Cash buffer vs. rebalancing

[jimbee]

Not saying that. I also have cash which is part of my investment portfolio and thus part of my AA%.
However, some of us for example take a set % of the remaining portfolio for the year. Let's say it is 3%, but we only use 2.5%, the remaining 0.5% not used goes into a cash type account which is not subject to future stock market movements.
If there is a bad year or let's say a one time large expense, it might come out of this account.
Just a different way of accounting for assets.

That is just accounting gymnastics. You're making a sinking fund with the excess. That's a perfectly valid method of saving for future purchases. Not including it as a part of your total AA means your financial assets are more conservative than you're telling yourself. Money is fungible.

 

[Dtail]

That is just accounting gymnastics. You're making a sinking fund with the excess. That's a perfectly valid method of saving for future purchases. Not including it as a part of your total AA means your financial assets are more conservative than you're telling yourself. Money is fungible.

Let's say this a different way.
If one has 1.9m in investment assets with a cash account of 100k outside of the AA and their AA is 50/50, you would say I believe it really is 47.5/52.5. (Hope my math is correct)
I am saying that if I believe the 50/50 allocation on the 1.9m will satisfy my risk profile and generate enough returns, etc, then that works for me.

 

[Huston55]

A Balloon Ride

I took a balloon ride with my DW & a chest of gold coins & dollar bills; we were headed toward an important destination. The gold coins & dollar bills were heavy and affected our loft & speed in the balloon so, we had to plan carefully with how many coins & bills we could take & how far we could go. During one portion of the ride, the winds buffeted us severely. But, I had a plan for this. I took a portion of the gold coins out of the chest and put them in my pocket to prevent the effects of the winds. Low & behold, that didn’t make any difference! We still ended up where the wind took us. Fortunately, the story has a happy ending, because the wind was at our back & we were able to travel much further than planned with the gold coins & dollar bills we had.

 

[audreyh1]

That is just accounting gymnastics. You're making a sinking fund with the excess. That's a perfectly valid method of saving for future purchases. Not including it as a part of your total AA means your financial assets are more conservative than you're telling yourself. Money is fungible.

I only have a target AA in my retirement account. I rebalance to that AA annually. I don’t care about the rest of the assets.

In other words - my total AA across all investable assets has no bearing - I don’t take any action on it. knowing what it is doesn’t tell me anything particularly useful. I guess your point is that my overall AA is more conservative. So what? How does that matter? Do you think I’m fooling myself about my long term returns? Why would I not take the way I structure my assets into account?

Investments aren’t fungible - long-term investments like stocks and bonds are not identical to cash. They have markedly different long-term characteristics. So I don’t understand the “Money is fungible” mantra either.

 

[TwoByFour]

As @audreyh1 and others have explained enough times in the past, not everyone including myself wish to subject certain cash funds or portions of their emergency funds to market fluctuations. Thus they are not part of the AA.

So instead of exposing it to market fluctuations you expose it to inflationary loss.

This doesn't mean that this concept isn't taken into account when incorporating one's AA%.

You can't have it both ways - either the cash is part of your AA calculation in which case it is not a "bucket", or it not part of AA and it is a bucket.

Most of us (or all of us) have some cash on hand. The question here is whether we keep that amount limited by maintaining a target AA by rebalancing, or let it grow in some outside bucket. Cash is the most liquid asset we can have so it is great in that respect but it is constantly eroding due to inflation, so that is why I limit it through my target AA and rebalancing.

 

[Dtail]

So instead of exposing it to market fluctuations you expose it to inflationary loss.



You can't have it both ways - either the cash is part of your AA calculation in which case it is not a "bucket", or it not part of AA and it is a bucket.

Most of us (or all of us) have some cash on hand. The question here is whether we keep that amount limited by maintaining a target AA by rebalancing, or let it grow in some outside bucket. Cash is the most liquid asset we can have so it is great in that respect but it is constantly eroding due to inflation, so that is why I limit it through my target AA and rebalancing.

Cash can be/is exposed to inflationary losses whether it is considered part of the AA or not considered part of the AA.

Once I get to or ever get to a comfortable/target balance of cash outside the AA, then I won't add further to this balance. Thus the balance will eventually be limited outside the AA without rebalancing concepts per se.

See @audreyh1's post above for a further take on this conversation.

 

[pb4uski]

..... Investments aren’t fungible - long-term investments like stocks and bonds are not identical to cash. They have markedly different long-term characteristics. So I don’t understand the “Money is fungible” mantra either.

Given stocks and bonds are liquid like cash then money is fungible.

Retiree A has $2m in retrement assets and $10k in their local bank account that they use to pay their bills.

Retiree B has $1.5m in retrement assets and $510k in their local bank account that they use to pay their bills.

