liquid cash in retirement: keep 2-3 years of expenses?!

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OakPhilliesFan
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liquid cash in retirement: keep 2-3 years of expenses?!

Post by OakPhilliesFan »

I'm 35, so I admit that I haven't thought too hard about managing cash flow in retirement. I'm aware of SWR, VPW, SPIAs, etc. But recently I saw a link to this Simply Money podcast. At around 11:00 the two hosts start discussing emergency funds. It's a fairly standard discussion until about 14:10:
When you get to retirement, an emergency fund is going to take on two jobs. The first job will be, if the check doesn't come or there's an emergency, you're going to have some extra money. But the second great function of an emergency fund -- let's say, as an example, you were to retire, and you were taking your money out on the 15th of every month. And you got to the 15th of February this year, and all of a sudden you looked at your investment account and you went, my goodness, it's down 10%, and I'm going to take my money that I need this month to pay the bills out, and all these shares are down? I don't want to sell shares when they're down. I want to, you know, buy low, sell high. I want to sell the shares from my account when it's high. What should I do?

The answer at Simply Money, we would say, a good strategy is to have two to three years' worth of living expenses set aside in very short-term, very liquid assets that don't have any market risk associated with them so that in that situation, whether it's at the end of one month or at the end of a year or a year and a half where markets have been down, you can say, I still have another two years or year and a half worth of income here. It doesn't mean you'll never have to sell a share at a loss to provide yourself with income, but it will certainly minimize the number of times because three years should give you, from a historic perspective, plenty of time for a market to cycle down and then come back up, at which point you're back in the game.

What would have happened if the market had gone down 10% in February and it had stayed down for three months or six months? If every month you were withdrawing money from your account and it was 10% lower than it was at the beginning of the year, that's a substantial amount of your money that is not there to grow any longer because it's been affected by market declines. If instead you could take money that probably isn't growing or shrinking (with the lousy rates that you get in a bank today), at least then you're giving the money that you would have otherwise withdrawn from your retirement a chance to grow and recover, and when you do that, then you wind up over time saying wow, that decline was not nearly as detrimental to my long-term investments, because I didn't have to go raid them at a time when my advisor might have been saying -- we might have been saying to you -- well, if you've got someplace else to go get the money, might not be a bad idea.
Maybe I'm missing something, but this makes very little sense to me. First is the market timing aspect: how much of a decline is enough to turn to withdrawing from liquid cash, and how much of a recovery is enough to stop? More importantly (as they even point out), that liquid cash is not declining with the market, but it isn't growing with it either! Why is it better to forgo future growth on 2-3 years' worth of living expenses than to sell shares when the market is down? Isn't this just a more complicated way of -- in the best case -- coming out exactly the same as you would have, if you perfectly time the market and save just the right amount of living expenses?

I can see that there might be some psychological benefit to doing things as they propose, but personally I'd feel much worse knowing that I was losing money in the attempt to gain some peace of mind. That would actually give me less peace of mind.

Is my analysis wrong? What do people who actually have to deal with this issue think? Is there another or better way to deal with sequence of returns risk?

Edit: Just thought of another possible problem with their strategy. If the 2-3 years of expenses come out of existing investments, that's 2-3 years of extra income or capital gains tax to pay right when they are taken out, rather than gradually over time.
sport
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Re: liquid cash in retirement: keep 2-3 years of expenses?!

Post by sport »

They seem to forget about one important thing: Bonds. When you are retired, you probably have a substantial amount in bonds. Bonds are not going to drop 10% suddenly. In fact, when the stock market declines, your allocation to bonds is going to have a higher percentage. So, you withdraw from bonds, not stocks. Yes, you need some cash in retirement. You may have to replace the roof, you might need another car, you might have some large medical bills. However, IMO, large amounts of cash serve little purpose.
The Wizard
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Re: liquid cash in retirement: keep 2-3 years of expenses?!

Post by The Wizard »

No need for Emergency Fund in retirement. Main use for it in working years is for job loss, which is moot in retirement.

Also no need for large cash buffer, based on my three years of retirement thus far.
I keep $3000 to $5000 in my checking account and reinvest the rest.

What is helpful is to have extra income beyond your basic expenses in retirement. That can be helpful when problems arise...
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SpaceCowboy
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Re: liquid cash in retirement: keep 2-3 years of expenses?!

Post by SpaceCowboy »

I'm retired and I keep a substantial amount in cash or cash equivalents. How would you classify my CDs?
I have spent much more time in retirement thinking about the fixed income side (bonds and cash) than I did during accumulation partially because it's a higher allocation now. I don't have a target for the cash / bond split, but keep demand deposits for 1-2 years of normal expenses. My overall allocation to cash including demand deposits, CDs and stable value funds is probably 25%+ of my portfolio. Things come up more than once a year where I need ready access to cash, for example to jump on a new high yield CD deal before it gets pulled. Also, life happens and cash is useful for dealing with unexpected expenses. It's a big part of sleeping well at night.
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Re: liquid cash in retirement: keep 2-3 years of expenses?!

Post by tacster »

The Wizard wrote:No need for Emergency Fund in retirement. Main use for it in working years is for job loss, which is moot in retirement.

