"Keep two years' expenditure in cash"

[MyNameIsUrl]

I've read similar guidance in various places, namely that although the bulk of one’s retirement funds may be invested, one should keep enough cash to cover two (or one, or three) years’ expenditure.

What does this mean in practice? Hold cash in a sipp (often at 0%)? Would a bond etf be close enough to cash? Or is the slowly-eroding value of the cash a price worth paying for the reduction of market risk?

[kempiejon]

I like Premium Bonds; as a couple that's £100k and all interest tax free; I'm not sure what your annual expenditure is but that'd cover most of mine for 3 years. I do hold a couple of bond/gilt ETFs too. I have a month or so in interest paying current accounts at a %, Tesco have just cut from 3% to 1% I'll need to check the market place for a better deal. I have 2 regular savers that mature and are restarted annually offering 5% but yes inflationary erosion is the price of safety.
For me I like to have 3 years of expected expenditure on hand, figuring that a 50% loss of income that recovers over 6 years could be borne out comfortably and absorb some inflation too but really it's finger in the air time as to what amount of cash and what risk you take with your investments. I have in the back of my mind that for some spending or large purchases the amount of very cheap short term credit available to me with credit card balance transfer or introductory purchase periods of a couple of years could be deployed.

[Alaric]

I have in the back of my mind that for some spending or large purchases the amount of very cheap short term credit available to me with credit card balance transfer or introductory purchase periods of a couple of years could be deployed.

For large purchases, you could wait to be surprised. In other words utilise an unexpected cash infusion from a compulsory take over. Greene King in the last couple of days being a case in point.

With the ease and speed of sale on platforms, you are perhaps holding cash not so much for liquidity, but for protection against income shocks such as dividends being suspended or bonds defaulting. If expenditure can also be suspended at short notice, that may reduce the need to hold cash, which in current conditions isn't going to give much of a return.

[SalvorHardin]

What does this mean in practice? Hold cash in a sipp (often at 0%)? Would a bond etf be close enough to cash? Or is the slowly-eroding value of the cash a price worth paying for the reduction of market risk?

I take the view that it's a mixture of cash, short-term deposits and highly liquid investments which exhibit very little volatility. So a bond fund which invests in short-term bonds, treasury bills, etc. is close to being cash. But bond funds which hold longer dated bonds aren't (because their prices are more volatile).

Premium Bonds are close enough to cash. Their value is fixed, they can be turned into cash reasonably quickly and a very secure institution is backing them. One thought is to put half of your two years' expenditure fund in a one-year term deposit account and the rest in instant access deposits and banknotes. I'm very partial to banknotes when inflation is low - there's a big psychological benefit in holding cash.

There was a study published three years ago which said that people were happier the more cash they had. The amount held in your bank account had a major influence on how happy you were, moreso than your total wealth. Joe Gladstone was one of the researchers:

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

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

[AleisterCrowley]

I'm very partial to banknotes when inflation is low

So are burglars

[77ss]

I've read similar guidance in various places, namely that although the bulk of one’s retirement funds may be invested, one should keep enough cash to cover two (or one, or three) years’ expenditure.

What does this mean in practice? Hold cash in a sipp (often at 0%)? Would a bond etf be close enough to cash? Or is the slowly-eroding value of the cash a price worth paying for the reduction of market risk?

It depends on your expenditure! For me, 20K in Santander at 1.5% plus some Premium Bonds works. I would never hold significant amounts of cash with a broker.

The 'right' answer is always going to depend on your personal circumstances.

[kogsawelly]

The 'right' answer is always going to depend on your personal circumstances.

Exactly. If someone has guaranteed income from say a FS scheme or annuity then very little cash needs to be held, maybe a few months as an emergency fund.
Kogsawelly

[Itsallaguess]

Just a note to say that one of the important reasons for this guidance is to help avoid the potentially devastating downsides of 'Sequence of returns risk' -

https://www.investopedia.com/terms/s/sequence-risk.asp

https://www.thebalance.com/how-sequence ... ey-2388672

Basically, if a market downturn crops up in the first few years of retirement, then having to draw down affected investments at a relative low can have a devastating long-term affect on the remaining portfolio, so best to be able to draw down from somewhere else if this unlucky event does crop up...

I began to like Premium Bonds for this type of buffer.

I think that's probably about as exotic as I'd want to get with something as important as this, but I understand why some people might look to squeeze some more out of what might be quite a substantial capital amount.

Cheers,

Itsallaguess

[ursaminortaur]

Just a note to say that one of the important reasons for this guidance is to help avoid the potentially devastating downsides of 'Sequence of returns risk' -

https://www.investopedia.com/terms/s/sequence-risk.asp

https://www.thebalance.com/how-sequence ... ey-2388672

Basically, if a market downturn crops up in the first few years of retirement, then having to draw down affected investments at a relative low can have a devastating long-term affect on the remaining portfolio, so best to be able to draw down from somewhere else if this unlucky event does crop up...

