Nest Egg Management

[FireDreamer]

As we get closer to our 'number', I'm exploring ways to manage our nest egg in FIRE. I have two questions. First, how to organize our accounts to minimize the sequence of returns risk? I'm thinking of building up a large reserve of cash (1-3 years of expenses) to buffer against extended down markets as this seems to the approach most folks take. To choose the source of our 'salary' per (year? Quarter? Month?), sell from the best performing asset class; if all are down, pull from the cash reserve to fund our 'salary'. At the end of each year, rebalance. I'm not clear on the trigger to replenish the cash reserves, however. Or, do you simply consider the cash reserves as the 'bond' AA, and let rebalancing refill?


The second part I'm not settled on is - how to manage after-tax and tax-deferred accounts since I won't be able to touch the tax-deferred accounts for close to 10 years (FIRE before 50 based on current trajectory). Do I treat them as two separate AA, or as one big pile of money as I have been? The risk of two separate is I'll have a larger investment in bonds in my after tax accounts than I would like. However, the risk of one big pile of money is I won't be able to rebalance as easily as I withdraw down from my after-tax funds. Seem like two different piles with their own AA.

How did others approach these?

[OldShooter]

FWIW we look at an overall AA. For a few years, I rebalanced looking only at the total and fiddling with individual accounts to keep our overall number where we wanted. My rationale was that individual account didn't matter, only the overall AA. But tuning AA this way got to be kind of a PITA, so now I try to keep our two big accounts internally and roughly matching the AA target. (They are IRAs, so no tax issues.) I have a couple of Roths, though, that will become part of our estate so those are 100% equities.

I am a "close enough is good enough" rebalancer. Someone wanting to hold allocations to 1% +/- of target might not like this approach.

[chassis]

Take your salary whenever you want to. Quarterly makes sense to me. Annually also seems good. Weekly, bi-weekly and monthly seem too much effort to me, and unnecessary.

2-3 years of cash seems reasonable.

Sell parts of positions in order to maintain your target asset allocation.

[Montecfo]

To me cash is just a part of your bond allocation. I keep a lot presently, but only because bond yields are so low.

If you are rebalancing annually, you want to do your rebalancing in tax deferred if possible. Do not volunteer taxes by taking larger gains in taxable, in my opinion.

I am an active investor with mainly individual stocks. So I am generating funds regularly as I sell positions. I use some of that to replenish cash.

While I view my portfolio in the aggregate, you have to keep an eye on your allocation in taxable, in my view. You want to have some non-volatile investments there to pull cash from.

I use high quality dividend paying stocks for that. Also tax friendly.

These are good questions to be asking. Good luck.

[Exchme]

There is no running and hiding from a poor sequence of returns that hammers whatever you happen to own. Studies have shown that anything you do is mostly just tricking yourself. The best protections are to have more money than the bare minimum needed to retire or some side income.

Also, be aware that the required "number" to retire historically was higher when stock valuations were high and today valuations are astronomical. See the new post at big ERN as part of his now 46 part series of articles on safe withdrawal rates:

https://earlyretirementnow.com/2021/...46/#more-39875

[OldShooter]

Quote:

Originally Posted by Exchme There is no running and hiding from a poor sequence of returns that hammers whatever you happen to own. Studies have shown that anything you do is mostly just tricking yourself. ...

Links? References? That is a pretty broad statement.

[FireDreamer]

I read the provided link; well sections 1, 2 and the conclusion, thanks. It basically says the SWR can be 3.75-6%, depending on a variety of factors.
I think that's generally accepted in this forum.

However, I don't understand your statement:

Quote:

Originally Posted by Exchme Also, be aware that the required "number" to retire historically was higher when stock valuations were high and today valuations are astronomical.

My 'number' is total value of our nest egg to generate our expected budget with a WR of 3.5%. Our budget has a bit of fluff in it. I already have more than enough to cover our bare-minimum @3.5%. My target number is to cover everything we could possibly want with some cushion. I think that's a fairly conservative approach. Are you suggesting a lower SWR; or a higher total account value?

[chassis]

Quote:

Originally Posted by Montecfo To me cash is just a part of your bond allocation. I keep a lot presently, but only because bond yields are so low. If you are rebalancing annually, you want to do your rebalancing in tax deferred if possible. Do not volunteer taxes by taking larger gains in taxable, in my opinion. I am an active investor with mainly individual stocks. So I am generating funds regularly as I sell positions. I use some of that to replenish cash. While I view my portfolio in the aggregate, you have to keep an eye on your allocation in taxable, in my view. You want to have some non-volatile investments there to pull cash from. I use high quality dividend paying stocks for that. Also tax friendly. These are good questions to be asking. Good luck.