Also no need for large cash buffer, based on my three years of retirement thus far.
I keep $3000 to $5000 in my checking account and reinvest the rest.

What is helpful is to have extra income beyond your basic expenses in retirement. That can be helpful when problems arise...
^This right here. If unexpected expenses crop up, redeem investments as needed to cover them.
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delamer
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Re: liquid cash in retirement: keep 2-3 years of expenses?!

Post by delamer »

The idea of keeping a couple years of expenses in cash is consistent with the Bucket strategy for retirement funds. Trying doing a search on that for more information.

And a year of expenses would be net expenses after annuities and Social Security.
Last edited by delamer on Mon May 09, 2016 6:52 pm, edited 1 time in total.
MIretired
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Re: liquid cash in retirement: keep 2-3 years of expenses?!

Post by MIretired »

OP:
Edit: Just thought of another possible problem with their strategy. If the 2-3 years of expenses come out of existing investments, that's 2-3 years of extra income or capital gains tax to pay right when they are taken out, rather than gradually over time.
You can leave the majority of this in a MM fund still in the IRA.

OP:
I can see that there might be some psychological benefit to doing things as they propose, but personally I'd feel much worse knowing that I was losing money in the attempt to gain some peace of mind. That would actually give me less peace of mind.
This to me is the main method I don't like, either. It's going too far as described--
a good strategy is to have two to three years' worth of living expenses set aside in very short-term, very liquid assets that don't have any market risk associated with them so that in that situation, whether it's at the end of one month or at the end of a year or a year and a half where markets have been down, you can say, I still have another two years or year and a half worth of income here. It doesn't mean you'll never have to sell a share at a loss to provide yourself with income, but it will certainly minimize the number of times because three years should give you, from a historic perspective, plenty of time for a market to cycle down and then come back up, at which point you're back in the game.
Sitting in too much cash has an opportunity cost(or risk, I'd call it.) I think I'd like to balance the risks.--too much safety has the cost/risk of lower returns overall. 3 years of cash earning neg. 1%+ real for 30 years is enough to concern me.
I think there should be a well thought out balance of risks in stocks, corp. bonds, treasuries, CDs, and cash, etc. with regard to the probability and severity of the risk. There are annuities, also, but any one of all these assets doesn't neccessarily have to be held depending on the investor's case.
Like : instead of 3 yrs. cash; one yr. cash and 2 yrs. bonds. Bonds have low correlation to stocks, you don't have to totally worry that both stocks and bonds will be down. And how much down is worse than sitting in cash to avoid it?
Or should you liability match or 'bucket'? Or can you use just an asset allocation. I think 'bucket' plans can also easily have an opportunity cost if not mindful of all risks, including opportunity.
Last edited by MIretired on Mon May 09, 2016 6:59 pm, edited 1 time in total.
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blueblock
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Re: liquid cash in retirement: keep 2-3 years of expenses?!

Post by blueblock »

I have 2016 living expenses in checking, and 2017 expenses in savings. The idea that I'm "losing money" on these funds is laughable. We're talking what, a few hundred bucks? I'll take the liquidity, thanks.

I agree with The Wizard that there is no need for an emergency fund in retirement (though we part ways on a buffer). If things get hairy, I let my taxable brokerage account stand in for an emergency fund, with my Roth as back up of last resort.

The important point here being, it's good to have options with respect to tax obligations as a result of unanticipated draw-downs.
MIretired
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Re: liquid cash in retirement: keep 2-3 years of expenses?!

Post by MIretired »

I agree that cash and short term investments is at the nitpicking end of allocations. And I agree with the ROTH as an emergency use, and , I'd say large one time expense use.
MIretired
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Re: liquid cash in retirement: keep 2-3 years of expenses?!

Post by MIretired »

blueblock,
You raise a good point about liquidity that I didn't totally consider. If the world goes 'in a basket', I'd have the ability to function for a while, which is a great underlying security. I actually haven't totally designed my allocations around my advice yet either(another point.) I have a line of 3 yrs. worth of better than cash or MM mutual funds for an average return and disruption.
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Re: liquid cash in retirement: keep 2-3 years of expenses?!

Post by livesoft »

I have more than 10 years of expenses in a taxable account in things like Vanguard Total Stock Market Index fund. I could sell it all and get the cash in my checking account in about 3 days. I don't need any cash.

If you ask, "But what if the market is down 50% when you have to sell?" Well, then I would have 5 years of expenses in a taxable account. Anything that I sell low, I would just buy something similar, but not substantially identical, in my tax advantaged accounts by exchanging from a bond fund. Selling something in my taxable account is practically tax-free under the current tax laws. If the taxable account runs out, then Roth IRAs could be used.

See also: https://www.bogleheads.org/wiki/Placing ... ed_account

2 to 3 years of cash is simply a psychological crutch. That's OK for folks who need such a psychological device. I don't need it.
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JoMoney
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Re: liquid cash in retirement: keep 2-3 years of expenses?!

