Cash Buffer in case of poor sequence of returns

shinytop

michaels said:

Here is some maths/research for those who still think a cash buffer makes sense:

https://earlyretirementnow.com/2017/03/29/the-ultimate-guide-to-safe-withdrawal-rates-part-12-cash-cushion/

You have to think about how long a correction might last in real rather than nominal terms and then also factor in rebuilding the cash buffer for the next correction.

For the purists this is good but pensions are invested in by people.  People feel better having a cash buffer and even if they read and understood stuff like this they might still choose to have one.  It's the same reason we pay our mortgages off early, don't invest 100% in equities or drip feed large cash sums into investments. Very interesting though.  

Sea_Shell

It's one thing to have a plan on paper that "wins", but quite another to have a plan that lets you sleep soundly at night.

stephenadarglas

I'm with Seashell and Shinytop on this one.  Wife and I both in our early sixties (both with DBs).  Cash buffer set aside to take us through to SP and then we can safely reconfigure our investments.  That's in 2.5 years and six years for SP.  Of course if our total return each year rises then that will be added to our cash buffer which can, if needed, increase our income.t

Linton

michaels said:

Here is some maths/research for those who still think a cash buffer makes sense:

https://earlyretirementnow.com/2017/03/29/the-ultimate-guide-to-safe-withdrawal-rates-part-12-cash-cushion/

You have to think about how long a correction might last in real rather than nominal terms and then also factor in rebuilding the cash buffer for the next correction.

Having read the paper, it seems me that it forms a very inadequate basis for a retirement strategy where one wants to support a particular standard of living for say 30 years..  The paper makes frequent references to the % of the pot size which of course dont apply if your pot has just fallen by 50%. If you want to model retirement scenarios properly against historic data you need the Firesim type of calculation where fixed periods of a similar duration to one's retirement plans are modelled with expenditure increasing annually by an inflation matching % of the initial pot size.   The key question is where this capital comes from.

The conclusion seems to be that one should be 100% equity and everything will work out, lower return, less volatile investments make the situation worse.  I dont think this is a common view among retirement pundits, a 60/40 split being far more often quoted.  In my case I regard the cash buffer as being part of what is close to 40% non equity.

Perhaps what is being said arises from the author being part of the FIRE community where the aim is to retire very early, perhaps in ones 30s, with standard of living being a secondary concern.

michaels

I don't think this is about a split of assets, cfiresim etc can be used to run scenarios to compare performance of different asset mixes (based on historic experience) but the idea of a cash pot to be used when 'markets are low' is all about timing the market - i.e. changing allocation between asset classes depending on some (arbitrary) decision as to whether individual asset classes are currently 'under priced or overpriced.  I thought this was generally frowned upon in the retirement planning community.

For example if you draw from the cash portion of your portfolio rather than the share portion you are effectively increasing your share weighting so saying' I think shares are a better investment currently than cash', drawing from shares is saying the opposite.  Unless you think you have some way of knowing better than the market what the future relative values of shares and cash are then you are taking a gamble rather than sticking with your initial planned asset split that was presumably chosen to maximise income whilst minimising risk of running out of money.

Linton

michaels said:

I don't think this is about a split of assets, cfiresim etc can be used to run scenarios to compare performance of different asset mixes (based on historic experience) but the idea of a cash pot to be used when 'markets are low' is all about timing the market - i.e. changing allocation between asset classes depending on some (arbitrary) decision as to whether individual asset classes are currently 'under priced or overpriced.  I thought this was generally frowned upon in the retirement planning community.

For example if you draw from the cash portion of your portfolio rather than the share portion you are effectively increasing your share weighting so saying' I think shares are a better investment currently than cash', drawing from shares is saying the opposite.  Unless you think you have some way of knowing better than the market what the future relative values of shares and cash are then you are taking a gamble rather than sticking with your initial planned asset split that was presumably chosen to maximise income whilst minimising risk of running out of money.

"Timing the market" is about taking action before an event you "know" is going to happen.  The cash buffer is different in that it its use is a reaction to something that has already happened.  The objective is simply to continue to enjoy an acceptable standard of living when selling extra units/shares would reduce the core investment you need to sustain future income.

In a sense you do know the future in that you believe that over the long term equity prices will rise though there may be times when there are rapid falls followed by a short to medium term extended recovery.  If you do not believe this you would be foolish to invest in the first place.

You do know better than the market what is in your interest.  The market isn't as concerned as you that your income is maintained. It does not take that into consideration when setting prices. 

The initial planned split between equity and non-equity should have been determined taking into account the likely need for a temporary alternative source of income. If you do not believe a buffer is needed why would you want any non-equity? You would be confident that you could survive no matter what happened and so would sleep soundly during the most severe of crashes.

Of course it is not against the laws of science that all of this could fail and you could be left destitute in your old age.  But in this case you wont get security from investing no matter what you do beyond diversifying to ensure that it is only global disasters that will destroy your plans.  In card games there is a strategy for dealing with bad hands.  You play on the assumption that the cards will fall just right for you.  If they do you win what should have been a lost game, if not you would have lost anyway.