Thoughts on Short-Term Reserves

[TromboneAl]

We've been very fortunate with our investments, and after ten years of retirement, we've just about used up our taxable funds. That is, we're just about to start actually using our retirement funds.

All our retirement funds are in stock or bond funds in Vanguard. As per our plan, we've shifted our asset allocation 1-2% every year, and now stand at 43% stocks, 55% bonds, and 2% short-term reserves (age 63).

My target calls for 6% short-term reserves, and I'm considering whether I should convert some of the retirement funds to money market (still within the IRAs).

The two reasons I see for the short-term reserves are (1) to have money that's highly liquid (in case of emergency), and (2) to be able to avoid cashing in stocks or bonds during a big change in their valuation (e.g. crash of Weee!).

As for liquidity, I can sell shares of a stock fund just as quickly as for a MM fund.

So, the only value in converting some to MM would be for reason 2.

I'm thinking, therefore, that we should convert an amount equal to six month's expenses to MM funds.

What are your thoughts?

Thanks!

Al

 

[pb4uski]

When we first REd, I went from a 60/40/0 AA to 60/34/6 with the 6% in an online savings account that pays 0.95% (MM returns stink compared to online savings accounts). I changed my AA principally for the reasons that you mention, particularly reason 2... and because retirement was new to us.

Last year, I shaved the cash back to 5%, in part because I started my pension so we now have some income monthly other than just savings withdrawals.

I figure that the 5% in cash cost me probably 0.15%/year in total return (4% return from bonds less 1% on cash, times 5%) and am willing to forego that 0.15% in return for the peace of mind.... I suspect as I get more comfortable with retirement that I may shave the cash back even further.

 

[Finance Dave]

I think it depends on your risk tolerance. I"m 55, but have been become quite risk averse since we are phasing out of w*rking....no easy way to make up for losses. I would always want to have at least 2 years' worth of spending in a guaranteed account for the reason you mention #2.


As for bonds, I always differentiate between maturities (technically the terms are bills, notes, and bonds). If you really mean bonds (greater than 10 years to maturity), even then the duration can dramatically affect volatility with interest rates...so I'd want to know the portfolio duration.


I'm comfortable holding bills as part of the "cash cushion", but not notes or bonds....I see those as having moderate risk levels.


In summary, you mention 6 months of spending in MM, I would do 2 years.

 

[FUEGO]

I like the peace of mind that comes from having a year or two in cash or cash-like securities (CDs, short term bond fund). We have somewhere around $40-50k in our money market account right now. That cash plus dividends from taxable accounts will last us two years.

Market crashes tomorrow (and all my current side hustle income disappears)? Not worried for 2 years. Of course I don't have any bond holdings, so this cash IS my fixed income allocation. Like a mega emergency fund.

 

[Finance Dave]

I like the peace of mind that comes from having a year or two in cash or cash-like securities (CDs, short term bond fund). We have somewhere around $40-50k in our money market account right now. That cash plus dividends from taxable accounts will last us two years.

Market crashes tomorrow (and all my current side hustle income disappears)? Not worried for 2 years. Of course I don't have any bond holdings, so this cash IS my fixed income allocation. Like a mega emergency fund.

That's exactly how I feel...but everyone is different and that's what makes the world interesting.

 

[DrRoy]

I keep about a year's worth of spending in cash.

 

[mystang52]

I think the best approach for cash reserves is CD ladders. You can renew if the cash is not needed, or obviously cash in when they come due. Meanwhile, you are maximizing the return; Money Market and straigh savings instruments yield so little, CD ladders at least pay somewhat more.

 

[Finance Dave]

I think the best approach for cash reserves is CD ladders. You can renew if the cash is not needed, or obviously cash in when they come due. Meanwhile, you are maximizing the return; Money Market and straigh savings instruments yield so little, CD ladders at least pay somewhat more.

Good point, agree

 

[MBAustin]

I now usually move expected cash needed for the year into the bank MM fund in January. I also keep a good portion of our bond allocation in a limited-term tax-exempt bond fund that has demonstrated relatively consistent NAV even during large market fluctuations.

 

[pb4uski]

I think the best approach for cash reserves is CD ladders. You can renew if the cash is not needed, or obviously cash in when they come due. Meanwhile, you are maximizing the return; Money Market and straigh savings instruments yield so little, CD ladders at least pay somewhat more.