+1 agree on looking at cash as part of a bond allocation (low vol) and the use of dividend paying stocks to produce income.

[FLSUnFIRE]

I'm very recently FIREd and this is my approach. I FIREd with enough cash to last through 2022. Near the end of 2022 once I know my distributions and any earned income I might have, I will replenish to get me through expected 2023 spending choosing my withdrawal amount to manage MAGI to maximize my subsidy as best I can. I plan to do the same near the end of each year. This is more about managing taxes than sequence of returns risk as time in the market for my long horizon is my friend so I'm not anxious to pull out more than I need. If I sell more than I need (managing MAGI) due to a down market (sell more to max out "gain harvesting" due to the lower return -more of the proceeds being principle vice taxable gains), I will reinvest the excess with a higher cost basis.

This is all taxable, at some point probably between age 50-55 depending on how the market treats me and considering any expected earned income, I will start a SEPP. Ideally, I will find a sweet spot with the SEPP that covers my expenses but isn't so high that it pushes me out of subsidies under ACA. At that point, I will let the taxable ride and add/take any surplus/shortfalls from the SEPP needed to cover my expenses. My Roth, I will let ride and view as an insurance policy/future BTD. I also have a HELOC set up if I need to tap quick liquidity and/or decide I want to defer selling for tax purposes.


The first few years will be a roll of the market dice and set the stage for the balance of my retirement. At 47 now, by my early 50s I should have an idea where I stand and if I have dough to blow.

[mrfeh]

Quote:

Originally Posted by FireDreamer As we get closer to our 'number', I'm exploring ways to manage our nest egg in FIRE. I have two questions. First, how to organize our accounts to minimize the sequence of returns risk? I'm thinking of building up a large reserve of cash (1-3 years of expenses) to buffer against extended down markets as this seems to the approach most folks take. To choose the source of our 'salary' per (year? Quarter? Month?), sell from the best performing asset class; if all are down, pull from the cash reserve to fund our 'salary'. At the end of each year, rebalance. I'm not clear on the trigger to replenish the cash reserves, however. Or, do you simply consider the cash reserves as the 'bond' AA, and let rebalancing refill?

Sounds like a good plan. And the second number in your AA isn't "bond", it's fixed income, and cash is part of fixed income.

Quote:

The second part I'm not settled on is - how to manage after-tax and tax-deferred accounts since I won't be able to touch the tax-deferred accounts for close to 10 years (FIRE before 50 based on current trajectory). Do I treat them as two separate AA, or as one big pile of money as I have been? The risk of two separate is I'll have a larger investment in bonds in my after tax accounts than I would like. However, the risk of one big pile of money is I won't be able to rebalance as easily as I withdraw down from my after-tax funds. Seem like two different piles with their own AA. How did others approach these?

View AA in total, across entire portfolio. Maintaining your AA is easy - if you sell equities in taxable, simply buy them back in your tax-advantaged account(s).

[38Chevy454]

Your plan is basically the bucket strategy where you have three buckets:
1-2 years in cash or very conservative. AA such as 20/80 with 80% or more in fixed income.
2-5 years of moderate AA, say something like 60/40.
Balance in your long term more aggressive AA, such as 80/20 with 80% or more in equities.

Overall whether you use partitioned buckets or just adjust your AA to cover, in the end the idea is take income needs from the higher appreciated assets. Replenish your buckets or AA as needed.

When to take income (withdrawals) is mostly personal choice. Whatever works for you.

[Montecfo]

Quote:

Originally Posted by mrfeh View AA in total, across entire portfolio. Maintaining your AA is easy - if you sell equities in taxable, simply buy them back in your tax-advantaged account(s).

Yes but a reminder not to sell loss securities in taxable and immediately buy them back in a retirement account. That violates wash sale rules.

[Montecfo]

Quote:

Originally Posted by Exchme Also, be aware that the required "number" to retire historically was higher when stock valuations were high and today valuations are astronomical.

We have had a good run but S&P 500 is at 21x forward earnings. Not cheap but not outrageous in my opinion with close to 90 percent of the index beating on earnings, and with the 10 year bond below 1.5%.

I think tools like firecalc are your friend. The 4 percent rule is quite conservative, but staying under it of course adds safety.

