What and how much cash?

Fabtasia

Having read about pension management, there's definately a view to have some money in cash to protect against the market.

I'm looking at the interest rates on cash ISA, winnings on premium bonds and they don't seem that high?  It feels like by leaving too money cash, it's going to very quickly devalue.  

Have a missed some of the cash options? How much cash do you hold to protect against the market  in terms of months/years of spending?

I understand that there is always a risk versus reward angle.

Linton

At current inflation rates cash wont "very quickly" devalue.  In another thread the experience of several people who were already retired and kept detailed records was that their basic living costs have barely risen over perhaps a decade.

We keep about 8 years normal expenditure drawdown needs in cash, mainly PBs, but this is available for major one-off expenditures as well. Having a sizeable buffer avoids any loss of sleep during significant market falls and permits a higher risk/reward balance in long term investments than would otherwise be the case.

gm0

There are divergent views on this between "none",  "2 years",  "a bit more",   "liability matched portfolio"

Assume we are discussing flexible drawdown of DC.  And a scenario where you have State Pension coming (or 2 for a couple).  And we are discussing maintaining household "income" against market conditions - not emergency cash for house repairs or similar..

There is a need to consider the what/where/how of family and living arrangements (housing) in retirement and based on that timeline plan the following:

Desired Drawdown Income - if you can accept variable income this element may need less or even no cash buffering - your choice

Essential Income  - this element probably needs some buffering if you want to stop selling growth assets for a while in a major correction (This is the SORR protection essentially).

For example a major correction and full recovery to par or indexed par can take 7 years in the history but avoiding selling full income value for a year or two at the "apparent" bottom of the P/E sentiment multiplier correction can help reduce the overselling of fund units in the worst of times.  The buffered retiree will have more units left than the unbuffered one for the same continuity of income.

SP arriving mid-60s covers more essential income so the required buffering diminishes.  You are also up to 1/3 of the way into retirement.  Annuities can be bought later at better value if desired or not to the potential benefit of heirs

At the extreme end the liability matching philosophy says that you have no business being in risk assets AT ALL (with 80% loss potential) for the essential income need part once the capacity for work diminishes.  So net any guaranteed - Annuity/Sp etc) and the "not growth assets" portfolio should reflect this with any extra funds "discretionary portfolio" above that as risky as you like up to 100%.  This extreme is very difficult to implement presently as zero to very low risk assets with an inflation return are essentially unavailable.  So while it is a theoretical possibility to pile up cash and linker gilts - and you can do it if you have so big a fund you don't care - most of us have to stay invested in risk markets and set a buffer and access strategy on the above spectrum and then adjust in flight to what happens as and when something difficult happens during a 40 year retirement which it will - very probably three or more times.

Albermarle

Could be of interest 
DC Pot is 'big enough' but can't see how to lock in the value in real terms? - Page 5 — MoneySavingExpert Forum
Reducing volatility risk prior to retirement - Page 4 — MoneySavingExpert Forum
Reducing volatility risk prior to retirement - Page 4 — MoneySavingExpert Forum

Linton

gm0 said:

There are divergent views on this between "none",  "2 years",  "a bit more",   "liability matched portfolio"

Assume we are discussing flexible drawdown of DC.  And a scenario where you have State Pension coming (or 2 for a couple).  And we are discussing maintaining household "income" against market conditions - not emergency cash for house repairs or similar..

There is a need to consider the what/where/how of family and living arrangements (housing) in retirement and based on that timeline plan the following:

Desired Drawdown Income - if you can accept variable income this element may need less or even no cash buffering - your choice

Essential Income  - this element probably needs some buffering if you want to stop selling growth assets for a while in a major correction (This is the SORR protection essentially).

For example a major correction and full recovery to par or indexed par can take 7 years in the history but avoiding selling full income value for a year or two at the "apparent" bottom of the P/E sentiment multiplier correction can help reduce the overselling of fund units in the worst of times.  The buffered retiree will have more units left than the unbuffered one for the same continuity of income.