They both have the same gap amounts (spending less retirement income like pensions and SS)... which retiree is better off?

 

[NW-Bound]

Accumulating unspent cash outside of the portfolio is the same as building up cash AA when the market has had a good run. This may be a safe thing to do, no matter how you do it, as both bonds and stocks may be in for some rough time ahead.

I have been talking about raising my cash AA, but being a stock lover, have had a tough time getting away from the "buy" button every time the market takes a dip.

 

[OldShooter]

Great reading on a cool and rainy Sunday morning!

Given stocks and bonds are liquid like cash then money is fungible.

Retiree A has $2m in retrement assets and $10k in their local bank account that they use to pay their bills.

Retiree B has $1.5m in retrement assets and $510k in their local bank account that they use to pay their bills.

They both have the same gap amounts (spending less retirement income like pensions and SS)... which retiree is better off?

Good example. I can't say which is better off because I don't know what "better off" means. What I can say is this:

If Retiree A's and Retiree B's $2,010 have the same AA and substantially the same investments then their portfolio risk level is substantially the same, too.

If Retiree A's $2M and Retiree B's $1.5M have the same AA and substantially the same investments then Retiree B's risk level is lower than Retiree A's. The degree depends on the AA.

If Retiree A's $2M and Retiree B's $1.5M have the same AA and Retiree B looks only at the partial portfolio, then he/she is at risk for misunderstanding his/her actual risk level.

How abour Retiree C, who has a margin account with $2.5M invested, $500K of which is borrowed money? If he/she looks only at the AA of the $2.5M, then he/she is at risk for misunderstanding his/her actual risk level.

The point being, of course, that only by looking at all investable assets and liabilities can an investor get a good picture of his/her investment risk level. But, obviously, if the investor prefers to look at only part of the portfolio there's nothing morally wrong with that. It's a free country.

As I said previously, all of this is just mental accounting. It does not change the facts on the ground.

 

[Fedup]

I agree it’s psychological, some people have a hard time saying they have low equity AA, aka conservative because they will lose money to inflation.

 

[audreyh1]

Given stocks and bonds are liquid like cash then money is fungible.

Retiree A has $2m in retrement assets and $10k in their local bank account that they use to pay their bills.

Retiree B has $1.5m in retrement assets and $510k in their local bank account that they use to pay their bills.

They both have the same gap amounts (spending less retirement income like pensions and SS)... which retiree is better off?

These two cases become different when you take into account rebalancing and withdrawals.

Retiree A and B withdraw annually from their retirement assets according to a chosen withdrawal rate, and only rebalance their retirement assets to a target AA.

Now the picture completely changes.

 

[OldShooter]

These two cases become different when you take into account rebalancing and withdrawals.

Retiree A and B withdraw annually from their retirement assets according to a chosen withdrawal rate, and only rebalance their retirement assets to a target AA.

Now the picture completely changes. ...

Exactly. It is because they are not rebalancing to the same AA. Retiree B has chosen to ignore part of his/her assets when doing the rebalancing.

Using 60/40 as an example, Retiree A is rebalancing to 60/40. To simplify, assume Retiree B is still at 1.5 and .5, then he/she is rebalancing to 45/55. As you say, a completely different picture. (If Retiree B is replenishing the $500K bucket and reducing the value of the $1.5M tranche, then the rebalancing is to an even more conservative AA.)

If Retiree B wants 45/55 AA there is nothing wrong with that, but segregating a bunch of cash and pretending that the AA is something other than what it really is seems like kind of a mind game to me. But, hey, if that's what floats Retiree B's boat, then so be it.

 

[pb4uski]

These two cases become different when you take into account rebalancing and withdrawals.

Retiree A and B withdraw annually from their retirement assets according to a chosen withdrawal rate, and only rebalance their retirement assets to a target AA.

Now the picture completely changes.

Not really. We know that success rates do not vary much across a wide range of AAs... 50/50 to 90/10.

Even if Retiree B's retirement assets are 100% stock, overall he is 75% stock and 25% cash.... and let's say that Retiree A's AA is 75/0/25 or even 75/25/0... their success rates are not significantly different.

Firecalc... $2m in assets, $80k spending, 75/25/0.... 94.9%
$2m in assets, $80k spending, 75/0/25.... 96.6%

 

[TwoByFour]

Cash can be/is exposed to inflationary losses whether it is considered part of the AA or not considered part of the AA.

Of course it is, that is not the point here. The point is that a portfolio has the perfect balance of inflationary exposure to other risk factors. No single asset is perfect, we combine them in what we each believe to be the proper ratio to balance all the pluses and minuses so that the portfolio, as a package, does exactly what the investor wants.

I trust my portfolio and AA to weather market swings, inflation swings, and interest rates swings so I put 100% of assets in it. You guys who like to use cash buckets don't trust your AA and portfolio so much so you have created a hedge. It is not wrong or bad, just another way of looking at things.