[Exchme]

Quote:

Originally Posted by FireDreamer I read the provided link; well sections 1, 2 and the conclusion, thanks. It basically says the SWR can be 3.75-6%, depending on a variety of factors. I think that's generally accepted in this forum. However, I don't understand your statement: My 'number' is total value of our nest egg to generate our expected budget with a WR of 3.5%. Our budget has a bit of fluff in it. I already have more than enough to cover our bare-minimum @3.5%. My target number is to cover everything we could possibly want with some cushion. I think that's a fairly conservative approach. Are you suggesting a lower SWR; or a higher total account value?

I would investigate in FireCalc, but be looking for zero failures instead of just a low percentage and be thinking about what expenses you could cut out if things did not go well. Historically, the ERN article points out that you are unlikely to have great outcomes and more likely to have poor ones when the CAPE is over 20 and it is way higher than that now. In other words, we may be feeling good about retirement because stocks are very high priced, but if they return to historical norms, our portfolios would be hurt badly and that withdrawal % could zoom to unsustainable levels.

[Exchme]

Quote:

Originally Posted by OldShooter Links? References? That is a pretty broad statement.

I was responding to the question OP was asking about how to organize accounts to minimize SORR and OP was proposing holding up to 3 years in cash.

Bucketing strategies like this fail in that it is certainly possible to minimize risk of one specific disaster by taking an overall non-optimum approach, but doing so leaves you worse off in many other cases. For instance, if the dreaded downturn were to occur at 3 years and 1 day (when OP has spent down the cash cushion) instead of the case OP is guarding against of a downturn at retirement + 1 day, that the OP would be worse off since cash did nothing for 3 years but suffer inflationary losses and meanwhile the same downturn must be faced, but with fewer resources.

The obvious place for OP to start reading is the Bogleheads wiki on the subject which includes results of various studies.

https://www.bogleheads.org/wiki/Buck...ket_strategies

The nut of it is this quote:

"These strategies are an optical illusion at best and create a potential for grave disappointment at worst...."


The better strategy is to meet an uncertain future is to stick to your stock/bond allocation.

With respect to rebalancing, the soft rebalancing OP suggested is not wrong, but on average won't be a lot different in result than just rebalancing as needed.

As for tax deferred being stranded for the next 10 years, OP can set up SEPP (substantially equal periodic payments) to get to the tax deferred money early if need be.

[mrfeh]

Quote:

Originally Posted by Exchme I was responding to the question OP was asking about how to organize accounts to minimize SORR and OP was proposing holding up to 3 years in cash. Bucketing strategies like this...

Except the OP never mentioned following a bucket strategy. You did.

The cash buffer would not be spent unless the market was down, so if a bear market started at retirement + 3 years, the OP would still have that 3 year buffer to pull from.

[SnowballCamper]

Quote:

Originally Posted by chassis Take your salary whenever you want to. Quarterly makes sense to me. Annually also seems good. Weekly, bi-weekly and monthly seem too much effort to me, and unnecessary. 2-3 years of cash seems reasonable. Sell parts of positions in order to maintain your target asset allocation.

+1

If your asset allocation is right for you, it includes the years of cash you're comfortable with. Also, living off the investments means you're probably doing taxes quarterly, so I'd rebalance, pay taxes, and pay myself quarterly. Keep it simple.

Edited to add: I think a different (more aggressive) AA for the tax deferred money makes sense since it is on a different timeline.

[ERD50]

Quote:

Originally Posted by OldShooter Quote: Originally Posted by Exchme View Post There is no running and hiding from a poor sequence of returns that hammers whatever you happen to own. Studies have shown that anything you do is mostly just tricking yourself. ... Links? References? That is a pretty broad statement.

I don't have any links/refs, but my limited research and modelling is in agreement with Exchme.

Think about it - that big SORR occurs after a big run up in the market, and then a crash. Trying to run and hide with a conservative portfolio in the early years, means you haven't shared in as much of that run up, leaving you less prepared. It might be a wash, but I'm skeptical that it can help to nay large degree, and since that timing would be fairly rare (retiring at just the 'wrong' time), seems like the odds are you'd leave money on the table (which is OK if it really gave you protection, but I'm not convinced it does)

Quote:

Originally Posted by mrfeh Except the OP never mentioned following a bucket strategy. You did. The cash buffer would not be spent unless the market was down, so if a bear market started at retirement + 3 years, the OP would still have that 3 year buffer to pull from.

I think he was just speaking loosely - a 'reserve of cash' can be described as a bucket. And since there seem to be so many ill-defined "bucket strategies", I'm not sure you can say that holding that bucket for 3 years isn't a "bucket strategy". But as I said above, that cash will be a drag, and I'm skeptical you end up ahead.

