Question about Asset Allocation-Cash

[OldShooter]

If one is retired, then I think that any cash should be part of your fixed income allocation which includes then bonds, savings accounts, cash, T-bills, etc.

I personally don't hold any cash if I can help it. I have some cash in my checking account which is enough to pay next week's bills. Otherwise, if I need money, then I am selling investments just-in-time to pay bills. That is, I am essentially living paycheck-to-paycheck where "paycheck" means selling shares of an equity or bond fund.

And if you are going to ask me, "What about an emergency fund?", then I will say I have credit cards and can get any needed cash in a couple days by selling shares. I don't have a job to lose, so I don't need an emergency fund in case I lose my job.

This is pretty much our approach as well, though we don't run it so close. Typically we will have a few $K in each of our checking accounts, selling something when we need to top up the accounts. This happens every 1-3 months depending on time or year, any travel, etc.

We also have a $250K HELOC that we haven't used in years but the bank seems to want to keep it open. Every month or two they send a nice brochure telling me all the wonderful things I could do with their money. I can't imagine what/how/when we might need that line but it is there.

 

[mrfeh]

Great information and thanks everyone for the replies! There is so much to learn from this site!

I have recently eliminated my PAS arrangement with Vanguard and I am self managing at this point. I want to make sure that my overall asset allocation is appropriate for my age and situation.

I am 61 yrs old and my wife is 54. Our plan is to retire in 3.5 years. No pensions.
Overall portfolio including cash - 1.3M

I am wondering what recommendations would be for an appropriate asset allocation and cash reserve bucket?

Thanks

Start here: https://www.bogleheads.org/wiki/Bogleheads®_investing_start-up_kit

For simplicity's sake, split your portfolio into equities and fixed income (fixed income = bonds, money market accounts, CDs, cash).

 

[audreyh1]

audreyh1 >>> if I may ask, has your portfolio grown over your retired years to date? You have weathered many storms while retired as a young person and seem to be doing great!

Yes, fortunately we started with a more than adequate pile, and it grew, even though for a short period in early 2009, it was slightly below where we started in nominal terms, which represented about a 40% drop from recent highs. Yet I had still managed to rebalance in spite of the scary situation as I felt we would have enough fixed income remaining to weather an extended downturn if necessary. As a consequence, recovery was faster and the portfolio has grown even more during the long post 2009 expansion.

 

[Montecfo]

Cash is part of my bond allocation. It is invested in bonds with various wrappers.

I do not understand taking out cash first.

 

[street]

Yes, fortunately we started with a more than adequate pile, and it grew, even though for a short period in early 2009, it was slightly below where we started in nominal terms, which represented about a 40% drop from recent highs. Yet I had still managed to rebalance in spite of the scary situation as I felt we would have enough fixed income remaining to weather an extended downturn if necessary. As a consequence, recovery was faster and the portfolio has grown even more during the long post 2009 expansion.

Thanks for your retired longevity story, and through some bad years it is a testimony and a confidence builder for sure. Thanks

I do recall you sharing that before with us, but I like to hear the success stories and never get tired of them.

 

[rayvt]

I am wondering what recommendations would be for an appropriate asset allocation and cash reserve bucket?

Thanks

Nothing in the cash reserve bucket. Google it, see what Kitces & others have to say.

Asset allocation: I think that whole "100 - your age in bonds" doesn't make any logical sense. Plenty of articles & papers out there. Seems to be that any allocation from 20/80 to 80/20 all work about the same.

 

[hulurt1]

I have a 93 stock and 7 cash. I'm retired and live off cash and small pension. I know everyone here does not look SS as part of there investment but that money is my back up if stocks drop and I run out of cash. I'm 66 and will wait until 70 for SS.

 

[SnowballCamper]

I found this to be educational on the topic.

https://www.aacalc.com/docs/asset_allocator_comparison

 

[Rianne]

Our bonds are earning 3-5%, so I don't consider them cash.We've had our bond funds for over 20 years. On the I bonds, we'll pay hefty taxes, also on the bonds in our tIRA, so don't consider them cash. For us, cash is the immediate, tax free use of money for:
1. Living for 2 years
2. Car, roof, house...etc. The last thing we want to use are bonds because that would create an income issue. The cash also supplements the ACA.

3. I do not count this cash as part of our portfolio as it's not earning interest nor is it taxable. I guess we could use CC, but if we had to sell something else to pay off the CC, there's an income issue that could effect our ACA subsidies.

I think of the cash as a cushion that has no effect on our tax burden or income and will keep us out of debt.

Psychological? Probably. Just the way we think about it.

 

[Eucerin]

in my mind: Bonds = cash (since the cash in invested in CDs)

I have learned that many people category cash into bond. I categorize bond and cash separately, my cash is in MM and CD

 

[audreyh1]

I have learned that many people category cash into bond. I categorize bond and cash separately, my cash is in MM and CD

The fixed income part of my AA is allocated between cash (MM funds, short-term CDs, high yield savings, t-bills), short-term bond funds and intermediate bond funds. I rebalance between them annually when they deviate much from the target allocation.