I began to like Premium Bonds for this type of buffer.

I think that's probably about as exotic as I'd want to get with something as important as this, but I understand why some people might look to squeeze some more out of what might be quite a substantial capital amount.

Cheers,

Itsallaguess

I agree that premium bonds are a good choice - and there is always the small chance of getting a really substantial return.

[Dod101]

From the point of view of what some call liquidity, two or three years expenditure is far too much in my experience (which covers the tech bubble in 2000 and the financial crisis in 2007/8. But you certainly need a 'float' or whatever you like to call it to cover relatively barren months for income and then at times like the 2007/8 crisis when they were a lot of dividend cuts. I hold about the equivalent of three years' expenditure in N S & I Index linked bonds. Sadly they are not available as a new purchase at the moment. I do that more as an asset allocation exercise rather than for back up against monthly expenditure shortfalls, and really more to guard against capital drops in my share portfolio, than for any income consideration. As cash for immediate back up purposes I most of the time will have 6/9 months expenditure in savings accounts. That is losing money for me and occasionally when I have a surplus, it will go into share top ups.

Works for me and is also very informal.

Dod

[Steveam]

This is totally dependent on circumstances. I’m lucky enough that my income significantly exceeds my extravagant expenditure so I could withstand an income drop of well over 50% and, if I pressed down on expenditure, I suspect I could do even better. Notwithstanding this I hold a cash or equivalents buffer (NS Indexed Linked/Premium Bonds/high interest savings) as I can comfortably afford to have a (slightly) suboptimal position if it gives me even a small amount of reassurance.

All of the above and most of the discussion assumes that our expenditure is known, controllable and predictable. Imagine that one’s expenditure needs to double or treble for a period or if one needs to meet a substantial and unexpected bill. (10 years ago I had a major medical event while on holiday which cost the insurer over £50k IN A CHEAP COUNTRY!)

Best wishes, Steve

[scrumpyjack]

The factors in this, IMO, are what is your irreducible expenditure, what is your guaranteed income after tax, what are your overall resources, what do you feel comfortable with and ensuring so far as possible being protected against inflation.

In my case I know I am never going to earn another penny, I have large irreducible outgoings due to family circumstances (carers etc), and ample resources. I have therefore since retiring built up cash resources (Premium Bonds, Term deposits, Bank deposits etc) that cover many many years of outgoings.

But everyone’s circumstances are different. I would prefer to err on the side of caution rather than find we have a repeat of 1974, 27% inflation, 98% taxation etc etc, and find myself running out of cash!

[xxd09]

A cash fund is a common part of a portfolio in order to have smooth day to day spending
The amount by definition kept out of the investment loop is debatable
2 years expenses is a common figure-allowing you to leave your investments alone during a market crash
Crashes happen and selling Equities and Bonds during a downturn is no fun
Some advocate 5 years of expenses but this is super cautious
The current situation where we are entering Brexit with the possibility of a severe downturn is a justification for keeping cash
Being retired with no earning income coming in would mean keeping more cash on hand rather than less
xxd09
PS for anybody interested there is a fine blog by a poster called “Sheepdog “ over on the Bogleheads forum who while retired got caught out by this very problem
It has become a signature post for this particular scenario

[monabri]

A cash fund is a common part of a portfolio in order to have smooth day to day spending
The amount by definition kept out of the investment loop is debatable
2 years expenses is a common figure-allowing you to leave your investments alone during a market crash
Crashes happen and selling Equities and Bonds during a downturn is no fun
Some advocate 5 years of expenses but this is super cautious
The current situation where we are entering Brexit with the possibility of a severe downturn is a justification for keeping cash
Being retired with no earning income coming in would mean keeping more cash on hand rather than less
xxd09
PS for anybody interested there is a fine blog by a poster called “Sheepdog “ over on the Bogleheads forum who while retired got caught out by this very problem
It has become a signature post for this particular scenario

This one?

https://www.bogleheads.org/forum/viewto ... 10&t=25126

[xxd09]

That’s the one -a salutary read for all us by a brave poster who described his error and the consequences of not keeping an adequate cash cushion
A great lesson for all of us especially retirees
xxd09

[Dod101]

That’s the one -a salutary read for all us by a brave poster who described his error and the consequences of not keeping an adequate cash cushion
A great lesson for all of us especially retirees
xxd09

The OP did not actually say that. What he said was that on the day he was writing he had lost a year's expenses. He did not say whether he lives off income or, as some US sites advocate, was selling capital to create his income. In the circumstances in which he was writing that is a good lesson on why that is not a good idea. Nor did he say he had a cash cushion or not. Maybe we can assume he did not. I do not know.

