Cash Holdings during Drawdown Phase

[Joe45]

I’m a fan of the “Early Retirement Now” website. ERN argues against a cash buffer or emergency fund on the basis that cash is a drag on growth and should be viewed as no more than a psychological buttress against irrational behaviour (ie selling after a fall).

In drawdown, holding little or no cash means selling investments on a regular basis in order to fund spending. I am due to move into drawdown in the next few months and cannot decide how often to do this. With 4 separate accounts between me and my wife, monthly trading will rack up costs. Selling at the beginning of each year to generate a whole year’s cash contradicts the anti-cash philosophy.

Perhaps the answer is somewhere in between: sell and rebalance quarterly. Can someone already in drawdown offer an opinion?

[swill453]

I’m a fan of the “Early Retirement Now” website. ERN argues against a cash buffer or emergency fund on the basis that cash is a drag on growth and should be viewed as no more than a psychological buttress against irrational behaviour (ie selling after a fall).

Is that not a contradiction? If you don't have a cash buffer then you will have to sell after a fall, which it says is irrational behaviour.

Scott.

[Joe45]

I’m a fan of the “Early Retirement Now” website. ERN argues against a cash buffer or emergency fund on the basis that cash is a drag on growth and should be viewed as no more than a psychological buttress against irrational behaviour (ie selling after a fall).

Is that not a contradiction? If you don't have a cash buffer then you will have to sell after a fall, which it says is irrational behaviour.

Scott.

ERN's research shows that losses caused by selling after a correction have, over a long period, a less significant effect than the drag caused by a cash holding.

[xxd09]

What I do
Aged 73-retd 17 years
Treat all our savings as one Portfolio (wife and I)
We have a mixture of SIPPs and ISAs
I draw from the all as required
I keep a cash buffer of a least 1 years living expenses more often 2 in a high interest BS account
I keep the Cash account topped up by selling chunks of shares or bonds as required
Tending to do one sale of shares/ bonds per annum to top up cash fund
A system with lots of flexibility and enables you to survive a downturn without forced selling of shares/bonds during a drop in the stock market
xxd09

[Dod101]

Do you mean Drawdown as in living off a SIPP or a wider investment portfolio?

I live entirely off my dividends and have never had a funding problem and I have never sold anything to create income. I have access to cash in the form of N S & I Index Linked bonds which I have never had any need to touch through several downturns. That cash is now equivalent to about 3 years spending and is more a conscious asset allocation exercise than a reserve for income. I ought to invest some of it I guess but I am reluctant to give up the index linking as they are no longer available.

Not sure I understand your problem.

Dod

[nmdhqbc]

ERN's research shows that losses caused by selling after a correction have, over a long period, a less significant effect than the drag caused by a cash holding.

I just wonder about big purchases (car) which you might make every 5-10 years. If you set the date to buy a new car and get unlucky you could have to sell a very large chunk at a very low moment for the markets. I guess you could let the markets determine the timing of the purchase if possible.

[Itsallaguess]

I’m a fan of the “Early Retirement Now” website. ERN argues against a cash buffer or emergency fund on the basis that cash is a drag on growth and should be viewed as no more than a psychological buttress against irrational behaviour (ie selling after a fall).

Is that not a contradiction? If you don't have a cash buffer then you will have to sell after a fall, which it says is irrational behaviour.

ERN's research shows that losses caused by selling after a correction have, over a long period, a less significant effect than the drag caused by a cash holding.

The problem I have with this approach to the issue of a cash buffer is that it places no real 'value' on the 'psychological buttress' itself, and I think that for at least some people, there is likely to be some real value in it...

In almost all other areas of life, we're often happy to pay for an improved level of 'comfort', and I often wonder why this approach to comfort is sometimes lost when discussing potentially 'improved technical outcomes' over 'more psychologically comfortable outcomes'...

I'm still working, so have not crossed this particular bridge yet, but I really cannot see me retiring without at least some level of cash buffer, and perhaps up to a couple of years worth in all honesty.

If that comes at a 'cost' to me in a financial sense over the long term, then I will weigh that 'cost' against the psychologically comforting affects of having it, and I really do think that, in the end, I'll be more than happy to pay it...

Cheers,

Itsallaguess

[Chrysalis]

I would have thought that an annual sale of assets for income is perfectly sufficient (it is what I do, but I also have other regular income coming in).
A couple of years cash buffer seems a prudent step to take, you really do NOT want to be selling every month into a big financial downturn, out of forced necessity to pay bills, no matter what someone on the internet has back tested mathematically. What would two years be, somewhere between 5 and 10% of your assets?

[1nvest]

.. In drawdown, holding little or no cash means selling investments on a regular basis in order to fund spending. I am due to move into drawdown in the next few months ..

Depends upon your distinction between 'cash' and 'investment'. If for instance you allocate a proportion of your total investment into 'bonds' then that might involve a simple 3 year ladder. The first rung of which might be instant access (where 1.4% type present day rates are available). The next rung might be a 2 year fixed term (present day rate 1.8%), third rung a 3 year fixed term (present day rate 2%). Equal amounts in each rung = 1.73% collective interest rate (comparable to the recent inflation rate), with a third of those bonds total value in instant access. After 2 years when the 2 year bond has matured and the 3 year bond is a year out from maturity, use the proceeds from the maturing bond to to buy another 3 year bond. If interest rates rise, then those later purchased bonds will equally yield more. In practice rungs will become unbalanced .. spending out of instant access, 2 year maturing, juggle the amount split between buying another 3 year and amount kept in instant access as deemed appropriate. Emergency large expense and all of instant access might have to be supplemented with selling some stock/shares.

