Strategy: Having enough low risk savings to cover spending needs for most statistically likely market downturns...

[glasswave]

Newbie, and perhaps stupid, question.
I don't know if I am phrasing this correctly. But if one wants to keep most of their "retirement savings in index funds," supplemented by enough "low-risk/reasonably liquid investment/savings" so that if there is a market downturn, they can not touch their retirement savings in index funds and use their "low-risk investment/savings" to cover their spending needs until the market and their "retirement savings in index funds" recovers, then start rebuilding the buffer in their "low-risk investment/savings."

How many years worth of spending expenses should one have stashed away in their "low-risk investment/savings" to cover most any statistically likely market downturn?

Is there a rule-of-thumb/formula for this? Is this a viable strategy? Is there a name for this sort of strategy?


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[aja8888]

Newbie, and perhaps stupid, question.
I don't know if I am phrasing this correctly. But if one wants to keep most of their "retirement savings in index funds," supplemented by enough "low-risk/reasonably liquid investment/savings" so that if there is a market downturn, they can not touch their retirement savings in index funds and use their "low-risk investment/savings" to cover their spending needs until the market and their "retirement savings in index funds" recovers, then start rebuilding the buffer in their "low-risk investment/savings."

How many years worth of spending expenses should one have stashed away in their "low-risk investment/savings" to cover most any statistically likely market downturn?

Is there a rule-of-thumb/formula for this? Is this a viable strategy? Is there a name for this sort of strategy?


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Probably no real rule of thumb, but look at history. For instance, the downturn in Japan's stock market took 30 years to recover (somewhat). One period in the U.S. was between 2000 and 2010 I believe where stocks did nothing.

 

[swakyaby]

I think some people might call this the bucket strategy. The first bucket is your emergency/cash equivalent holdings. For people who are still working or in retirement but have a source of income (pension, social security), this bucket might be as low as 6 months of expenses. But for retirees who rely solely on their investments for living expenses, it’s often 3 to 5 years of expenses to weather market downturns. The 2nd bucket usually consists of bonds for a time frame of 5 to 10 years. And equities comprise the 3rd bucket for long term growth. The first bucket gets replenished from either the 2nd or 3rd bucket to maintain the asset allocation you originally planned for.

 

[Koolau]

I don't know of a rule of thumb. Most down turns last 6 months to 18 months but there certainly are exceptions. If you really want to insure that you (almost) never have to dip into your equities during a down market, maybe pick a number like 5 years?? There may be other options as well. You might be able to borrow what you need (HELOC or from your insurance) to tide you over and preserve you equities. Nor should you worry about taking cash from your longer term CDs if that's needed. You'll lose (maybe) 90 days interest but that may be way better than taking from beaten down equities.

I think the biggest issue is how much cash on the side do you need to sleep at night? Whatever that amount is, will it greatly affect you in the long term (loss of growth)? If not, sleep is better than high returns IMHO but YMMV.

I ask myself the same question from time to time though I sleep just fine. I have a ready source of fixed income that I could have done better with by being more invested in equities. I'd say my fixed (and very liquid) cash is on the order of 5 years worth though it's not laying around money. It IS invested in a Guaranteed Income Fund (GIF) (also called a Stable Value Fund) which is usually only available in a 401(k) or maybe through the gummint/military savings system.

Let us know what you come up with and remember that YMMV.

 

[glasswave]

I think some people might call this the bucket strategy. The first bucket is your emergency/cash equivalent holdings. For people who are still working or in retirement but have a source of income (pension, social security), this bucket might be as low as 6 months of expenses. But for retirees who rely solely on their investments for living expenses, it’s often 3 to 5 years of expenses to weather market downturns. The 2nd bucket usually consists of bonds for a time frame of 5 to 10 years. And equities comprise the 3rd bucket for long term growth. The first bucket gets replenished from either the 2nd or 3rd bucket to maintain the asset allocation you originally planned for.