Personally I think if, like most of us here I assume, we are living off the income generated by dividends from our portfolios we are at much less risk. Even in 2008, income did not entirely disappear, it reduced but that was it and it recovered fairly quickly.

Dod

[tikunetih]

Cash is just part of overall portfolio design, and there is no one-size-fits-all.

For example, someone with a very aggressive equity allocation that performs well in plenty of circumstances but very poorly in some others may derive significant psychological comfort and utility from holding a large chunk of cash alongside those equities, whereas someone with a portfolio much more diversified across asset classes and thus more robust to a broader range of outcomes may have and feel less need to allocate so much to cash.

Key is giving thought to unusual outlier conditions, both market and personal, that may - or more likely will - very occasionally come along, and to think about how you and your portfolio would deal with those conditions.

From that bogleheads thread, it reads like the fella's amygdala had lit up in the face of the threat perceived by absolutely brutal markets and accompanying doomsday newsflow, compelling him to "do something", which was to sell way beyond that required by his nearer term cash flow requirements. Easily done when fight or flight takes over.

People derive a lot of comfort from holding a big bundle of cash, but if you hold large amounts for the long term it'll create a performance drag that could become very material, so there's a balance to be found, and that choice should be a personal one arrived at after careful thought.

[Alaric]

Personally I think if, like most of us here I assume, we are living off the income generated by dividends from our portfolios we are at much less risk. Even in 2008, income did not entirely disappear, it reduced but that was it and it recovered fairly quickly.

What 2008 did kill off was the notion that you could park cash in an instant access account and still get a half decent yield on it, by which I mean in the 4% to 6% range. So for any sort of return, you had to accept the risks to capital and go into equities if you wanted to get something out of your savings. That's were we are today, with a FTSE 100 tracker yielding up to 4.75% and cash about a third of that.

[Hariseldon58]

It’s a good question of how much cash to have...

I retired in November 2007 with a very heavy equity bias to my portfolio, not a lot of cash and some property income.

We know what happened next and the maximum drawdown I experienced was close to 50%....

As previously mentioned dividend income held up well, the property income ( from an industrial unit I let ) held up and my cash positions were inadequate, just a few months income.

We managed, expenditure was kept modest, nothing extravagant, I did receive a deferred payment of cash from a previous business transaction and I did a zero deposit, 100% mortgage purchase of a flat, (a flat for my daughter at uni and let a spare room out) with a tracker mortgage (interest rates fell dramatically within a few months) , ploughing any spare cash in the market, the recovery came in 2009 and all ended well, was it comfortable? No.

So whilst I still have a heavy equity bias ( 85%) 5% in property I have 10% in NS&I and US Treasuries having a cash like buffer is very comforting...

What I took forward from my one experience is that your spending is not fixed , £24k pa represents a quite comfortable living standard but with limited travel and being sensible, at present we probably spend more than this again on travelling but we fund all future commitments and can clearly turn off the tap of excess spending, if needs must then could bring the cost of living down to about £14k

So if expenditure has a 4 to 1 ratio, dividend income just about funds expenditure at the extravagant layer then a 50% reduction would cope with reduced expenses.

Given the cash/US treasuries would fund about 4 years of expenditure at the extravagant level without recourse to dividends and 10 years at a more basic level then I feel this is reasonable but given Uber high inflation/confiscatory taxes then disaster strikes !!!

The cost of 10% of the portfolio bringing in a negative real return is probably about 0.35% pa at a portfolio level and I think this is not an unreasonable “insurance “ premium.

The real danger is a portfolio that assumes a high level of return say 4%, for an income that is barely enough to cover needs and in those cases short of going back to work then having a couple of years income in cash would be prudent !

[Gilgongo]

Just a note to say that one of the important reasons for this guidance is to help avoid the potentially devastating downsides of 'Sequence of returns risk'

Sorry for necroposting on this thread, but having read it I have a question relating to the issue of sequence risk.

Most guidance I've read says that during falling markets in the first 10 years of retirement you should avoid drawing down on stock holdings and instead eat bonds/gilts. And most retirement portfolios are recommended to have about a 60/40 stocks/bonds because of this.

But to what extent is cash an alternative to bonds or gilts for this purpose? Assuming that cash is in an interest-bearing account of course. Is it definitely the case that the loss of return from bonds/gilts doesn't make up for holding cash to offset sequence risk as it's free to hold and sell? I guess it depends how much cash we're talking about, so for the sake of argument, perhaps 20% of a portfolio cash with 20% bonds and the rest stocks?