Managing Near-Term Assets

[clifp]

+1

I think people get way too hung up on the concept of 'short term money. It's all money, people.

It would be different for someone who needed exactly $X in one year, and $X was the only liquidity they had at the time. Yes, then you need to be super-conservative with it. OTOH, are you really planning to spend your last liquid dollar within the next year? Sounds like a bigger problem needs to be solved.

-ERD50

+1 and 1/2

Before the meltdown I also operated in the one big pot of money. I still mostly operate this way.

However, 3 years ago I started building a CD ladder which has 1/2 years living expense in each year as well as keeping ~1/2 year in money market/savings. The plan was to make a 5 year CD ladder although with Penfed 10 years CD who knows...

There is some comfort in knowing that if the market goes south, interest rates plummet, and dividends get cut, that will have a year to figure out which depressed assets I need to sell to maintain my living.

 

[audreyh1]

Yes, it's mostly psychological, although experts do tell you to manage money intended for different time frames separately.

Over 10 years, my short-term fund for living expenses has allowed me to look at my long-term portfolio in a much more dispassionate way, ignore sudden scary market events, and still rebalance when blood is in the streets instead of running for the hills. Without it, I'm not sure I would be able yo stay disciplined with my long-term investment plan.

In investing, psychology is everything, IMO.

Audrey

 

[dex]

+1 and 1/2

Before the meltdown I also operated in the one big pot of money. I still mostly operate this way.

However, 3 years ago I started building a CD ladder which has 1/2 years living expense in each year as well as keeping ~1/2 year in money market/savings. The plan was to make a 5 year CD ladder although with Penfed 10 years CD who knows...

There is some comfort in knowing that if the market goes south, interest rates plummet, and dividends get cut, that will have a year to figure out which depressed assets I need to sell to maintain my living.

Shouldn't that be -1 and 1/2 since you are disagreeing with the idea of one pot of money?
---
I think your 3 years of cash is the way to go. You can ride out most stock market downtrends. If that isn't enough you could use dividends/interest to prepare for a longer time period.

 

[FinanceDude]

The bucket approach works well, ya just need different size buckets...............

 

[LOL!]

Yes, it's mostly psychological, although experts do tell you to manage money intended for different time frames separately.
...
In investing, psychology is everything, IMO.

Audrey

I agree that it is psychology, mental accounting, and behavioral traps. But it seems to me that one can rise above these if one acknowledges these factors. I liked the book by Gilovich and Belsky "Why Smart People Make Big Money Mistakes and how to correct them". After I read that book, I threw off the chains that had been holding me back. I step over buckets nowadays and not in them.

 

[audreyh1]

Why "rise above" something that works well? This is not a "mistake" that needs to be corrected. Certainly not a "Big Money Mistake". I am not seeking to maximize long term return, just to manage volatility and have a reasonably long portfolio survival.

Audrey

 

[BigNick]

The reason we keep separate cash buckets (rather than plan for liquidation of stock/bond fund holdings) is that the market is always in flux, for both stock/bond holdings (as you well know) and we don't want to get into a position of selling when funds are at a point lower than purchase price (e.g. not paper, but actual loss). As profits (in both equity & bond holdings) are shown throughout the year, a portion of these funds are sold off and added to cash, if needed to maintain our target. If it's a down year (e.g. 2008), we just sit tight (but sleep well).

I'm slightly surprised that someone who obviously thinks very hard about their investments would still have this approach to sunk costs. Give or take the costs of the transaction, it makes no difference whether you realise the loss or spend the cash - in fact, there might be tax advantages to taking the loss.

There are good risk management reasons to hold a mixture of bonds and cash (and the rest), but to not sell a particular asset simply it would represent a nominal loss compared to the purchase price is not rational.

Assuming (again) that transaction costs and tax considerations can be discounted, you have a pile of "money" (stocks, bonds, cash) and a decision to make about how you balance the future growth/income/risk associated with that pile of money. That's it. How much you bought X stock or Y bond for is irrelevant. (Of course, it has emotional value, but taking advantage of people's tendency to honour sunk costs is one of the ways in which the hard-headed people make money.)

 

[Free To Canoe]

For the first year of our cash stash we use a money-market account.

For the second year of our cash stash we use a five-year CD ladder, with the idea being that we hopefully won't have to break into it but once or twice a decade. As you can imagine, we re-started this system in 2009...