Thanks for your response but I am having a difficult time understanding it.

In one case you say 3 to 5 years is enough, then you say have 5 - 10 years income in bonds. Then you mention a 3rd bucket "for long term growth."

If "bucket 1" is ""retirement savings in index funds,"" and "bucket 2" is ""low-risk investment/savings"" why the need for a 3rd bucket? Which is it to weather most statically likely down turns "3-5 years" or "5-10 years?"

Is my ""low-risk investment/savings"" what you are calling your "bond bucket?"

¯\_(ツ)_/¯


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[glasswave]

I don't know of a rule of thumb. Most down turns last 6 months to 18 months but there certainly are exceptions. If you really want to insure that you (almost) never have to dip into your equities during a down market, maybe pick a number like 5 years?? There may be other options as well. You might be able to borrow what you need (HELOC or from your insurance) to tide you over and preserve you equities. Nor should you worry about taking cash from your longer term CDs if that's needed. You'll lose (maybe) 90 days interest but that may be way better than taking from beaten down equities.

I think the biggest issue is how much cash on the side do you need to sleep at night? Whatever that amount is, will it greatly affect you in the long term (loss of growth)? If not, sleep is better than high returns IMHO but YMMV.

I ask myself the same question from time to time though I sleep just fine. I have a ready source of fixed income that I could have done better with by being more invested in equities. I'd say my fixed (and very liquid) cash is on the order of 5 years worth though it's not laying around money. It IS invested in a Guaranteed Income Fund (GIF) (also called a Stable Value Fund) which is usually only available in a 401(k) or maybe through the gummint/military savings system.

Let us know what you come up with and remember that YMMV.

Thanks for your response.

I guess what I need to sleep at night, is enough years in my "low-risk investment/savings" bucket so that I can continue to live the same life style and be confident that my ""retirement savings in index funds,"" bucket will be able to recover from most any "statistically" likely market downturn.

I don't think I have a HELOC, GIF or Stable Value Fund or at least I do not know what those things are..


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[rembrandt]

Use a HYSA.

 

[bada bing]

If you are of a more traditional retirement age of 62+, another strategy that I personally use is to manage for enough guaranteed income to cover your base budget. Things like deferring SS, having a pension and/or purchasing a SPIA. If those add up to cover your necessary expenses, it makes it a lot easier psychologically to stay the course with equities. IMO that reduces the size of a cash bucket needed. "Spending from bonds" while deferring SS is one method to get towards that point. JMO, but now is a favorable interest rate time to shop a SPIA, if you're the correct age age and financial status to benefit from one.

 

[Al18]

2022 taught us it’s a mistake to own bond index funds. The past 10 years of bond fund performance is typically just under 2% per year. Instead of bond funds, I recommend purchasing CD’s at 1, 2, 3, 4 and 5 years. All are currently paying about 4.25% APR per year. Some folks prefer Treasury’s instead, and they have the advantage of no state taxes on the interest.

 

[marinauser]

On Jan. 1 I have enough cash to get me through the year. I keep sufficient dollars in an tIRA account in very short term CD/Bonds for a second year. That is plenty for me to sleep at night. Other than that, I have no allocation to cash. Everything else is either equities or fixed income of more than 1 year duration.

 

[Al18]

You need to set your stock/fixed income allocation according to your goals. For me, it’s 55% stock/45% fixed income. That works out to about 20 years fixed income.

 

[Diogenes]

I guess what I need to sleep at night, is enough years in my "low-risk investment/savings" bucket so that I can continue to live the same life style and be confident that my ""retirement savings in index funds,"" bucket will be able to recover from most any "statistically" likely market downturn.

Mainstream retirement-planning considers historical or simulated "Monte Carlo" scenarios of ructions in the market. Suppose that stocks drop X% and the bear market lasts Y years. OK, if the criterion is to not run out of money over some stipulated duration, given these scenarios, what rate of return is "safe"? From that one might pick the most stringent scenario, capping one's annual withdrawals. Or, one might back off even further. Thus we have the much-vaunted 4% rule and its more conservative variants. I've seen a version down to 2.6%, for example attributed to the influential book, "The Missing Billionaires".