 

[audreyh1]

Exactly. It is because they are not rebalancing to the same AA. Retiree B has chosen to ignore part of his/her assets when doing the rebalancing.

Using 60/40 as an example, Retiree A is rebalancing to 60/40. To simplify, assume Retiree B is still at 1.5 and .5, then he/she is rebalancing to 45/55. As you say, a completely different picture. (If Retiree B is replenishing the $500K bucket and reducing the value of the $1.5M tranche, then the rebalancing is to an even more conservative AA.)

If Retiree B wants 45/55 AA there is nothing wrong with that, but segregating a bunch of cash and pretending that the AA is something other than what it really is seems like kind of a mind game to me. But, hey, if that's what floats Retiree B's boat, then so be it.

I don’t understand the “pretending” aspect here. So, a retiree chooses to have a retirement portfolio that they draw from and rebalance to a target AA. They have some cash outside of that. Why does the all assets AA matter?

Is the point that the total AA has a lower exposure to equities than the retirement portfolio? OK. Now why does that matter?

 

[Fedup]

Not everybody relies entirely on their equities portfolio. I don’t think I sleep well if I do. It’s the frosting for me.

 

[audreyh1]

Not really. We know that success rates do not vary much across a wide range of AAs... 50/50 to 90/10.

Even if Retiree B's retirement assets are 100% stock, overall he is 75% stock and 25% cash.... and let's say that Retiree A's AA is 75/0/25 or even 75/25/0... their success rates are not significantly different.

Firecalc... $2m in assets, $80k spending, 75/25/0.... 94.9%
$2m in assets, $80k spending, 75/0/25.... 96.6%

But Retiree B is NOT taking $80K in withdrawals, he’s taking $60K in the scenario I responded to.

That’s true in my case anyway.

There are probably too many different scenarios that use the label “cash bucket/buffer” to lump them all together.

 

[audreyh1]

Of course it is, that is not the point here. The point is that a portfolio has the perfect balance of inflationary exposure to other risk factors. No single asset is perfect, we combine them in what we each believe to be the proper ratio to balance all the pluses and minuses so that the portfolio, as a package, does exactly what the investor wants.

I trust my portfolio and AA to weather market swings, inflation swings, and interest rates swings so I put 100% of assets in it. You guys who like to use cash buckets don't trust your AA and portfolio so much so you have created a hedge. It is not wrong or bad, just another way of looking at things.

The most important thing IMO is for the early retiree, especially one dependent on their investments for most of their annual income, is to stay invested.

Each has to choose whatever organization of assets and methods they need to help them stay invested, as well as providing for long term portfolio survival and near-term income needs.

BTW - I trust my system. I’ve been through two really nasty bears since retiring, stayed invested, and even managed to rebalance my portfolio near the bottoms, scary as it was. I don’t plan to change my system now.

 

[audreyh1]

Let's say this a different way.
If one has 1.9m in investment assets with a cash account of 100k outside of the AA and their AA is 50/50, you would say I believe it really is 47.5/52.5. (Hope my math is correct)
I am saying that if I believe the 50/50 allocation on the 1.9m will satisfy my risk profile and generate enough returns, etc, then that works for me.

Yeah, that’s basically how I look at it, especially since I am only withdrawing from the $1.9M in this case.

In our examples, the only thing someone can tell me is that I have a slightly lower equity allocation overall, but I also have a slightly lower withdrawal rate overall.

 

[OldShooter]

... Is the point that the total AA has a lower exposure to equities than the retirement portfolio? OK. Now why does that matter?

It doesn't matter if that lower equity AA is what the person wants, but it seems silly to me to camouflage the true AA by removing part of the fixed income tranche from the calculation. I see no benefit to this compared to just maintaining the desired AA by looking at the whole portfolio. This also avoids the situation where the AA invisibly drifts around as the ratio between the ignored assets and the un-ignored assets changes. KISS, IOW.

But, whatever floats your boat. I have never understood people wanting to watch a bunch of rich guys run around chasing balls of various shapes in order to make even richer guys even more rich, but that seems to be pretty popular too.

 

[Dtail]

Yeah, that’s basically how I look at it, especially since I am only withdrawing from the $1.9M in this case.

In our examples, the only thing someone can tell me is that I have a slightly lower equity allocation overall, but I also have a slightly lower withdrawal rate overall.

Exactly, so in my example and for me I don't really expect my non AA cash account to be more than 5% of investment assets (if I were including it in investment assets for calculation purposes), is there really a major difference between 47.5/52.5 and 50/50 for retirement success?

However, I want guarantees for the purposes in which I intend to use these monies and yes there is also some psychology there that these monies are 100% "safe".