A practical discussion on the use of an 'income-reserve' or 'cash buffer'..

[Arborbridge]

My own position is that I draw down 80% of my HYP dividends, and leave the rest to be invested. My official minimum IR is about 18 months, though in practice there is actually more cash hanging around which I is normal rainy day money.

I draw a regular amount as my pension from a SIPP and it just happens that my ISA accounts have become the pool of income I call my "safety margin" for reinvestment. In the current circumstances, I might elect to reduce the drawings on the SIPP - as and when the dividends fail and the cash in there gets low - and draw some from the accrued dividends in the other two accounts.

I'm in two minds as to whether to use my IR cash or the safety margin cash. Psychologically, the SM being re-invested makes me feel I'm still moving forward, especially when shares will be at bargain prices for a while - but then spending IR cash makes one feel life is getting too threadbare.

On the good side, I expect my expenditure will drop for a couple of months - although having just moved house, it hasn't yet! And of course, some of that "cash hanging around" was destined for work on the house. There will be some big fixed costs that won't drop - e.g. marina fees come in a great lump in May as do various charitable payments which I would not axe. I'd guess my desire or ability to reduce expenditure may not be that great!

My feeling is that the system is robust enough for now - unless as Miner says there is blood on the streets. My expectation was for a 50% fall in HYP income, followed by a gradual climb back over 5-7 years.

Arb.

[Arborbridge]

With the cancellation of bank dividends for more than one year and the behaviour of the PRA it is getting near to it

Dod

Very worrying is the domino effect on the insurance sector. They will probably follow the banks down this route - about 18% of my income, though that includes Admiral.

Arb.

[csearle]

Still building so can't add anything practical. Just see this as a cautionary tale regarding what I must expect of any income reserve I build in in the future.

Excellent thread.

Chris

[Julian]

Still building so can't add anything practical. Just see this as a cautionary tale regarding what I must expect of any income reserve I build in in the future.

Excellent thread.

Chris

Don't forget, or at least give very, very serious consideration to a safety margin as well Chris. In my opinion safety margin (excess divi income vs what is drawn each year) plus income reserve (cash buffer equivalent to some months/years of income drawn) was the two-level protection methodology that I needed to help me sleep well at night when I was a 100% HYP-focused investor living entirely off my HYP income.

- Julian

[Steveam]

I very much agree with Julian’s comment about safety margin.

I had a considerable safety margin and, each year, used some of the safety margin to reinvest and some of the safety margin to increase the income reserve. After half a dozen good years I entered this period with a safety large safety margin (a 30 to 50% drop in income would be ok) and an income reserve of about 3 years “squeezed” expenditure in cash or cash equivalents.

I’m quite optimistic that I’ll get through this without touching the IR but not worried if I need to do so.

So, back to Julian’s point: a safety margin is wise and think carefully about how you deploy it.

Best wishes,

Steve

[ursaminortaur]

I very much agree with Julian’s comment about safety margin.

I had a considerable safety margin and, each year, used some of the safety margin to reinvest and some of the safety margin to increase the income reserve. After half a dozen good years I entered this period with a safety large safety margin (a 30 to 50% drop in income would be ok) and an income reserve of about 3 years “squeezed” expenditure in cash or cash equivalents.

I’m quite optimistic that I’ll get through this without touching the IR but not worried if I need to do so.

So, back to Julian’s point: a safety margin is wise and think carefully about how you deploy it.

Best wishes,

Steve

Unfortunately it isn't just the banks which are stopping paying dividends so even if you had a safety margin of actually normally receiving more dividends than you actually spend you may well be caught out by the number of companies now suspending or cancelling dividends. Hence I'm pretty certain that i'm going to have to start using my safety buffer in a couple of months time. I've currently got a bit of cash in bank accounts plus £50,000 in premium bonds so should be able to weather it without having to sell any share holdings unless the dividend suspensions go on for a number of years and will probably look at buying using this coming year's ISA subscription (out of that money) probably gradually dripping it in over the year.
Even though the cash/near cash safety buffer is there for precisely this sort of situation it is somewhat unsettling to have to actually bite the bullet and use it.

