What to do with cash under your IRA

[Russman]

Hi all,
Love reading all the comments and advice from the members on this website. There seems to be a high level of wisdom that this site has compared to most of other sites that I've perused. Also the people on this site seem more genuine and sincere, where other sites are rampant with ego maniacs and bitter hostile comments.

Here's my question today. Under my traditional IRA, which makes up my portfolio, I have a mix of 68% diverisified stock funds, 15% bond funds, and 17% in a money market cash account. I annually draw about 4% from the cash account each year to supplement my pension. I usually replenish the 4% with gains acheived from my equities. So each year, that leaves about 13% that's sitting idle not really earning anything. That cash cushion gives me a little piece of mind that even if the whole market crashed, I would have something left in reserve. The counter to that, of course, is the fact that the cash is not earning anything.

Would I be better off trying to put some of that into a 5 year CD, where I could earn an extra 2% on the cash portion ? Or simply leave it, and have money available to buy stock when(if) there's a correction (which everyone believes is coming at some point in the next year or two).

Appreciate to hear your thoughts.

 

[Al18]

Your plan of moving some of your cash into a CD sounds like a good idea to me. I think 68% in stocks for a retired person is on the high side, and if it was me, I would sell off some to get it down to 60%. You could start a 5 year CD ladder, putting some money each year into a 5 year CD.

 

[pb4uski]

Is all your retirement savings tax deferred? Is 68%/15%/17% your desired target AA?

Assuming yes to both, then I would probably change the 17% cash to 8% (two years of withdrawals) in an online savings account earning 1% and the other 9% in a CD (wait and see if PenFed offers another nice CD special again this Decemeber - last year's special was 3% for 5 years).

If you have other taxable investments you are living off then you need to look at your AA across both taxable and tax-deferred investments.

 

[LOL!]

I'd put your cash in your bond funds.

You can easlity calculate how much money leaving it in cash had cost you over the past 1-, 3-, and 5- years.

If your bond fund drops in value, so what? You would still be ahead of keeping it in cash because the bond fund has done so much better than cash in the past.

 

[Animorph]

Here's Kitces's cash buffer paper:

Research Reveals Cash Reserve Strategies Don't Work... Unless You're A Good Market Timer? | Kitces.com

"In the end, the reality is that while cash reserve strategies appear psychologically appealing, their actual benefits as an enhancement for retirement income sustainability appear to be a mirage upon closer inspection. The buffer zone approach appears to do little to effectively "time" the market, and/or to the extent it does, the benefits are overwhelmed by the adverse consequences of a large allocation of cash in the portfolio that drags down long-term returns. Notably, though, separate research has shown that shifting equity exposure in light of market volatility (and based on fundamental valuation principles) can in fact enhance both returns, risk-adjusted returns, and the sustainability of retirement income - and without the unfavorable impact of an unduly large cash position."

I think mainly you want to avoid having 13% of your portfolio sitting in cash for 30 years of retirement. Certainly that makes little sense. What you need to have is a plan for utilizing that cash. Use it when the market goes way down. Replenish it after the market has recovered.

My cash buffer is nominally $0. I have a detailed retirement plan that uses a simplistic fixed investment gain, X% per year, and lists the start of year portfolio value and spending for each year, among many other things. When the real portfolio value crosses the next start of year portfolio value, I sell equities to raise the cash needed for that year's expenses. I have 2014 and 2015 covered, and the portfolio needs to grow another 5% before I raise cash for 2016. While I may have a bunch of cash lying around at times, that just means that my retirement plan is on track. I don't need to do any better than that. Currently most of the cash is in online savings accounts at 0.9% interest, and some is in bonds.

If I run out of cash, I sell from the portfolio monthly as needed to meet expenses. So hopefully I'm as fully invested as I can get when the portfolio is below desired levels and presumably the market is down.

If I have a lot of cash, like now, I'm happy to reinvest in equities if the market is more than 20% down. Balancing the risks of running out of cash too early and missing out on low prices. I started ER in 2007 with a giant 30% or so in cash because of worries about the economy. Nearly all of that was reinvested throughout the bear market, and I sold equities month to month during the recovery. It really, really helped that DW decided not to retire and her income almost covered our expenses.

That's my solution to the cash buffer problem, cash out when ahead of plan, spend the cash first, then sell equities month to month. Reinvest if practical when the market is down 20% or more. Kind of my bond plan too, since my portfolio is 98% equities and 2% cash with no bonds (unless I have too much cash for too long).

 

[rayvt]

What you need to have is a plan for utilizing that cash. Use it when the market goes way down. Replenish it after the market has recovered.

That's the problem right there. The replenish strategy.
In addition to the bit about having a 13%-17% cash allocation, of course. I modelled this with a spreadsheet and tried a number of different strategies for replenishing the cash bucket. None of them worked. Turns out that "when [::handwaving::] the market recovers" is easier to say than to implement. Another fantastic idea crushed by cruel reality. https://www.dropbox.com/s/xf4ma5blug27aws/SPY_Withdraw_by_CashBucket_rules.xls

After playing with it a lot, it became clear that Kitces is righter than he thought. The best strategy is to take periodic withdrawals while keeping to your asset allocation. For convenience, I generally withdraw the entire year's amount in January and then spend it one month at a time.

 

[karluk]

Would I be better off trying to put some of that into a 5 year CD, where I could earn an extra 2% on the cash portion?

I would either invest in a short term bond fund or construct a CD ladder with your cash. I have no problem at all with the size of your cash buffer. My concern is the fact that it is invested in a money market account that is guaranteed to lose value to inflation.

For comparison, I have a much larger percent of my portfolio in my retirement account's stable value fund than your 17% money market allocation. Disregarding some differences in risk, the main difference is yield. The stable value fund has a high enough yield to more or less keep up with inflation, so I have no problem at all leaving money parked there. But it would drive me crazy to have a significant amount in a money market fund yielding only 0.01%.

 

[Ed_The_Gypsy]

Here's Kitces's cash buffer paper:

Research Reveals Cash Reserve Strategies Don't Work... Unless You're A Good Market Timer? | Kitces.com

"In the end, the reality is that while cash reserve strategies appear psychologically appealing, their actual benefits as an enhancement for retirement income sustainability appear to be a mirage upon closer inspection. The buffer zone approach appears to do little to effectively "time" the market, and/or to the extent it does, the benefits are overwhelmed by the adverse consequences of a large allocation of cash in the portfolio that drags down long-term returns. Notably, though, separate research has shown that shifting equity exposure in light of market volatility (and based on fundamental valuation principles) can in fact enhance both returns, risk-adjusted returns, and the sustainability of retirement income - and without the unfavorable impact of an unduly large cash position."

Animorph, I had come to the same conclusion a few years ago when I was testing Galeno's strategy and reported it here. I am far beyond early retirement. Our SS will give us the stability that your DW's income gives you. I favor collecting dividends in a MMF over the year, then taking a simple X% (not firm yet; eye-balling 3.5%, but could be as high as 5% depending on health) of the total pot (dividends included), rebalanced AA from time to time. Still blank on other details. Your method looks interesting.

 

[heeyy_joe]

I buy insurance on my assets. Holding some cash in your asset allocation can be viewed similarly. The opportunity cost and loss of value to inflation is the insurance premium.

 

[Rothman]

I don't follow why the CD ladder strategy isn't the right way to go, PenFeds 3% 5year could be effective unless the ladder represents too much of the portfolio thereby risking inflation exposure, but given it represents a reasonable 10% of portfolio seems like it has to buffer market exposure given we are planning SWR around 3% as our goal.