This provides a ladder of interest rate sensitivity.

 

[Mdlerth]

The answer you require is to a question you didn't ask

I am wondering should I include cash and savings into my asset allocation, or just investments?

My investment asset allocation is
Stock-53%
Bond- 34%
Cash- 8%
Other- 5%

Overall Asset allocation (including savings) is
Stock-43%
Bond- 27%
Cash- 26%
Other- 4%

What I am trying to understand is, say I want my allocation to be 55% stock, am I 2% light or 12% light?

The answer you asked for is "12% light".
The True Answer, which you didn't ask for, is "It doesn't matter".
The explanations behind the True Answer are given below:

A lot of it is a matter of personal preference.... the success rate between 40/60 and 80/20 are very similar.

Plenty of articles & papers out there. Seems to be that any allocation from 20/80 to 80/20 all work about the same.

So are you pleased with the overall allocation of both halves? If so, no need to change anything.

Live long and prosper.

 

[downrod]

The answer you asked for is "12% light".
The True Answer, which you didn't ask for, is "It doesn't matter".
The explanations behind the True Answer are given below:







Live long and prosper.

I am struggling with this. If AA doesn't matter, why wouldn't everyone just assume the least amount of risk and do something like 10/90?

The Boglehead investment starter kit says that AA is one of the most important decisions that an investor can make.

 

[street]

I am struggling with this. If AA doesn't matter, why wouldn't everyone just assume the least amount of risk and do something like 10/90?

The Boglehead investment starter kit says that AA is one of the most important decisions that an investor can make.

A very good question and I have wondered the same thing. There was been many great illustrations with different AA and all seem to be very close in gains and losses.
I will be watching for responses.

 

[Mdlerth]

Managing total risk, not just market risk

I am struggling with this. If AA doesn't matter, why wouldn't everyone just assume the least amount of risk and do something like 10/90?

The Boglehead investment starter kit says that AA is one of the most important decisions that an investor can make.

I've seen this debated here any number of times. Here is what I concluded.
There is (mostly) consensus on the principle that risk and reward go together, so over a long period of time, reviewing a large number of data points, lower-risk investments (i.e., bonds) typically deliver lower returns than higher-risk ones (i.e. equities). And vice-versa.

However, there is NOT consensus on what direction that principle should guide an individual retiree. Consider a person who has "won the game", having amassed a portfolio sufficiently large to withstand any reasonable amount of volatility and still provide enough $$ for the remainder of his life. It can be argued, cogently, that such a person need not burden himself with the risks of market swings and could therefore target a low equity exposure. If the portfolio returns less than the maximum possible won't make any difference, since the portfolio will achieve its mission of 100% funding the owner's expenses.

OTOH, it can also be argued with equal logic that such a person could afford to target a high equity exposure, since that is likely to result in higher long-term returns. Perhaps a person who is less sensitive to fluctuations in the daily (or yearly) value of his portfolio, and hopes to leave a significant legacy, would fall into this camp.

We all are human beings, subject to emotional influences which sometimes leads us to act on impulse rather than on data. So alternatively, imagine a severe market meltdown, wherein someone's stash rapidly loses half its worth. Then imagine that person panicking and selling out at just the wrong time.

The Bogleheads are right: you should pick an AA. Did your kit specify what yours needs to be? Making a recommendation that precise is way above my pay grade, other than "the shadowy extremes are where monsters lurk so I wouldn't play there". I've seen a bunch of data that show probability of retirement success is maximized in a wide area which includes the middle.

I've concluded that the purpose of the AA, whether it's 30/70 or 80/20, is to discipline us to rebalance periodically with the consequence that we will sell assets when they are relatively high and buy assets when they're relatively cheap.

I don't know if I've communicated my thoughts clearly, but I bet some other folks will weigh in with upgrades (or maybe tell me I'm full of s... baloney).

 

[Eucerin]

I am struggling with this. If AA doesn't matter, why wouldn't everyone just assume the least amount of risk and do something like 10/90?

The Boglehead investment starter kit says that AA is one of the most important decisions that an investor can make.

The AA matters and matters alot. Proper AA is the appetite of your risk tolerance. If the market is down, your portfolio would be tolerably down within your anticipation, and vise versa; that is why each person set their AA differently 60/40 or 70/30, some retirees who has retired for many years has AA 20/80 (stock/bond).
If you set the AA at 60/40 and after re-balance it becomes 58/42, I will say that it don't matter due to small difference; but anything more than 10 points up or down, I will say it does matter.

 

[pb4uski]

The point is that success ratios are similar with AAs from 40/60 to 80/20.... see below. However, success ratio simply means the number of trials that the balance is less than zaro.

However, what is significantly different is the volatility of the ride and the long-run upside.

Same assumptions.... 40/60:

FIRECalc looked at the 119 possible 30 year periods in the available data, starting with a portfolio of $750,000 and spending your specified amounts each year thereafter.

Here is how your portfolio would have fared in each of the 119 cycles. The lowest and highest portfolio balance at the end of your retirement was $-140,801 to $2,813,342, with an average at the end of $676,519. (Note: this is looking at all the possible periods; values are in terms of the dollars as of the beginning of the retirement period for each cycle.)