[Arborbridge]

Can I just apply to keep things uniform by referring to "safety margin" and "income reserve" rather than inventing other terms? These twocover te possibilities and their meanings have been well established. To invent other expressions for either just begs the question in people's minds about what the new term means; whether it is the same or something different.

Thanks.


Arb.

[Itsallaguess]

Can I just apply to keep things uniform by referring to "safety margin" and "income reserve" rather than inventing other terms?

These two cover the possibilities and their meanings have been well established.

To invent other expressions for either just begs the question in people's minds about what the new term means; whether it is the same or something different.

That's a good point Arb, thanks.

Are you willing to put some brief definitions down for each reference, to help draw a line in the sand at this stage of the thread, and thus be helpful to everyone going forwards?

Cheers,

Itsallaguess

[Dod101]

Another small item occurred to me at the weekend. I am very glad that I do not have any financing deal arranged for my car. In my position where I do not have a pension, I never have any form of debt. I would hate to be making monthly payments on my car at the moment for instance, especially when I only drive about 3 miles each week. When I bought my car new just over three years ago, I paid for it by that old fashioned method, a cheque but it means that there is no 'hangover'

I never have any debt and then I know exactly where I stand each month. Important I think.

Dod

[Arborbridge]

Can I just apply to keep things uniform by referring to "safety margin" and "income reserve" rather than inventing other terms?

These two cover the possibilities and their meanings have been well established.

To invent other expressions for either just begs the question in people's minds about what the new term means; whether it is the same or something different.

That's a good point Arb, thanks.

Are you willing to put some brief definitions down for each reference, to help draw a line in the sand at this stage of the thread, and thus be helpful to everyone going forwards?

Cheers,

Itsallaguess

As I understand it, based on extensive discussions on TMF years back:

Safety Margin: the difference between the dividends received and those drawn down to live on. Example: in my case I drawn down 80% of my dividends and reinvest the rest. The SM dividend stream could also be used to rebuild the Income Reserve when required.

Income reserve: cash (or perhaps "near cash" which can be easily accessed, such as premium bonds) which is held in order to make up lost income if dividends fail.

Based on the credit crunch experience, one might plan for a 50% drop in dividend income in the first year, with between 5 and 7 years recovery time. Using this, people have suggested anywhere between 1 and three years HYP income should be held in reserve. There is a decision each investor must make about the trade off between a large income reserve in which the cash earns virtually nothing, and investing more which gives a greater return but more risk.

That more or less sums it up, but I would expect someone with greater authority such as Gengulphus to treat this subject more academically.


Arb.

[Itsallaguess]

Can I just apply to keep things uniform by referring to "safety margin" and "income reserve" rather than inventing other terms?

These two cover the possibilities and their meanings have been well established.

That's a good point Arb, thanks.

Are you willing to put some brief definitions down for each reference, to help draw a line in the sand at this stage of the thread, and thus be helpful to everyone going forwards?

As I understand it, based on extensive discussions on TMF years back:

Safety Margin: the difference between the dividends received and those drawn down to live on. Example: in my case I drawn down 80% of my dividends and reinvest the rest. The SM dividend stream could also be used to rebuild the Income Reserve when required.

Income reserve: cash (or perhaps "near cash" which can be easily accessed, such as premium bonds) which is held in order to make up lost income if dividends fail.

Based on the credit crunch experience, one might plan for a 50% drop in dividend income in the first year, with between 5 and 7 years recovery time. Using this, people have suggested anywhere between 1 and three years HYP income should be held in reserve. There is a decision each investor must make about the trade off between a large income reserve in which the cash earns virtually nothing, and investing more which gives a greater return but more risk.

That more or less sums it up, but I would expect someone with greater authority such as Gengulphus to treat this subject more academically.

Thanks Arb - that's helpful and I think defines both aspects both distinctly and clearly.

Cheers,

Itsallaguess

[vrdiver]

...I appreciate that it's one thing to generate such a facility, and perhaps another thing entirely to begin the walk of actually *using it*....

Your question about using the Income Reserve reminded me of a sketch by Rhod Gilbert: https://www.reddit.com/r/videos/comment ... andwiches/

After all, if I actually use my IR, it won't be there to use should I need it!