The result is that instead of asking what percentage of our portfolios should be specifically in non-volatile assets, we ask, for a more conventional mix of stocks, bonds and cash, what's a safe rate of annual withdrawal. "Safe" is a weasel-word, but its inherent meaning is that so doing, we wont' run out of money (or in the alternative, we won't deplete our portfolio), in any but some truly cataclysmic case.

Personally I suffer from the desire to never reduce my portfolio. Maybe the OP does as well? Does this mean that the only "safe" withdrawal rate is 0%? I struggle with that!

 

[Montecfo]

I think some people might call this the bucket strategy. The first bucket is your emergency/cash equivalent holdings. For people who are still working or in retirement but have a source of income (pension, social security), this bucket might be as low as 6 months of expenses. But for retirees who rely solely on their investments for living expenses, it’s often 3 to 5 years of expenses to weather market downturns. The 2nd bucket usually consists of bonds for a time frame of 5 to 10 years. And equities comprise the 3rd bucket for long term growth. The first bucket gets replenished from either the 2nd or 3rd bucket to maintain the asset allocation you originally planned for.

This strategy never really made sense to me. If you are maintaining your asset allocation, then you're going to have to sell equities on an untimely basis to replenish those buckets.

Getting back to the op's question, I think your bond allocation is what is useful for selling when equities are down. If you're using funds or ETFs, then probably your lower duration funds are what you'd be selling to minimize any damage.

I don't think most people maintain cash for this purpose, because that would be a big drag on returns speaking very generally.

 

[OldShooter]

... How many years worth of spending expenses should one have stashed away in their "low-risk investment/savings" to cover most any statistically likely market downturn? ...

One reason you're struggling is that statistics don't really apply to stock market forecasting. The further reason for this is that the shape of the distribution of future market results is unknown. Classically we think of the symmetrical bell-shaped "normal" or "gaussian" distributions, but sadly the market distribution is demonstrably not like that. "Fat tails" is one term that is often used, but in addition to having fat tails, the market distribution is not symmetrical. In fact, Nassim Taleb points out a paradox: If you do not know what the distribution is, you cannot know how many samples are needed to characterize it. I have seen a video, too, of Nobel laureate Eugene Fama bemoaning the fact that market statistics are very weak because we only have 100 years of data. (!)

So ... it boils down to what you're getting in this thread: guesses and discussions of extreme cases. But the good news is that you are basing your question on, IMO, a false premise. You won't and probably none of use here will hold our spending level if the market tanks. So that will make a FI tranche last longer. Another risk you don't mention is inflation, but again not susceptible to statistical prediction. So ... my answer is three years but I have no mathematics to justify that number nor am I too concerned about holding our equity tranche absolutely sacrosanct. For belts and suspenders, we do hold a high percentage of our FI tranche in TIPS.

If you're interested in this stuff, Taleb's "Fooled by Randomness" is probably a good place to start, though he can be kind of a lunatic. Another choice, more sedate, is "The Drunkard's Walk: How Randomness Rules Our Lives" by Leonard Mlodinow.

 

[perez99]

I keep it simple. Have enough in bonds to cover 5 to 10 years of expenses. The rest can be in stock funds. No buckets needed. Rebalance if it deviates to much. If downturn hits, then live from bonds. Don't rebalance until market come back. Hopefully the downturn duration is less than your bond coverage.

 

[audreyh1]

I usually set aside my withdrawal for the year. Beyond that, the fixed income (cash and bonds) in my asset allocation will cover us for many many years if needed.

 

[GravitySucks]

My head sez a five year bond ladder is enough, but my heart sez ten years.

 

[FlaGator]

You have to find our own way on this.