-ERD50

[Exchme]

Quote:

Originally Posted by mrfeh Except the OP never mentioned following a bucket strategy. You did. The cash buffer would not be spent unless the market was down, so if a bear market started at retirement + 3 years, the OP would still have that 3 year buffer to pull from.

Three years of cash non-performing for an indeterminate time on average drags down your returns, so you would need more than the typical "number" to retire safely. In other words, it hurts you.

The papers I linked to at Bogleheads show this explicitly. I was going to use a bucket strategy of about 3 years like the OP's myself and then read the BH articles. I still didn't believe it, so did my own modeling. My amateur efforts found the same thing as the Pros did. With a bucket, there were lots of degrees of freedom in a downturn - sometimes it's best to buy stocks, sometimes pay expenses, sometimes hold in case it gets worse. Then the question arises of refilling or not and if so, how fast and what market signal to use. So I looked and looked and couldn't find an algorithm that reliably beat a straightforward asset allocation with annual rebalancing.

A particular strategy can help protect you from one possible disaster scenario, but has tradeoffs that expose you more to other ones. There is no magic path to safety.

But this is a substantially smaller effect compared to the big error that comes from panic selling when it looks like everything is going to breakdown. So if a cash reserve helps OP emotionally weather a storm without panicking, it may be valuable. That's why it's called personal finance.

[RobLJ]

A few thoughts on Exchme and the non-utility of cash buckets.


1) buckets are a form of mental accounting, although there can be some utility there (or not)
2) I suspect Exchme and the Bogglers are right from a pure rational perspective about the non-utility or "drag" of the cash bucket on overall returns. Actually, I'm pretty sure.

3) However, (and this is a big butt) all this assumes that peeps will Boggly stick to their allocation in the face of a 30-50% stock drawdown, with all the implications. Even more so in a large and slow drawdown, which we have not seen except the NASDAQ in 2002. I'm pretty sure more than 1/2 of those on the forum would, but I've also noticed in '08 and after big draw downs the disappearance of posters on the forum. Did they get sick of us (or more likely me), did they extract all the "value" from our posts, or did they panic? I suspect the reality is a mix of all this and more (just got busy). Or it might be a pure figment of my imagination.


4) So, if a cash bucket keeps you from selling stocks in a large and fast drawdown, it has more utility than an Boggle analysis of sticking, rationally (and commendably) to a straight bond/sock allocation, without variation, which would be the "winning strategy," otherwise. As Buffett notes, cash also gives optionality, but none of us here are Buffetts. I had increased cash in 2019/2020 to skim gains to a point that cash was getting rather "hefty" but in March 2020 I only put 40% of it back into stocks. (That has done really well, by the way.)


5) As a final thought, 5 years ago I started to skim stock gains to increase cash to 5 years and decreased stocks, as an attempt to "run out the clock" to SS. This was an attempt to decrease SORR risk, up to SS. After SS (3 years for me 7 years for DW) all our essential expenses are covered; if not then at least 80%. SORR risk is then dead, other than inflation risk (which is real) and in fact since the COVID recovery it is probably already 90% dead. So I will be increasing the stock allocation and decreasing cash (and similarly bonds), but gradually, more rapidly after I claim SS.
So a cash "bucket" can be used to "run out the clock" so to speak before SS and "winning the game."

Caveat: were I 80%/100% stocks like many on the forum, I would now have "more." But I was not concerned with squeezing the sponge for all the drops but insuring a) a decent retirement which b) has now become a most excellent retirement, and c) now, some further reserves in case something happened to me. I am trying to slowly inform DW of the strategy. She is quite smart and also almost completely uninterested in investing.

5) On the last point, I am working on consolidating our accounts and simplifying investments over the next year or two to a strategy that DW can continue with little effort if something happens to me. Some excess cash will be useful there.

6) As a final point, there is some tension between maximizing retirement assets and minimizing the risk of mistakes by oneself or others. I have not sold in the last 3 crashes, but I am not completely sure of this 10 years from now and very not sure of DW. So, to summarize, cash/bonds (can) have a psychological component that can be crucial to one's retirement safety (to avoid selling in the crashes, in particular). Cash is not a sure insurance against panic sales, however, so it is a problematical strategy.


7) Just a few non-rational thoughts in terms of maximizing returns/withdrawals. To restate, I think the Boggles/Exchme trash of cash from a pure rational perspective is probably correct, although I might be able to come up with a few scenarios (probably unlikely) where cash is not trash.