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1nvest's take on Fire Cash

Including Financial Independence and Retiring Early (FIRE)
1nvest
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1nvest's take on Fire Cash

#398012

Postby 1nvest » March 22nd, 2021, 4:15 pm

Moderator Message:
This thread has been split off from this one so as to keep the original thread focused. Thanks, Chris

cash in retirement and how many "pots"

Depends upon your preferred asset allocation and circumstances.

Own a home and don't have to find/pay rent, liability matched.
Predict your lifetime expectancy, say 85.
Note down present day rates for each year of anticipated pension payments. Perhaps £13K/year pension paid as of age 60, supplemented with a £9K/year state pension at age 67.
Subtract the desired spending amount, perhaps £36K/year, and in this case that has a £23K/year shortfall for age 60 to 66 and then a 14K/year shortfall thereafter. Tallying all the pensions and £510K, tallying the shortfall = £427K. i.e. the pensions are like £510K in bonds that pace inflation. For the shortfall of £427K if you have that in liquid asset wealth then great, you just need a investment that paces inflation for that. In the absence of current choices for inflation pacing or better via 'normal' means such as index linked gilts, you might go with a reasonable 'safe' alternative.

Broadly the economy tends to move in a saw-tooth manner, two thirds of time doing well, one third of time in decline. Two thirds in positive real yields, one third in negative real yields. A reasonable choice of asset allocation for that is two thirds stocks, one third gold. Additionally we tend to see around equal amounts of occurrences of rising as falling interest rates. Long dated gilts do well during falling rates, 1 year gilts/cash does OK during rising rates. Split stocks 50/50 between domestic small cap and foreign large cap and that's 5 total assets. Allocating equal amounts to those and ... 20% in each of FT250, S&P500, gold, 1 year gilts, 20 year gilts. Historically that was resilient, relatively consistent and broadly 5% type real (after inflation) gains.

Swapping out 20% each in 1 and 20 year gilts for a 10 year bond bullet might equally achieve similar results. As might swapping a 10 year bullet for a 10 year ladder, where when we hold each bond to maturity we don't need to mark to market and can just calculate each years gain as the average of the prior 10 year gilt yields. With 40% allocation to that and one bond maturing each year = 4% of portfolio value from a maturing gilt each year, supplemented with some dividends from the 40% stock holdings. Perhaps 5% in total. Reviewing/rebalancing yearly, perhaps in March (fiscal year ends/starts so we can opt to action a change in the old or new year (or a combination of both) according to whichever may be the more tax efficient) and as part of that you put aside the anticipated cash you'll need for the year. i.e. at current low interest rates might as well just dump it all into your cheque/regular account.

Playing things safe, and if we assume a 3% real rate of return we can calculate that would need £320K of capital to cover our needs as per the above example case. Or otherwise jig around with the figures. For instance lowering the yearly spend rate down from £36K to £30K and at a 3% real rate we only need £200K. Or at £24K/year spend it drops to £100K. At £22K, well the £13K occupational and £9K pension entirely covers that from age 67, so we just need to fill the £9K/year gap between age 60 and 67. Again that portfolio is a relatively safe choice as it is less prone to sequence of returns risk - is unlikely to lose a lot shortly after having lumped £72K or whatever into it i.e. is well placed to likely offset counter inflation for the £9K x 8 years of 'filling the hole' between age 60 and 67.

For any of those situations when using that style of asset allocation no cash bucket/reserve is required, it automatically throws off the cash consistently (on a yearly basis). The cash for each year is handed to you at the start of each year.

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Re: Fire Cash

#406227

Postby 1nvest » April 22nd, 2021, 4:45 pm

Joe45 wrote:Any amount of cash is a drag on returns.
.
.
ERN also concludes that holding cash as part of your bond allocation won't in any event make much of a dent in your returns.

If stocks drops 33% then cash buys 50% more shares than before.

Will the next 50% gain occur before the next 33% fall? All in stock and a 50% gain followed by a 33% fall has you back to 0% gain/loss. For 67/33 stock/cash the same cycle has you up 3.6%

Some partner cash with stocks, shift 'bond' risk to the equity side. Others opt to hold broader (riskier) bonds. 80/20 stock/total bonds is similar to 90/10 stock/cash, where 10 cash is partnered with 10 stock as a 20% stock/cash barbell, that approximates a central bond bullet. The actual outcome can be near identical. The likes of Buffett prefer the 90/10 stock/cash choice, the likes of Boggle (used to) advocate stock and total bonds.

The difference between holding some cash/bonds to just holding stocks alone can be small subject to which time period you opt to select to measure across.

Money and gold where once the same, money was backed by gold and as such volatility was zero. That standard was ended, so that money could simply be printed/spent, for instance as a means to help pay down the cost of the Vietnam war. Upon such disconnect money and gold became much more volatile. Instead of continuing with 90/10 stock/cash you might have opted for 90/10 stock/gold - but again broadly didn't make much difference.

Fundamentally its a case of what assets and weightings would you prefer to hold, be most comfortable with. Or whichever might be the more cost/tax efficient. Gilts are lending to someone who can set interest rates, change how inflation is calculated, change taxation policies, print/spend money. Personally I feel uncomfortable with that, feels like the odds are stacked in their favour, a rigged table and as such I prefer stocks combined with gold, something tangible, in-hand and portable, accepted globally. However when partnered 50/50 with stocks a stock/gold barbell whilst combining to be like a central bond bullet does tend to be more volatile Sometimes relatively wins, sometimes relatively lags. Best to pick a choice and stick with it, as otherwise you'll be tempted to switch and likely at the wrong time, profit chasing more often leads to (relative) loss compounding.