Since starting to draw on the tIRA for expenses, I use my Roth as a holding tank for annual expenses. Do a "conversion" for what I need in the coming year and put it in ST Treasuries to capture some tax-free earnings. Draw it down from the Roth as needed.

Overall allocation is 70/30 with the bond portion covering about 8 years of expenses. All the bond/FI portion is in the tIRA.

 

[street]

Quote OP.
Is there a rule-of-thumb/formula for this? Is this a viable strategy? Is there a name for this sort of strategy?

I have no answer for these questions but your plan to live from low-risk funds is a key component to sustain the down markets.

This was my plan and goal to have enough in low-risk liquid funds to live on for my entire retirement years. I just checked our account where we only take fund for living and the account is the only place our SS and small amounts of income go through out just about 9 years in ER.

As of today, that account is just 80K less then when we started (ER) just about 9 years ago. The way it looks 80% of that account is still left for everyday living. So, my plan of living from that account and never having to tap any investments maybe a reality. All investments RMD at that time will go back into investments is my plan with those moneys.

So, for how much you need to stash in low risk is how long you want those to last. You will need to plan what you want in the future and what you want to do with your investment moneys.

My goal was focused on never using them, it is like I don't even have them. I wanted as bullet proof plan as I could master so to be ready for any downturn or for any unseen events. I really think our plan will work with the years we already have behind us and what is left.

 

[RetiredHappy]

Currently, our SS and qualified annuities payout cover about 50% of our expenses. Dividends from taxable brokerage accounts and RMDs cover the rest. In the IRA account, we have about 6 years worth of RMD in MYGAs. Dividends inside the IRA will cover another 2 years of RMD over 6 years, extending RMD withdrawals to 8 years without the need to sell equity positions.

 

[Exchme]

I don't recommend bucket strategies at all. Take a look at a couple articles at EarlyRetirementNow where he explains that the result of any particular size of bucket and refilling rules look a lot like random chance as to whether it helped:
Retirement Bucket Strategies: Cheap Gimmick or the Solution to Sequence Risk? – SWR Series Part 48 - Early Retirement Now

Discussing Retirement Bucket Strategies with Fritz Gilbert - SWR Series Part 55 - Early Retirement Now

January 25, 2023 – Welcome to another part of my Safe Withdrawal Rate Series. Today’s topic: Bucket Strategies in retirement. As you know, my blogging buddy Fritz Gilbert has written extensively on this topic at his Retirement Manifesto blog, for example: And likewise, I have written about my...

earlyretirementnow.com

I think expecting your future self to really keep increasing your stock percentage in a bad downturn is not very realistic unless you've been able to grit your teeth and do that your whole investing life. Most folks find it hard enough to simply rebalance in market downturns.

 

[audreyh1]

I don’t have a 80%+ equity allocation so I never worry about “selling equities when they are down” to cover living expenses. My equity allocation is more like 50%. Simple rebalancing will have you buying equities when they are down instead, and you can draw from fixed income during those bear equity market times. I have cash and short-term and intermediate term bond funds in my fixed income, so durations span a range.

 

[latexman]

If downturn hits, then live from bonds.

Agree.

Don't rebalance until market come back.

Disagree, kind of. This is an excellent opportunity to buy equities LOW. I understand the duration of the downturn is unknown, and rebalancing in a downturn may be a sphincter tightening adventure for many, but it is one of the few times to really ratchet up your portfolio.

 

[audreyh1]

Yes. Do some rebalancing when equities are low. Just make sure you still have enough cushion in fixed income.

It will be a scary time. It’s quite difficult psychologically to rebalance and buy equities when they are down hard. By that point everyone is expecting them to drop more! But if you have enough in fixed income, you can do this. I remember well living through this in late 2008/early 2009.

 

[GrayHare]

FWIW, recently I've been keeping three to five years of expenses in low risk. I refill to five years by selling riskier assets when they make new price highs.