Do you have set rules for replenishment of the stash once depleted?

Free to canoe

 

[clifp]

Personal finance for Vulcans

Shouldn't that be -1 and 1/2 since you are disagreeing with the idea of one pot of money?
---
I think your 3 years of cash is the way to go. You can ride out most stock market downtrends. If that isn't enough you could use dividends/interest to prepare for a longer time period.

No I fundamentally agree with the one pot money. I agree with ERD50 that people are way too hung up on buckets. I find Ray Luca (sp) buckets overly complicates things. I believe BigNicks analysis is spot on. Money is money it is extremely fungible and liquid assets be the stocks, bonds, money market funds, and even CDs are just that--liquid and easily transformed in cash needed to pay property taxes, grocery bills and utilities.

I'd even argue that having one pot, instead of buckets helped make money during the crisis. Because I had all my cash in one pot I was all be to take advantage of the huge opportunities to buy ownership in fabulous US and global companies at bargain prices. Like Warren Buffett I was convinced that stock prices would be significantly higher in 2013 and beyond than the were in Q4 2008. If I had my money in buckets I wouldn't have been able to take advantage of the bargains. Now like a lot of board members, I have a fair amount of Vulcan in my blood, which is generally a good thing during crisis cause it lets you invest with your brain and not your emotions.

However, one of the most important things I've learned in the last few years is that there are two sides to Personal Finance. The finance and the personal. From analytical, MBA,Vulcan, amateur stock analyst, finance etc side, I don't understand the bucket approach. Nor for that matter your decision to be 100% in cash. However, from personal side I really do.

I think I've posted about this before but maybe worth repeating. By Dec of 2009, I had completely used all of my cash reserves buying stocks that I was sure were undervalued. However, these stocks not only weren't going up but seemed to continue down at dizzying pace. Now a fair number of people did this back then obviously including Warren Buffett. However, I took it a step further. I also beginning writing naked puts on various stocks. In effect, I was writing insurance policy for investors terrified that their stocks were going to down to near zero Now this would have ok because the insurance premiums were so incredibly high due to the fear in the markets (i.e the volatility index VIX was off the charts) and many cases the puts were for Jan 2010 so I had plenty of time to come up with the cash. At one point I had written almost 200K in insurance policies/puts.

Now rationally,even the market if went down to Dow 2500, I still had enough GNMA funds, and Municipal bonds to pay off the insurance claims and still have a year or two worth of living expenses even if all my dividend stocks stopped paying. Compared to the vast majority of American I knew I was very good shape.

This is where the "personal" part of personal finance comes in. Eventhough rationally I knew that odds that various municipal bonds much less GNMA bonds would default or their price would collapse were very slim, in 2008 I realized anything was possible. When I looked at the few thousand dollar in a money markets, 10K in Ibonds and lousy 10K CD at Penfed due in Oct 2010, I had a genuine moment of panic. I thought "dude you have really screwed yourself, and your very comfortable Hawaii retirement." All those stocks, bonds, and MLPs you have are nice, but as far as cash goes you really don't have crap . How exactly are you going to pay your living expenses? "Mr sophisticated investor" you are a stupid idiot.

At personal level I started to really understand the appeal of CD ladders, buckets etc. I definitely would have slept better in 2008, knowing that no matter what happens in the stock or bond market a good chunk of my living expense over the next few years are in a bank with FDIC insurance. Now I frankly I hate locking my money away in a CD pay 3 or 3.5% or even the 5% 10 year PenFed CD knowing that the interest if fully taxable and at historically low levels etc. From a finance prospective is sub optimal in my opinion, however the peace of mind it provides is extremely value.

Likewise from a finance perspective I don't understand being a 100% cash, with zero current interest rates. But I completely understand the fear of losing 20 or 30% or maybe even 50% of your assets if we see Dow 5000 in the next year or so. The pain of losing far outweighs the potential benefits if you miss out on a move from 10,000 to Dow 15,000. This analysis is a completely personal one and there is no right or wrong answer. While we talk about risk tolerance, I think the reality is you don't really know your risk tolerance until you've experienced it. Boy did we all get a wonderful learning experience over the last couple of years. One which I'm perfectly happy never to repeat.

So my 1/2 vote for buckets or a separate short-term fund is for a really simple reason, if it helps you sleep better at night, then the economic pro or cons don't matter much.