VRD

[Wizard]

Can I just apply to keep things uniform by referring to "safety margin" and "income reserve" rather than inventing other terms?

These two cover the possibilities and their meanings have been well established.

To invent other expressions for either just begs the question in people's minds about what the new term means; whether it is the same or something different.

That's a good point Arb, thanks.

Are you willing to put some brief definitions down for each reference, to help draw a line in the sand at this stage of the thread, and thus be helpful to everyone going forwards?

Cheers,

Itsallaguess

As I understand it, based on extensive discussions on TMF years back:

Safety Margin: the difference between the dividends received and those drawn down to live on. Example: in my case I drawn down 80% of my dividends and reinvest the rest. The SM dividend stream could also be used to rebuild the Income Reserve when required.

Income reserve: cash (or perhaps "near cash" which can be easily accessed, such as premium bonds) which is held in order to make up lost income if dividends fail.

Based on the credit crunch experience, one might plan for a 50% drop in dividend income in the first year, with between 5 and 7 years recovery time. Using this, people have suggested anywhere between 1 and three years HYP income should be held in reserve. There is a decision each investor must make about the trade off between a large income reserve in which the cash earns virtually nothing, and investing more which gives a greater return but more risk.

That more or less sums it up, but I would expect someone with greater authority such as Gengulphus to treat this subject more academically.


Arb.

This raises a question in my mind. I think I read somewhere on TLF recently that Investment Trusts that hold an income reserve do not hold cash, they invest the funds in the portfolio. That makes me wonder about the concept of an Income Reserve as described here, given that many have likened it to the approach of some Investment Trusts.

I recognise that this means part of the portfolio is sold when income needs to be supplemented and that this may coincide with when share prices having fallen. But it is also the case that if kept as cash in the good years it will lose value in real terms, whereas if invested it may well perform better. I appreciate some may feel that it is simply not as safe as keeping it as cash, but if the idea is to follow the example of some Investment Trusts it is not illogical to reinvest it.

[tikunetih]

I recognise that this means part of the portfolio is sold when income needs to be supplemented and that this may coincide with when share prices having fallen. But it is also the case that if kept as cash in the good years it will lose value in real terms, whereas if invested it may well perform better. I appreciate some may feel that it is simply not as safe as keeping it as cash, but if the idea is to follow the example of some Investment Trusts it is not illogical to reinvest it.

I see it as a trade off.

If you keep a significant reserve of cash, then "on average" you should see lower long term returns and have less income overall.

But... in return for that you'll have less sequence risk (by avoiding needing to selling low for much longer), should sleep better at night, and with that have a lesser chance of being panicked or thrown off course by markets in a downturn.

As an individual investor, we don't have the benefit of being the "average case"; instead we each have a very individual roll of the dice, and so relying on "averages" is risky and we need to consider protecting ourselves in case through chance we end up experiencing an unlucky, outlier, damaging sequence of returns that could be extremely damaging to us. That's where the prudent use of a buffer comes in. Buying some insurance against being really lucky. The more you buy, the more expensive it becomes, so it's a trade-off, balancing risk & reward.

I don't think many portfolios are run to maximise returns; it's always a trade-off of factors, and the most important one is to achieve sufficient returns to meet your goals and do so while taking the least risk consistent with that.

I don't use an HYP, but this issue of cash reserves applies to any portfolio that someone's living off. It's well worth giving it plenty of thought IMO.

[Alaric]

but if the idea is to follow the example of some Investment Trusts it is not illogical to reinvest it.

Investment Trusts are closed end funds which means that they cannot be forced to pay back investors. That's as distinct from an OEIC. An individual's personal holdings are more akin to an OEIC, if in extremis the holdings have to be sold to pay living expenses.

[Dod101]

I think the difference is that investment trusts' 'income reserve' or Revenue Reserve as it is called in IT accounts are in general a much smaller proportion of the invested funds than will be the case with the average individual investor and they also have the option of either simply maintaining the dividend or indeed cutting it provided of course that they are distributing at least 85% of their current revenue profits. Therte need be no distress involved.