For our purposes, failure means the portfolio was depleted before the end of the 30 years. FIRECalc found that 8 cycles failed, for a success rate of 93.3%.

Same assumptions but 80/20:

FIRECalc looked at the 119 possible 30 year periods in the available data, starting with a portfolio of $750,000 and spending your specified amounts each year thereafter.

Here is how your portfolio would have fared in each of the 119 cycles. The lowest and highest portfolio balance at the end of your retirement was $-360,375 to $4,560,354, with an average at the end of $1,521,462. (Note: this is looking at all the possible periods; values are in terms of the dollars as of the beginning of the retirement period for each cycle.)

For our purposes, failure means the portfolio was depleted before the end of the 30 years. FIRECalc found that 6 cycles failed, for a success rate of 95.0%.

Would you be willing to stomach some volatility to have your heirs and charities get $1.5 million rather than $0.7 million?

 

[Rianne]

The point is that success ratios are similar with AAs from 40/60 to 80/20.... see below. However, success ratio simply means the number of trials that the balance is less than zaro.


Would you be willing to stomach some volatility to have your heirs and charities get $1.5 million rather than $0.7 million?

Good point.

 

[SnowballCamper]

You have to make your own decision.

I am struggling with this. If AA doesn't matter, why wouldn't everyone just assume the least amount of risk and do something like 10/90?

The Boglehead investment starter kit says that AA is one of the most important decisions that an investor can make.

I found this calculator and the associated research notes to be quite informative (but I am a bit of a nerd...).

https://www.aacalc.com/calculators/aa

Some relevant highlights:
Investing articles generally conflate risk with variability. It would be more accurate to say stocks are more variable than bonds.

Risk is a probability associated with an adverse outcome. The main risk for index investors is the probability that they sell at a low price.

Asset allocation is a tool to buffer your portfolio against high variability. This is needed because we generally interpret falling prices to keep falling, and we want to avoid loss. Our mistake in this situation is selling low (panic selling). It is a mistake because there is no loss until we sell.

So asset allocation is the most important thing because it can prevent us from selling low (panic selling) through its buffering effect.

On the other hand, asset allocation is least important when we're not going to sell the index fund, except as part of a defined withdrawal strategy in retirement.

Now back to the linked calculator. It does some advanced "economic man" analysis to compute a mathematically optimal asset allocation. Some key points it addresses:

• It recognizes the marginal value of the dollar
  
• It accounts for SS, pension, and other fixed income not subject to market risk
  
• The results generally depend on age, and amount of investible assets

In the end, the best asset allocation is the one you use, that is, the one that prevents you from selling low. If you exit the market in a panic, you aren't following any asset allocation.

Hence, it doesn't matter what your allocation is, but if you don't have one, you just made the biggest mistake.

 

[downrod]

Great information, everyone! I learn something every time that I visit this forum. Thanks!

 

[cooch96]

I think this is the best thread in awhile.

I advocate doing what is most intuitive for you, but you need to understand how most people define terms for the sake of communication.

I plan on using a Variable Percentage Withdrawal (VPW) method. To me, VPW makes the most sense to exclude cash (cd’s, mm fund, checking account) from AA. The cash is a fund to cover the spread when my withdrawal doesn’t make ends meet.

 

[Montecfo]

AA matters. It may matter less in terms of the success or failure of a withdrawal plan because we all tend to target very conservative withdrawal rates of 4% or less.

But at the chosen withdrawal rate, AA will determine the range of ending asset balances (higher ending asset balance with a more equity-tilted AA, generally).

 

[RunningBum]

I think this is the best thread in awhile.

I advocate doing what is most intuitive for you, but you need to understand how most people define terms for the sake of communication.

I plan on using a Variable Percentage Withdrawal (VPW) method. To me, VPW makes the most sense to exclude cash (cd’s, mm fund, checking account) from AA. The cash is a fund to cover the spread when my withdrawal doesn’t make ends meet.

Not following the logic here. If you can't make ends meet, your plan may be broken. If you have an additional $500K in cash, you're probably fine. If you have $5K in cash, probably not. Since the amount of cash buffer matters, it makes more sense (to me) to just include in calculations.

I also don't see why using VPW make a difference in that.

But, to each their own.

 

[cooch96]

Not following the logic here. If you can't make ends meet, your plan may be broken. If you have an additional $500K in cash, you're probably fine. If you have $5K in cash, probably not. Since the amount of cash buffer matters, it makes more sense (to me) to just include in calculations.

I also don't see why using VPW make a difference in that.

But, to each their own.

Exactly. Do what makes the most sense to you, but try to be clear when describing your plan to others. E.g. 100% equities plus 3 year’s of expenses in cash (cd’s and mm fund) with zero debt. Or $3.5million in real estate that generates $80k/yr net in rent. Both scenarios are clear to me without describing AA ratios.

It is simply more intuitive to me to use a cash reserve for lean years, and then replenish it in the fat. But I’m not questioning that keeping a target AA is better for most folks.

 

[meleana]

Yes. Include cash and savings