But online savings accounts offer better interest than CDs on the short end so it depends on how long a CD ladder that you have and how much you value simplicity.

 

[euro]

I don't hold that much cash (certainly not 2 years' worth) - instead, I view my untapped HELOC and my untapped margin account as appropriate sources of cash, should I need to weather a 2 year downturn.

 

[jazz4cash]

I think the best approach for cash reserves is CD ladders. You can renew if the cash is not needed, or obviously cash in when they come due. Meanwhile, you are maximizing the return; Money Market and straigh savings instruments yield so little, CD ladders at least pay somewhat more.

I agree with this also, but would substitute an online savings account for 6-12 mos of expenses or possible emergency.
What do MM accounts pay? Last time I checked at Ally, the online savings account was higher than the MM account.

 

[pb4uski]

Mine is much higher... Discover pays 0.95% and my Vanguard Federal MM fund pays something like 0.30%.

 

[Gotadimple]

I agree with this also, but would substitute an online savings account for 6-12 mos of expenses or possible emergency.
What do MM accounts pay? Last time I checked at Ally, the online savings account was higher than the MM account.

I agree, online savings account to hold one year of expenses (equivalent yield on a one-year CD is half what you can get at an internet bank).

Local checking/savings to hold 6-months of expenses (covers an unexpected expense), with the rest in a short term bond fund - ideally in a Roth account where there is no subsequent tax consequence for liquidating.

- Rita

 

[GravitySucks]

You might consider keeping some reserve outside the IRA so you don't get bumped up a tax bracket when an emergency strikes.

 

[NW-Bound]

You might consider keeping some reserve outside the IRA so you don't get bumped up a tax bracket when an emergency strikes.

+1

I always like to have a good taxable account, and it does not have to be all in cash either. It can be in stocks, and I make sure to harvest gains whenever possible so that some shares have been washed of gains. These can be sold for spending money with little tax implication, if and when I need the money.

 

[Sunset]

We are secure with 4-5 yrs worth of cash earning 1% interest.
Obviously missing out on some gains, but sleep pretty easy.

 

[audreyh1]

You might consider keeping some reserve outside the IRA so you don't get bumped up a tax bracket when an emergency strikes.

Agree with this.

 

[ziggy29]

I'm starting to keep a little more in cash myself. It helps that I have a taxable savings account at my CU earning 1.00%, and that I have access to the G Fund in my TSP. Not earning 0.05% on my cash makes it easier to take some of the table (or leave more of your additional savings off the table).

 

[DawgMan]

While still a few yrs from RE, I wonder where I will fall on this. Intellectually, I would think if you believe in your AA then your once/twice a yr rebalancing would produce your needed funds for the coming yr. OTOH, I see where the defensive gene will start to potentially override some of this by playing "what if" mind games... what if the market craps out for 2, 5, 7 yrs? I suppose this is where we start to argue with ourselves that we should create a 2 - 7 yr cash balance to buffer a market collapse? However, unless this was part of your real AA plan, the larger the cash balance being held, the more you potentially negatively affect your long term planned returns. So here are my questions, particularly for those that hold more than 2 yrs in cash... How/when are you replenishing the current yrs cash you are spending? In other words, if you are a 2 yr guy you are spending now 1 of those yrs worth of cash. At the end of 2017 do you rebalance and replenish the 2 yr balance regardless of market performance or do you make a personal judgement of letting your securities ride and spend the 2nd yr of cash? Of course, if you did the ladder, you are now potentially creating the anxiety that I would think you were trying to avoid by keeping the cash balance. Curious as to how those of you who practice keeping a balance in RE actually implement your use/replenish of the cash.