 

[rescueme]

I'm slightly surprised that someone who obviously thinks very hard about their investments would still have this approach to sunk costs. Give or take the costs of the transaction, it makes no difference whether you realise the loss or spend the cash - in fact, there might be tax advantages to taking the loss.

There are good risk management reasons to hold a mixture of bonds and cash (and the rest), but to not sell a particular asset simply it would represent a nominal loss compared to the purchase price is not rational.

Assuming (again) that transaction costs and tax considerations can be discounted, you have a pile of "money" (stocks, bonds, cash) and a decision to make about how you balance the future growth/income/risk associated with that pile of money. That's it. How much you bought X stock or Y bond for is irrelevant. (Of course, it has emotional value, but taking advantage of people's tendency to honour sunk costs is one of the ways in which the hard-headed people make money.)

First, all sales transactions are "tax neutral", since +95% of our retirement investments are in tax-deferred funds, and "sales to cash" are also held in the tax-deferred MM accounts. We do not pay any federal tax until the money is transferred to our checking account. BTW, we pay no state/local tax on any withdrawals, since our state/local taxes were paid at the time of contribution. Any gains (which is the money we're withdrawing) is tax free - other than federal tax. Since we would not gain anything from selling at a loss, there is no need to consider what is normal in a taxable account, since we don't hold any such investments. The other 5% is held in tax-free accounts (e.g. Roth and non-deductable IRA's).

I know you will probably respond with movement of funds from tax-deferred to non-tax (e.g. Roth conversion). We've already run the numbers, and since tax would have to be paid out of tax-deferred funds, the tax hit would be considerable. I'm a firm believer in not paying tax till tax is due. Since the majority of our terminal estate will be going to charity (except a portion to additionally fund our disabled son's trust) and if the tax laws do not change radically, a good portion of our estate will be going to our named charities with little/no tax paid.

Lastly, even though in dollar amount we have a lot in "cash", to take care of immediate retirement expenses, the actual % vs. our total holdings is quite small from an overall view. And over the next 7 years or so, that percentage will be less and less, as our SS and pensions come on-line. In fact, at that time our estimated withdrawl rate (around 2%) will be due to excess RMD's (e.g. money withdrawn beyond what we need to live on). We would be close to a 0% withdrawl rate if excess RMD's were not required.

 

[dex]

No I fundamentally agree with the one pot money. I agree with ERD50 that people are way too hung up on buckets. I find Ray Luca (sp) buckets overly complicates things. I believe BigNicks analysis is spot on. Money is money it is extremely fungible and liquid assets be the stocks, bonds, money market funds, and even CDs are just that--liquid and easily transformed in cash needed to pay property taxes, grocery bills and utilities.

I'd even argue that having one pot, instead of buckets helped make money during the crisis. Because I had all my cash in one pot I was all be to take advantage of the huge opportunities to buy ownership in fabulous US and global companies at bargain prices. Like Warren Buffett I was convinced that stock prices would be significantly higher in 2013 and beyond than the were in Q4 2008. If I had my money in buckets I wouldn't have been able to take advantage of the bargains. Now like a lot of board members, I have a fair amount of Vulcan in my blood, which is generally a good thing during crisis cause it lets you invest with your brain and not your emotions.

However, one of the most important things I've learned in the last few years is that there are two sides to Personal Finance. The finance and the personal. From analytical, MBA,Vulcan, amateur stock analyst, finance etc side, I don't understand the bucket approach. Nor for that matter your decision to be 100% in cash. However, from personal side I really do.

I think I've posted about this before but maybe worth repeating. By Dec of 2009, I had completely used all of my cash reserves buying stocks that I was sure were undervalued. However, these stocks not only weren't going up but seemed to continue down at dizzying pace. Now a fair number of people did this back then obviously including Warren Buffett. However, I took it a step further. I also beginning writing naked puts on various stocks. In effect, I was writing insurance policy for investors terrified that their stocks were going to down to near zero Now this would have ok because the insurance premiums were so incredibly high due to the fear in the markets (i.e the volatility index VIX was off the charts) and many cases the puts were for Jan 2010 so I had plenty of time to come up with the cash. At one point I had written almost 200K in insurance policies/puts.

Now rationally,even the market if went down to Dow 2500, I still had enough GNMA funds, and Municipal bonds to pay off the insurance claims and still have a year or two worth of living expenses even if all my dividend stocks stopped paying. Compared to the vast majority of American I knew I was very good shape.

