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?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.
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.