 

[lem1955]

While still a few yrs from RE, I wonder where I will fall on this. Intellectually, I would think if you believe in your AA then your once/twice a yr rebalancing would produce your needed funds for the coming yr. OTOH, I see where the defensive gene will start to potentially override some of this by playing "what if" mind games... what if the market craps out for 2, 5, 7 yrs? I suppose this is where we start to argue with ourselves that we should create a 2 - 7 yr cash balance to buffer a market collapse? However, unless this was part of your real AA plan, the larger the cash balance being held, the more you potentially negatively affect your long term planned returns. So here are my questions, particularly for those that hold more than 2 yrs in cash... How/when are you replenishing the current yrs cash you are spending? In other words, if you are a 2 yr guy you are spending now 1 of those yrs worth of cash. At the end of 2017 do you rebalance and replenish the 2 yr balance regardless of market performance or do you make a personal judgement of letting your securities ride and spend the 2nd yr of cash? Of course, if you did the ladder, you are now potentially creating the anxiety that I would think you were trying to avoid by keeping the cash balance. Curious as to how those of you who practice keeping a balance in RE actually implement your use/replenish of the cash.

When the market is down I still sell mutual funds and buy CD's but in smaller increments. If the market was way down I might skip a purchase and make up for it later. I keep 6 months cash in an Ally savings account at 1% and 3 more years in CD's inside my Traditional IRA. I have been retired one year. I expect this is more conservative than I will be five years from now.

 

[Lsbcal]

What we do now:

I take out the money for 2017 spending and bunch it with the unspent "spending" monies from 2015 and 2016. This money is in short term investment grade bonds (VFSUX at Vanguard). Some of it is in a Roth and some in an IRA.

It takes only about 2 days to cash some out and get into our Chase checking. At the beginning of each year I compute (using Turbo Tax) what the max withdrawals should be from the IRA. The Roth money is spent first and towards the end of the year we withdraw the IRA calculated amount.

I think over many years the short term IG bonds will do fine and better then actual cash (MM or Tbills). Even in a very bad recession I think this strategy holds up. But one could always do short term Treasuries if nervous.

 

[Sunset]

My simple plan is sell to cash out investments when the market is OK or high, keeping my 4-5 yrs pile of cash.
Should the market tank (down 20% or more from highs) I won't sell, and just keep spending from the cash pile.
Should market crater 75% , I might even invest a up to 1 year worth of cash, knowing prices probably won't fall farther so little risk.

I sold some things that were up in Nov/Dec so all set for 2017.

 

[Gotadimple]

While still a few yrs from RE, I wonder where I will fall on this. Intellectually, I would think if you believe in your AA then your once/twice a yr rebalancing would produce your needed funds for the coming yr. OTOH, I see where the defensive gene will start to potentially override some of this by playing "what if" mind games... what if the market craps out for 2, 5, 7 yrs? I suppose this is where we start to argue with ourselves that we should create a 2 - 7 yr cash balance to buffer a market collapse? However, unless this was part of your real AA plan, the larger the cash balance being held, the more you potentially negatively affect your long term planned returns. So here are my questions, particularly for those that hold more than 2 yrs in cash... How/when are you replenishing the current yrs cash you are spending? In other words, if you are a 2 yr guy you are spending now 1 of those yrs worth of cash. At the end of 2017 do you rebalance and replenish the 2 yr balance regardless of market performance or do you make a personal judgement of letting your securities ride and spend the 2nd yr of cash? Of course, if you did the ladder, you are now potentially creating the anxiety that I would think you were trying to avoid by keeping the cash balance. Curious as to how those of you who practice keeping a balance in RE actually implement your use/replenish of the cash.

First of all, your asset allocation needs a SANF (sleep at night factor). So, your comfort level with equities v bonds is important. In terms of steady value, bonds act to smooth the variability of equities.

Second, if the market is good and your allocation is out of whack, your bring it back in alignment with re-balancing - which means taking gains and putting them in bonds/cash/CD/etc.

To answer your question: I know how much cash I need from my portfolio, I rebalance annually to create the cash needed, which means repositioning from stocks to bonds, or vice versa. At the end of the rebalancing, my cash amount boosts existing cash to a total of two years.

AT THE SAME TIME, I also look at total bonds in terms of the number of years income it provides. If I need $40k annually from my portfolio and I have $400k in bonds, I know I have 10 years of income I can draw on if the equities are badly affected in a downturn. HTH

 

[TromboneAl]

Okay, good info, as usual.

I'm going to move 1-2 years of expenses from the Roth bond (VG Total Bond) to either a short-term bond or MM fund in the same Roth.

I'm complication-averse, so I'm willing to give up some return to keep things simple and stupid.

Thanks, guys.