This is where the "personal" part of personal finance comes in. Eventhough rationally I knew that odds that various municipal bonds much less GNMA bonds would default or their price would collapse were very slim, in 2008 I realized anything was possible. When I looked at the few thousand dollar in a money markets, 10K in Ibonds and lousy 10K CD at Penfed due in Oct 2010, I had a genuine moment of panic. I thought "dude you have really screwed yourself, and your very comfortable Hawaii retirement." All those stocks, bonds, and MLPs you have are nice, but as far as cash goes you really don't have crap . How exactly are you going to pay your living expenses? "Mr sophisticated investor" you are a stupid idiot.

At personal level I started to really understand the appeal of CD ladders, buckets etc. I definitely would have slept better in 2008, knowing that no matter what happens in the stock or bond market a good chunk of my living expense over the next few years are in a bank with FDIC insurance. Now I frankly I hate locking my money away in a CD pay 3 or 3.5% or even the 5% 10 year PenFed CD knowing that the interest if fully taxable and at historically low levels etc. From a finance prospective is sub optimal in my opinion, however the peace of mind it provides is extremely value.

Likewise from a finance perspective I don't understand being a 100% cash, with zero current interest rates. But I completely understand the fear of losing 20 or 30% or maybe even 50% of your assets if we see Dow 5000 in the next year or so. The pain of losing far outweighs the potential benefits if you miss out on a move from 10,000 to Dow 15,000. This analysis is a completely personal one and there is no right or wrong answer. While we talk about risk tolerance, I think the reality is you don't really know your risk tolerance until you've experienced it. Boy did we all get a wonderful learning experience over the last couple of years. One which I'm perfectly happy never to repeat.

So my 1/2 vote for buckets or a separate short-term fund is for a really simple reason, if it helps you sleep better at night, then the economic pro or cons don't matter much.

Good perspective. You can tell, I really don't have 'pots' of money.

I think the psychological aspect of investing is the most important. We are our own worst enemies in that regard. Most systems try to take out the emotional aspects. In that regard the 'pots' of money is a good idea, it also gives structure.

From my reading of those who lost most or all of their money in 'investing' or 'trading' the one mistake they made was they didn't have a goal for when to quit. They may have made a lot of money but didn't stop and change gears from making money to preserving and enjoying it.

So, I am at the point of preserving and enjoying it. At this time I see the risk losing more money than can be gained in stock market. The bond market is not worth the time, nor does it fit into the time line I see for when I might move out of cash.

You might be interested in reading the book by this guy. He has good advise.
Jesse Lauriston Livermore - Wikipedia, the free encyclopedia

 

[Free To Canoe]

While we talk about risk tolerance, I think the reality is you don't really know your risk tolerance until you've experienced it.

Lot's of good stuff in this thread but this one will go down in the annals of history (if it is not there already).

Free to canoe

 

[ERD50]

No I fundamentally agree with the one pot money. I agree with ERD50 that people are way too hung up on buckets.

I should probably expand a bit on that post. It may have been clear, but maybe not. While I call it one big pot of money, that still means divided up in some AA that meets your personal risk tolerance, and includes some liquidity for normal cash flow purposes.

But let's say I know I have a big expense due in a year or two (planned major house maintenance, new cars, or whatever). Let's call 'big' 1% or 2% of your NW (so roughly a 25% or 50% boost in expenses at the 4% level). I don't see the need to keep that money 'safe' in some dollar-certain investment like a CD or MM. I just keep it at my AA (while assuring that amount is reasonably liquid). When I need to pull it, I can do any rebalancing that is needed, and I need to consider tax implications.

Bonds/stocks may be down when we need to pull $ out - but we invest in stocks because we believe that over the long run they will be up. So odds are, they will be up when we sell. I just don't see the need to go super-conservative for a short time-frame, if we aren't also super-conservative for the long time-frame. Stick with the AA, IMO.

edit/add - geez, re-reading my own post I got struck with what seems now like an obvious point:

What the heck is the difference between pulling money out now to put in a MM for a purchase a few years out, and just pulling money out when needed? Either way, at some point you are pulling money out. Seems like deciding now is better than later is market timing?