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Re: Fire Cash

#406293

Postby 1nvest » April 22nd, 2021, 7:45 pm

I used that as a example on the assumption of yearly rebalancing, not timing the -33% drop and +50% peak, rather that that was what occurred at yearly rebalance timepoints.

You can get near bottoms by using a alternative style such as Zvi Bodie's Options based approach. Each week buy a 1 year at the money Option (he uses monthly intervals I believe). He scales exposure to 10x levels i.e. a overall 10/90 10x and 'cash' combination (he prefers TIPS/inflation bonds for the 90% allocation).

Since 1980 for example, the FT All Share had 73% of cases ending 52 weeks later being up. In the median case up 13.7% (arithmetic average 15.2%). With Call Options the downside loss is limited, upside potential (conceptually) unlimited. And one of the positions or more will have been started at close to the trough/bottom.

Those figures are price only based (dividends ignored). Similarly ignoring dividends the buy and hold annualised gain was 6.8%. Don't have the precise figure for dividends to hand, so assuming 4% then buy and hold total return was around 10.8%. For the Options 27% expired worthless, 73% in the average case gained 15.2% and 15.2% x 73% = 11.1%. Arithmetic averages however are distorted by one or more extremes, so the median is the better measure and 13.7 x 73% = 10%. That's all with no dividends or cash interest included, much/all of which might perhaps offset the time-value of the Options.

I'd guess/approximate no difference to either buy and hold or using 10/90 in 10x leveraged via Options/90% cash. You can do similar using other alternatives, half in 2x, half in 'cash' (bonds) for instance, yearly rebalanced. Or a third in 3x, two thirds cash. Note that the higher the leverage factor the more frequently you need to rebalance to realign weightings back to 50/50 2x/cash or 33/67 3x/cash in order to maintain alignment of total gains to that of 100% in 1x (buy and hold total return).

Accordingly cash isn't a problem in that context, as you can simply borrow from yourself (not have as much cash in the cash bucket) and replenish that later, whilst that costs only the loss of the interest that cash might otherwise have added for the duration that the cash was 'absent'.

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Re: Fire Cash

#406300

Postby 1nvest » April 22nd, 2021, 8:12 pm

With half in 2x stock, half in 'cash' in effect the 2x fund is borrowing the same amount again as what you invest in the fund in order to scale up stock holdings to twice as many. They do that daily so incur overnight/daily cost of borrowing overheads to do that. Their cost to borrow is similar to what return you might get for cash deposit interest rates. In which case to beat the index your cash just needs to earn more, beat daily cash interest rates and you in effect beat the index. A relatively safe asset allocation is the Permanent Portfolio for instance, 25% in each of stocks, gold, cash deposit and 20 year Gilt. When you swap 50/50 2x/cash over to 50/50 2x/PP since 2007 that added around 2% annualised alpha (higher rewards).

There are other uses for using leverage. For instance 25% in a 2x long stock (perhaps 2UKL) inside ISA, 25% in a 2x short stock within a SIPP (perhaps 2UKS), 50% cash, will tend to see a natural migration of SIPP value over to ISA, whilst the total portfolio value will tend to remain relatively flat. Tilt that a bit more, perhaps 50% in 2x long, 25% in 2x short, 25% cash and that's a form of 50/50 stock/bond holding but where SIPP value will tend to decline, ISA value rise. If SIPP additions are supplemented with 20% additional capital then that further enhances overall "rewards".

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Re: Fire Cash

#406311

Postby Itsallaguess » April 22nd, 2021, 8:33 pm

1nvest wrote:
With half in 2x stock, half in 'cash' in effect the 2x fund is borrowing the same amount again as what you invest in the fund in order to scale up stock holdings to twice as many. They do that daily so incur overnight/daily cost of borrowing overheads to do that. Their cost to borrow is similar to what return you might get for cash deposit interest rates. In which case to beat the index your cash just needs to earn more, beat daily cash interest rates and you in effect beat the index. A relatively safe asset allocation is the Permanent Portfolio for instance, 25% in each of stocks, gold, cash deposit and 20 year Gilt. When you swap 50/50 2x/cash over to 50/50 2x/PP since 2007 that added around 2% annualised alpha (higher rewards).

There are other uses for using leverage. For instance 25% in a 2x long stock (perhaps 2UKL) inside ISA, 25% in a 2x short stock within a SIPP (perhaps 2UKS), 50% cash, will tend to see a natural migration of SIPP value over to ISA, whilst the total portfolio value will tend to remain relatively flat. Tilt that a bit more, perhaps 50% in 2x long, 25% in 2x short, 25% cash and that's a form of 50/50 stock/bond holding but where SIPP value will tend to decline, ISA value rise. If SIPP additions are supplemented with 20% additional capital then that further enhances overall "rewards".


In what investment universe does an OP who asked -

I'd be interested to hear what plans you have for your cash in retirement and how many "pots" you intend to have.

then turn around after reading your post above, and say 'You know what, I'm going all in on that approach now - I was thinking it all wrong the complete time....'?

Cheers,

Itsallaguess


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