Some investors like to use constant average based asset allocations, maybe yearly rebalancing to 70/30 stock/bonds weightings. Others use variable weightings, maybe starting with 40/60 stock/bonds, drawing down bonds to zero over 20 years (3%/year income), leaving stocks to accumulate (reinvesting dividends), that ends 20 years with 100% stock, 0% bonds ... averaged 70/30 stock/bonds over the full 20 year period. Fundamentally both mathematically average the same overall stock/bond weighting over 20 years, but where in practice starting with 40% stock (40/60 stock/bond) and seeing that rise to 100% stock (100/0 stock/bond) is a form of time diversified cost-average-into stocks; It also ends with higher stock exposure risk than 70/30 (less stock exposure risk in earlier years than 70/30).

What are the prospects for 40 initial stock rising to 100 in real terms (restoring the original inflation adjusted start date total value) when accumulated (dividends reinvested) for 20 years? Well a 4.7% annualised real rate of return is the answer. No matter what however, assuming your bonds pace inflation then their drawdown supports 20 years of (reasonably) certain inflation adjusted income. If in 20 years stock accumulation hasn't gained anything at all, 0% annualised real gain, then quite likely those stocks will be paying a relatively high dividend yield (rising interests rates/inflation had caused stock price appreciation to be low/zero). Paying enough in dividends to live-off. Or if stocks had done well and recouped the inflation adjusted start date total value (and more), then .. start over again. Or of course at any point you might decide that stocks had performed sufficiently well enough to reset and restart afresh again (sell some stock to add to bonds).

Whatever you do opt for Joe, good luck. Coming up to and the early years are the more worrying - but generally those concerns relatively quickly fade. If not, then likely the discomfort means that whatever approach you are using perhaps isn't the best choice for you.

[Joe45]

Thank you all for your responses.

I am particularly taken by the idea that there is real value in the comfort of a cash buffer regardless of its value in financial terms. After all, the whole point of having money is to allow you to enjoy your life. I could after all save a bit by turning the heating off and wearing a coat indoors!

I need to expend a bit less mental effort fretting about how to squeeze every ounce of return from my portfolio.

[swill453]

Yes, my wife and I have about 18% of our joint portfolio in cash or cash-like, equivalent to nearly 5 years normal living expenses, and earning on average under 2%.

But it's of great comfort to us, and we've been very happy with overall performance over the last few, relatively benign, years. We'd expect to be even more comforted by it in a downturn.

If we started moving towards high inflation we may decide to do something a little different, but we'll take that as it comes.

Scott.

[SalvorHardin]

Cash has an important psychological effect that the investment textbooks mostly ignore. A study published in 2016 showed that the amount of money in a person's bank account was a much better predictor of their happiness than their overall wealth.

"Gladstone and his fellow researchers surveyed thousands of customers at a bank in the U.K. about their happiness in order to match their answers to transaction data linked to their bank accounts. “We find a very interesting effect: that the amount of money you have in your bank account right now is a better predictor of happiness than your aggregate wealth,” Gladstone explained. “Having more money in their bank account makes people feel more financially secure, which leads to an increase in happiness.”

He explained that, even for wealthier respondents — with a lot more in their savings and investments — a higher amount of money in their checking accounts seemed to lead to increased happiness."

https://www.pymnts.com/cash/2016/cash-o ... sychology/

https://www.ncbi.nlm.nih.gov/pubmed/27064287

http://www.joegladstone.com/spending-and-happiness

I typically keep 3 to 4 years' worth of basic living expenses in deposit accounts and Premium Bonds. The psychological benefit of having this is massive IMHO. Shortly after I retired (no pension; I live off my portfolio) I only had a few months expenses in cash and this relatively small cash buffer (even though the portfolio generates much more income than I need) was making me nervous. So I sold something and all of a sudden my mood improved drastically.

I suspect that if inflation takes off, the psychological benefits of holding cash will diminish substantially.

[tjh290633]

ERN's research shows that losses caused by selling after a correction have, over a long period, a less significant effect than the drag caused by a cash holding.

I just wonder about big purchases (car) which you might make every 5-10 years. If you set the date to buy a new car and get unlucky you could have to sell a very large chunk at a very low moment for the markets. I guess you could let the markets determine the timing of the purchase if possible.

I long ago began to put money away for car replacement by saving into a specified building Society account. This meant that in 60 years I have only used hire purchase or finance to buy one car. That one case was to take advantage of zero interest finance when I could get no further discount through paying cash. This goes back to 1960, when a medium sized car cost £600-700, and I was putting £10 a month into that savings account.

Today, similar cars cost about £15,000 or so, and putting away £200 pounds a month should achieve the same result. It depends on how frequently cars are replaced, but keeping low mileage cars for at least 10 years, and others for 6 or 7 years, the trade in value has tended to be high enough for the reserve fund to be built up significantly.

If your taste is more for large luxury cars, or for using the personal hire cintract approach, then you need to do your own calculations, but going for discounted cars, pre-registered, or low mileage used cars, it can work very well.

TJH

[JohnW]

Does reading this analysis help? Estrada finds that over many years in many countries a cash 'bucket' has disadvantages on several fronts:
Search for 'The Bucket Approach for Retirement: A Suboptimal Behavioral Trick? by Estrada'. You can find full text if you hunt around.