SP arriving mid-60s covers more essential income so the required buffering diminishes.  You are also up to 1/3 of the way into retirement.  Annuities can be bought later at better value if desired or not to the potential benefit of heirs

At the extreme end the liability matching philosophy says that you have no business being in risk assets AT ALL (with 80% loss potential) for the essential income need part once the capacity for work diminishes.  So net any guaranteed - Annuity/Sp etc) and the "not growth assets" portfolio should reflect this with any extra funds "discretionary portfolio" above that as risky as you like up to 100%.  This extreme is very difficult to implement presently as zero to very low risk assets with an inflation return are essentially unavailable.  So while it is a theoretical possibility to pile up cash and linker gilts - and you can do it if you have so big a fund you don't care - most of us have to stay invested in risk markets and set a buffer and access strategy on the above spectrum and then adjust in flight to what happens as and when something difficult happens during a 40 year retirement which it will - very probably three or more times.

A good summary of the options.  My aim is to achieve as close to your extreme end strategy as reasonably possibl.  It helps having a large pot thanks to the initial retirement plan assumptions turning out to have been very pessimistic,  There is a point when extra discretionary expenditure is less important than the lack of stress.

jamesd

It's primarily selling equities during equity drops that you're trying to prevent. Dividends and interest from bonds extend the time that cash will last and after the cash is exhausted you switch to bonds. A year or two of cash provided you have several years worth of bonds is likely to be enough.

If you're using a safe withdrawal rate the analysis for those typically assumes only equities and bonds, no cash at all.

There are times of low inflation and high bond prices when cash has historically been better than bods We're in one of those times now. So if you'd hold 30% bonds normally today you might hold 30% cash instead. The issue this protects against is capital losses due to rising interest rates reducing the capital value of the bonds held.

SouthCoastBoy

On a pot of around 1.4m I'm 60% equities 40% cash. Aged 56 retiring soon

JohnWinder

40% in cash, no bonds, might turn out to be a winning strategy for someone likely have 20 years investing ahead of them; and everyone's circumstances will dictate a different approach. But for the benefit of other readers, we should note that for the last 50 years there seems never to have been a 15 year period when cash returns beat intermediate term nominal government bonds. Over that 50 years, the cash would have returned a 40% gain (inflation adjusted), and the bonds 400% (inflation adjusted).

If you've got the time and can stomach the volatility, bonds should return more than cash; and why not since they carry interest rate risk which you hope to be rewarded for.

Linton

JohnWinder said:

40% in cash, no bonds, might turn out to be a winning strategy for someone likely have 20 years investing ahead of them; and everyone's circumstances will dictate a different approach. But for the benefit of other readers, we should note that for the last 50 years there seems never to have been a 15 year period when cash returns beat intermediate term nominal government bonds. Over that 50 years, the cash would have returned a 40% gain (inflation adjusted), and the bonds 400% (inflation adjusted).

If you've got the time and can stomach the volatility, bonds should return more than cash; and why not since they carry interest rate risk which you hope to be rewarded for.

Generally most private investors dont hold safe bonds for their 15 or 50-year return.  If you are solely investing for that time frame why hold significant bonds at all?  More important is stability in the short/medium term.  Under current unprecedently low interest rates safe bonds generate no significant return beyond cash whilst bearing the risk that an increase in interest rates will lead to a decrease in value in £ terms.

jamesd

JohnWinder said:

But for the benefit of other readers, we should note that for the last 50 years there seems never to have been a 15 year period when cash returns beat intermediate term nominal government bonds. Over that 50 years, the cash would have returned a 40% gain (inflation adjusted), and the bonds 400% (inflation adjusted).

That rise is part of what has created the unusual conditions favouring cash today. Quantitive easing and already very low interest rates is the other part. For bonds to continue rising, interest rates would need to continue falling. Since they have already gone to zero and negative in some developed economies there's limited scope for that to happen.

This situation is temporary and has happened only two or three times in the last hundred or so years.

bostonerimus

People using a Total Return strategy will keep two or three years spending in cash so they can ride out a big market decline. If you are conservative you might have more or if you have stable income sources like SP or a DB you might have less. I keep a years spending in the bank to cover big expenses and emergencies and then have a couple more years cash in a Stable Value fund in one of my retirement accounts.