil. So, it's your choice. You'll bear the pain of reduced returns from carrying excessive "what if a down market happens" cash and you'll gain approximately zero protection from "selling equities in a down market."
What is your current AA? Are you sure that in a down equity market you'd have to sell diminished equities? That is, there would be absolutely nothing else in your portfolio you could tap?
DW and I were fully retired at the onset of the Great Recession (that enough of a "down market for ya?) and had an approximate 60/40 AA. DW had a pension which covered about one third of our expenses and I had zero. By taking our divs + interest and spending some bonds that matured, we were never even close to needing to sell diminished equities. And we did not cut spending a penny.
I think the need for holding cash to cover expenses in a so-called "down market" is highly overstated for folks with diversified portfolios....... Now, having said that, if you have an extremely high equity AA paying low dividend levels, that might be another story. Why don't you share some details with us in that regard?
Edit: I should add, if you're a nervous Nelly (and I don't mean that in a derogatory way - we all are who we are), and having cash available to avoid any portfolio maneuvering when making major purchases or in so-called "down markets," helps your peace of mind, then keep the cash. The dollars lost to the expense of holding cash would be well spent if they help you sleep at night!
While I keep a bit of emergency cash on hand and have access to credit (which in 12+ yrs of FIRE I've never needed), I actually enjoy cruising the portfolio looking for harvest opportunities when the need for "spendin' money" arises!