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...ncertain-world-swr-series-part-46/#more-39875

 

[OldShooter]

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:

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]

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]

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.

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]

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]

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]

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]

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/Buckets_of_Money#Other_bucket_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]

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]

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]

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)

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]

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.

 

[ImThinkin2019]

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.

RobJ, Exme, and all, thank you so much for this discussion.

We have been guilty of going to cash when we think we have too much money in the market and the market seems risky to us. Pretty much at least in the last 10 years we would have been better off staying in. But if the market crashed our conclusion would have been different!

It was nice to have cash when Covid hit, so we could invest a little in the market. Wish we put in more.

We will study the bogleheads discussion and probably be more disciplined about setting an AA and adjusting accounts periodically.

Also keeping a cash bucket so we can delay SS is good for us. It gives comfort also. The points RobJ made about this were useful for us, especially taking the emotion out of "comfort cash" and just calculating how much we need.

The recent discussions about individual stocks (started in the post by 38Chevy454 are also very interesting to us. We tried that in the 90's and could not beat the S&P 500. Some people are good at it and willing to spend the time. For us, the risk was not worth the effort.

Today is one of those days where I have read several posts that really helped in our thinking. Thank you so much to all of you who share their experience on this forum!

 

[Markola]

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.

We’re FIREd and we remain fully invested with very little cash and, therefore, cash-drag. I like all my dollars going to work every day so that I don’t have to. We have a 50/50, globally-diversified index fund portfolio, which means we have many years of expenses in bonds, which tend to do quite well when the stock half periodically goes on vacation without giving me any notice.

 

[Aerides]

We have about a 3 year cash bucket, maybe 4. Mostly in CD's chugging away at a paltry half percent or something...But that's ok. It was always in our plan so we'd never have to be thinking about selling at a loss from our taxable accounts during a downturn. It also helps us manage capital gains as we don't HAVE to sell in any given year if other income is up, for managing to the ACA.

Perhaps once we get to SS, we would consider reducing the cash balance, but for now I'm not in any rush. Yes I'm leaving gains on the table by not having more of it invested, I know that, it's doing other good for me with peace of mind.

 

[ERD50]

We have about a 3 year cash bucket, maybe 4. Mostly in CD's chugging away at a paltry half percent or something...But that's ok. It was always in our plan so we'd never have to be thinking about selling at a loss from our taxable accounts during a downturn. It also helps us manage capital gains as we don't HAVE to sell in any given year if other income is up, for managing to the ACA.

Perhaps once we get to SS, we would consider reducing the cash balance, but for now I'm not in any rush. Yes I'm leaving gains on the table by not having more of it invested, I know that, it's doing other good for me with peace of mind.

I prefer to keep that in bonds (BND, VBMFX or similar) - while BND might drop a bit if I had to sell in a downturn, it is pretty stable. I feel comfortable with that possibility of a small loss compared to the longer term gains of BND vs CDs.

Over the past 10 years, BND hasn't gone negative at all (ref start time), and has returned ~ 39.8% (3.38% CAGR).

https://www.portfoliovisualizer.com...location2_1=100&symbol3=BND&allocation3_2=100


-ERD50

 

[Markola]

^^^^^. I can understand those reasons.

Purely in terms of portfolio returns, and in response to the OP, the various gymnastics that passive, fixed AA investors attempt to try to hide from stock downturns really don’t work, and active investing to hide is proven to be downright suicidal except for the luckiest few.

Here are three $1,000,000 portfolios over time from 1992 to present, i.e. the last 29 years:
-Domestic allocation for simplicity
- 5% withdrawn annually
- dividends and interest reinvested

Portfolio 1 is a simple 60/40 allocation that is rebalanced annually. The Compound Annual Growth Rate (CAGR) was 3.44%(Remember, we’re taking out 5% to spend each year.)

Portfolio 2 is 60/20/20 (20% cash) allocation rebalanced annually. CAGR was 3.2%

The Balanced Index Fund is 60/40 and rebalanced almost daily. CAGR was 3.32%

I’ve played with various rebalancing schemes, and no rebalancing at all, on Portfolio Visualizer and am convinced that over time none of the fiddling protects from stock downturns enough to get excited about. There simply is no place to hide. [During stock bear markets, the Fed typically cuts interest rates, so I shift my attention to my growing home equity and bond fund prices.]

Spending cash during a stock downturn is just a mentally-comforting form of temporarily building a more aggressive portfolio, which one eventually must rebalance back to a cash position. IOW, spending down cash, then replenishing it later is just slow-motion rebalancing. It makes no difference long term. One can rebalance regularly, quarterly, annually, using rebalance bands or no rebalancing at all, yet each option’s line crosses the others’ periodically. And the one with the 20% cash is consistently the laggard.