Post by JoMoney »

"very short-term, very liquid assets that don't have any market risk associated with them" is not quite the same as "liquid cash" which is the term/title you used
I wouldn't keep it in "liquid cash" if it was literally for 2-3 years of expenses, but it would be in safe instruments with maturities/duration matching that 2-3 year time period. A dollar you need in 3 years is as safe in a treasury bond that matures in 3 years, will pay you interest along the way, and turns into cash when it matures without needing to be sold on a market. Bank CD's are probably paying even better yields, and a level of safety just about on par... but it sounds like that's not really the gist of what you're asking about.

If you were following a constant-mix balanced stock/bond investment policy, you probably wouldn't be worried about having to sell stocks because they were low, you'd already be selling bonds to get your allocation back in line and that would be providing the cash for whatever withdrawals you needed and help get your portfolio back in balance.

As someone else mentioned, what they're talking about seems more like a bucket approach (which I kind of like) ... but since the bucket needs to be refilled eventually anyways, it's likely to wind up very similar to a constant-mix rebalanced portfolio, but may be using dollar amounts instead of percentages, and/or doing some mental accounting tricks with regard to what's happening while the mechanics end up doing the same thing with a similar result as what the constant-mix % rebalancing would be doing.
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IlliniDave
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Re: liquid cash in retirement: keep 2-3 years of expenses?!

Post by IlliniDave »

Having 5-10% (~1-2 year's worth) of portfolio in short-term, cash-like instruments is pretty standard advice for retirees. These guys are a little more conservative, and except for not being a high bravado approach, I don't see a huge issue with it. I'm skeptical that it will negate the volatility of the stock market.

One thing I didn't get from the excerpt is the general portfolio these guys recommend. If it's 100% equities except this cash reserve it's a different matter than if the rest of the portfolio is a 50/50 stock/bond split (which in my mind makes the cash portion a bit redundant).

For the last number of years I've kept a year's worth of expenses in a combination of cash, MM, and muni bonds. Chances are I'll keep that going forward even after I retire. Mostly it would be to cover large, unexpected expenses that come up. To me those events can be stressful and adding on top of them a decision regarding liquidation of investment assets is something I'd rather avoid. My preference is to separate investment transactions from everything else so they can be made with a 'clear head'. Simply a personal quirk of mine.
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kjsammy
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Re: liquid cash in retirement: keep 2-3 years of expenses?!

Post by kjsammy »

This idea was discussed in a recent Wealth Track program. http://wealthtrack.com/murray-financial-healing/
His idea is to be 100 percent invested in equities with 2 years of living expenses in savings. That way you can ride out a bad market, just leaving your investments alone until the market recovers. As he presented the info it made sense.

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Re: liquid cash in retirement: keep 2-3 years of expenses?!

Post by OakPhilliesFan »

IlliniDave wrote:One thing I didn't get from the excerpt is the general portfolio these guys recommend. If it's 100% equities except this cash reserve it's a different matter than if the rest of the portfolio is a 50/50 stock/bond split (which in my mind makes the cash portion a bit redundant).
Yeah, that's a very good point. They didn't discuss allocation in general in this podcast, only emergency funds, but I agree that it makes a big difference for making sense of their retiree emergency fund recommendation.

Reading all of the replies so far, it seems that keeping 1-3 years of expenses in cash, TIPS, short-term bonds, etc., is a reasonable choice some people make in retirement, but that if you have a large enough bond allocation of any sort, rebalancing will force you to buy low and sell high anyway.
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Re: liquid cash in retirement: keep 2-3 years of expenses?!

Post by feh »

In general, I agree with the thought that it doesn't make sense to have a bucket of 2-3 years in cash.

However, I think there is at least one situation where it makes sense...an early retiree who is living off of taxable accounts only (no pension, no SS). For tax efficiency, that taxable account is 100% equities. If the market is down, use funds from the cash bucket instead of selling equities, to reduce the chances of running the taxable account down to $0 before tax advantaged accounts can be accessed.
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Re: liquid cash in retirement: keep 2-3 years of expenses?!

Post by Dandy »

A lot depends on your age, portfolio size and size of your withdrawals to supplement your retirement. I think keeping 2 or 3 years or so liquid is a decent idea for many. There are retirement "emergencies" that can be funded, it can also be substituted from your normal "risk" portfolio when the equity and bond markets are underperforming. It can also be used to buy riskier assets when they "are on sale".

Liquid assets are like shock absorbers. Expenses are often a bit lumpy and having some liquid assets can smooth out many of those. e.g. need a new driveway, major car repair or replacement, replacing some appliances, dental work not covered etc. No need to take a loan or sell investments.
HIinvestor
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Re: liquid cash in retirement: keep 2-3 years of expenses?!

Post by HIinvestor »

Blanket statements and "one size fits all" really fits few people. Some folks get sizable funds every month--from rentals, pension, social security, royalties, dividends, or whatever. If the funds they get every year/month will cover their expenses, what's the shortfall and why would they need a significant amount of liquid cash? On the other hand, if they pretty much have NO funds coming in and they will need to liquidate to have funds for living expenses, that is a different picture and they do need to consider having funds in "different buckets" so they can use the bucket that works for the time they need it, as was stated by others above.
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