If the individual investor was to invest his/her income reserve, it is no longer an income reserve, or at least no longer a cash reserve and that would defeat the whole purpose of it. An IT is not necessarily using the Revenue Reserve as a supplement in a distress situation; it may and often is simply the case that the revenue is insufficient to allow the dividend increase which the IT wants maybe to maintain their 53rd year of dividend increases or whatever.

I suggest that Wizard's idea is a non starter. As has been suggested, maintaining a cash reserve is the trade off for peace of mind and currently., although my portfolio is down about 21/2% my cash reserves are still where they were and that is the point.

Dod

[tjh290633]

This raises a question in my mind. I think I read somewhere on TLF recently that Investment Trusts that hold an income reserve do not hold cash, they invest the funds in the portfolio. That makes me wonder about the concept of an Income Reserve as described here, given that many have likened it to the approach of some Investment Trusts.

Moderator Message:
As described above, an Income Reserve is essentially a cash reserve, or near cash reserve. In this context it is the Safety Margin which can be reinvested, as it will then provide more income.

Discussion of how ITs handle their "Income Reserve Fund" are OT in this discussion.

TJH

[Wizard]

This raises a question in my mind. I think I read somewhere on TLF recently that Investment Trusts that hold an income reserve do not hold cash, they invest the funds in the portfolio. That makes me wonder about the concept of an Income Reserve as described here, given that many have likened it to the approach of some Investment Trusts.

Moderator Message:
As described above, an Income Reserve is essentially a cash reserve, or near cash reserve. In this context it is the Safety Margin which can be reinvested, as it will then provide more income.

Discussion of how ITs handle their "Income Reserve Fund" are OT in this discussion.

TJH

Feel free to delete the references to ITs if that is what offends, but I think the question is still valid, should the income reserve be held in cash or not? As for how income reserve is defined, that is only Arb's definition. It isn't a bad definition, but it is not carved in stone nor is part of the guidance for this board.

[1nvest]

I don't use an HYP, but this issue of cash reserves applies to any portfolio that someone's living off. It's well worth giving it plenty of thought IMO.

I draw my own 'dividends' to my own level and timing out of total returns using yearly capital gains tax allowance and tax harvesting practices. Supplemented with a company pension comparable to the yearly income tax allowance amount. With relatively low dividends - £2000 or less, and they're also tax free (low yield portfolio). A relatively low safe withdrawal rate (SWR) by its nature provides a relatively safe steady/regular inflation adjusted income that you draw no matter whether the portfolio is up, down or sideways. More worthy of thought is when to draw (top up cash account) - as opportunities present themselves. With a standard SWR you might draw once yearly, or even monthly, but you can revise that to draw maybe two or more years of SWR if the portfolio has performed well, or not at all if the portfolio is down and there is sufficient in your cash account. Cash reserves are just a cash account, requiring little thought, better than carrying cash around in a wallet.

[Arborbridge]

I don't use an HYP, but this issue of cash reserves applies to any portfolio that someone's living off. It's well worth giving it plenty of thought IMO.

I draw my own 'dividends' to my own level and timing out of total returns using yearly capital gains tax allowance and tax harvesting practices. Supplemented with a company pension comparable to the yearly income tax allowance amount. With relatively low dividends - £2000 or less, and they're also tax free (low yield portfolio). A relatively low safe withdrawal rate (SWR) by its nature provides a relatively safe steady/regular inflation adjusted income that you draw no matter whether the portfolio is up, down or sideways. More worthy of thought is when to draw (top up cash account) - as opportunities present themselves. With a standard SWR you might draw once yearly, or even monthly, but you can revise that to draw maybe two or more years of SWR if the portfolio has performed well, or not at all if the portfolio is down and there is sufficient in your cash account. Cash reserves are just a cash account, requiring little thought, better than carrying cash around in a wallet.

Hardly relevant to this board, but thanks for the insight. Most here would prefer not to wrestle with decisions imposed by capital downturns such as 2008 and now, and this board is no place to propose an alternative to HYP.
I trust we will not feel the need to discuss this further.

Arb.