-ERD50

 

[clifp]

edit/add - geez, re-reading my own post I got struck with what seems now like an obvious point:

What the heck is the difference between pulling money out now to put in a MM for a purchase a few years out, and just pulling money out when needed? Either way, at some point you are pulling money out. Seems like deciding now is better than later is market timing?

-ERD50

Exactly, now that you point it out it is obvious but it wasn't before at least not to me.

I think a big part of the problem is so many rules are written for working people or retirees who are primarily living on SS and pension and don't have access to big pool of money. If you are working stiff saving up to buy a new car or make a down payment on a house, which you plan/need to buy in 6 months to a year. You shouldn't stick the money in a small cap index fund, even though on average it will earn more money than money market. The consequences of not having enough money for the house or car are quite severe much more important than extra 5 or 10% you'd earn in the small cap fund.. If on the other hand if it is a few percent of your net worth keep it in the small cap fund till you need it. Of course the number of books telling people how to become millionaire is lot bigger than than those telling how to chance our money behaviors once you accumulate a million.


I see a similar thing with insurance. I see a lot of people (e.g. mom) who take out insurance on bunch of things which frankly they can easily self insurance on (trips, collisions on older cars, extended warranties etc.)
A 25 replacing a 3 year old car that got totaled, is a major financial event.
For a 60 year old retiree it shouldn't be a major event, and if you pool all the money you save from paying premiums, on cars, contacts, trips, appliances you should easily be able to pay for the things that need replacing. But this all assumes you have the funds to easily replace these things and many working people simply don't. So advice that is sensible for a 25 year old is bad for 60 year old.

 

[Marc1962]

Bonds/stocks may be down when we need to pull $ out - but we invest in stocks because we believe that over the long run they will be up. So odds are, they will be up when we sell.

[...]

What the heck is the difference between pulling money out now to put in a MM for a purchase a few years out, and just pulling money out when needed? Either way, at some point you are pulling money out. Seems like deciding now is better than later is market timing?

Don't you wind up hurting aggregate return due to reverse dollar cost averaging when you sell as/when needed?

 

[DblDoc]

Don't you wind up hurting aggregate return due to reverse dollar cost averaging when you sell as/when needed?

There is no way to know a prior. If one assumes that over the long term stocks will appreciate then you are increasing your aggregate return by waiting until the money is needed before pulling it out.

DD

 

[WilliamG]

Having some liquid and lower volatility assets in your allocation actually allows you to spend from the lower gain assets longer while higher gain assets can grow/recover. Keeping the portfolio risk balanced helps me sleep at night better than having x years of low return buffer.

 

[Marc1962]

There is no way to know a prior. If one assumes that over the long term stocks will appreciate then you are increasing your aggregate return by waiting until the money is needed before pulling it out.

Thanks, that does make sense.

I suppose I can mitigate the reverse dollar cost averaging effect (selling assets for lower prices on average) by requiring the sale of each asset for expenses to improve the degree to which the portfolio conforms to its ideal asset allocation. That would force me to sell high.

 

[audreyh1]

Thanks, that does make sense.

I suppose I can mitigate the reverse dollar cost averaging effect (selling assets for lower prices on average) by requiring the sale of each asset for expenses to improve the degree to which the portfolio conforms to its ideal asset allocation. That would force me to sell high.

Yes - most people using AA, rebalancing is part of the withdrawal. They take from whichever asset class has performed best over the year.

In taxable accounts many folks allow distributions to accumulate in cash over the year, take that, take whatever else is needed from funds that are above target allocation, and then rebalance what remains as needed.

Personally, I never worried about "the reverse dollar cost averaging effect". Probably because I maintain an AA.

Audrey

 

[Marc1962]

Thanks for the explanation, Audrey. I like that approach better than the bucket method I have read about.

 

[Nords]

Do you have set rules for replenishment of the stash once depleted?
Free to canoe

You mean, as in "go get more"?

If the market has a down year then we don't replenish our cash stash.

If the market's down a second year then we don't replenish our cash stash. During the third year we pick the least-worst-performing equity and sell enough of that to cover our expenses.

When the market recovers beyond that year's expenses then we start replenishing the cash stash. We're just about there.

I'll add one more aspect to ClifP's excellent explanation of recession spending: consumer-durable bargains. We contracted extensive home-improvement work during the recession for a significant discount, when a couple years before we couldn't even get our phone calls returned. We used our dry powder on our home equity.