Exploring drawdown options - take from cash vs equities first?

GazzaBloom

I'm a few years from retirement and I continue to explore and learn about differing drawdown strategies. One area I've been mulling is a quasi bucket strategy, holding around 2 years of living expenses as cash and an invested pension with an 80/20 mix between low cost stocks index fund and a bonds fund.

My initial thought was to draw from the 80% stocks fund to sustain living expenses during years the stocks gained but turn off the tap and switch to drawing from the cash if the market drops say 10% or more and only revert back to stocks drawdown once it has recovered. if the cash buffer gets deleted then I would draw from the bonds fund for a further period of time until stocks recovered. Based on current projections I would have around 5 years of living expenses in the cash and bonds.

The general bucket strategy recommendations I have read suggest that you should draw from cash first then top up the cash with gains from the stocks/bonds, say after 12 months, cascading money down the "ladder"

But after 1 year isn't that effectively the same as drawing from the stocks in the first place except you have depleted 1 years worth of money from your cash buffer?

Or am I missing something?

MarkCarnage

Unless your stock portfolio generates enough dividend income to replenish the cash buffer, you will be drawing from the stock portfolio at some point, just a question of when.
Right now, I would also question the efficacy of an automatic 20% allocation to bonds (except index linked). Might be worth considering holding a bit more cash and/or using wealth preservation funds which have the flexibility to have a more dynamic asset allocation. 

Audaxer

GazzaBloom said:

My initial thought was to draw from the 80% stocks fund to sustain living expenses during years the stocks gained but turn off the tap and switch to drawing from the cash if the market drops say 10% or more and only revert back to stocks drawdown once it has recovered. if the cash buffer gets deleted then I would draw from the bonds fund for a further period of time until stocks recovered. Based on current projections I would have around 5 years of living expenses in the cash and bonds.

The general bucket strategy recommendations I have read suggest that you should draw from cash first then top up the cash with gains from the stocks/bonds, say after 12 months, cascading money down the "ladder"

But after 1 year isn't that effectively the same as drawing from the stocks in the first place except you have depleted 1 years worth of money from your cash buffer?

Or am I missing something?

I agree that you should draw from stocks first if they are making gains so that you keep your cash buffer for when stocks are falling. I would say the most simple way is to draw your income annually as you rebalance, so that you are left with the same percentages of stocks, bonds and cash that you started with.

pensionpawn

Audaxer said:

GazzaBloom said:

My initial thought was to draw from the 80% stocks fund to sustain living expenses during years the stocks gained but turn off the tap and switch to drawing from the cash if the market drops say 10% or more and only revert back to stocks drawdown once it has recovered. if the cash buffer gets deleted then I would draw from the bonds fund for a further period of time until stocks recovered. Based on current projections I would have around 5 years of living expenses in the cash and bonds.

The general bucket strategy recommendations I have read suggest that you should draw from cash first then top up the cash with gains from the stocks/bonds, say after 12 months, cascading money down the "ladder"

But after 1 year isn't that effectively the same as drawing from the stocks in the first place except you have depleted 1 years worth of money from your cash buffer?

Or am I missing something?

I agree that you should draw from stocks first if they are making gains so that you keep your cash buffer for when stocks are falling. I would say the most simple way is to draw your income annually as you rebalance, so that you are left with the same percentages of stocks, bonds and cash that you started with.

With a significant holding in cash (due to fiscal inertia in a rising market through a mandatory fund sale) I have been asking myself the same question. My current thoughts are similar i.e. if growth in the fund is sufficient to cover the loss due to inflation in the cash holding and the reduction in the fund then yes, draw from the fund pool.

Linton

I think 2 years is too short a time period for your cash and the jump from that to 80% equity is too large.  This would particularly be the case if you were using the cash for emergencies and large one-off expenditures.

In a crash your 80/20 portfolio could drop by 40%.  Might you get a little worried with only a 2 yea buffer?  I have about 15% of my liquid wealth in cash both as a buffer and to cover emergencies and large one-off items.

Also I would see the 20% in bonds as a potential problem.  Bonds are there to provide some diversification from equity.  However safe bonds are at a price where the effective interest rate has been squeezed to near zero which means there is very little room for increased capital value to mitigate an equity crash.  Indeed there is the possibility of both equity and safe bonds falling in price at the same time.

Perhaps it would help if you looked at your portfolios in a different way.  Really the 20% bonds in the equity portfolio are not doing much - they change a 50% fall in a crash to a 40% fall which is not likely to have much effect on your psychological reaction.  On the other hand if you were go with a 100% long term equity portfolio and regard the current 20% bond portion as a short/medium term lower risk investment alongside cash you would then have a buffer of perhaps 7-10 years.  This should enable you to more or less ignore a crash.  It certainly should not cause sleepless nights.

If you wish to work in this way you could increase your cash and use the rest of the allocation to create a more focussed portfolio to cover the second half of the 7-10 years.  You would benefit from some return to provide medium term inflation matching but should not increase risk to chase anything more.

Prism

If you are rebalancing each year back to your original split regardless of the performance of each asset then it doesn't matter where you take that years income from. In that case I wouldn't see cash as a 'bucket', more just a bond alternative that behaves a little differently. 

The reason you don't tend to see much guidance on how to use a cash buffer, and if to replenish it, is that historically there was no need for cash really - government bonds did the protection for you and worked a lot better than cash.

As Linton suggest, your cash/bond allocation should really be able to cover up to 10 years of living expenses.

GazzaBloom

Thanks all, I recognise that currently bonds aren't likely to perform so I may consider just holding that 20% as cash as well, so 5 years (that could last longer if we cut back a bit) of annual expenses as cash and the rest 100% equities, which would be a split of around 70/30. I would plan to increase the cash over time moving to 60/40, 50/50 if market returns allow, especially once my wife's pension starts to pay out (around 3 years after I retire) and we also have a Stocks & Shares ISA that I don't plan to draw on for every day living expenses but use for luxury spend, holidays, savings for car upgrades etc.

It's easy to manage a pension when you are working and paying in to it but the work and attention needs a different emphasis when looking at retirement that's for sure!

MarkCarnage

If you wish to work in this way you could increase your cash and use the rest of the allocation to create a more focussed portfolio to cover the second half of the 7-10 years.  You would benefit from some return to provide medium term inflation matching but should not increase risk to chase anything more.

This is what I was getting at with the suggestion to look wider than conventional bonds....thinking wealth preservation funds, like PAT, CGT, Ruffer etc.....the current strategy from central banks to cap nominal bond yields in a period of rising inflation certainly doesn't encourage me to hold much in the way of conventional bonds in a portfolio. 

GazzaBloom

MarkCarnage said:

If you wish to work in this way you could increase your cash and use the rest of the allocation to create a more focussed portfolio to cover the second half of the 7-10 years.  You would benefit from some return to provide medium term inflation matching but should not increase risk to chase anything more.

This is what I was getting at with the suggestion to look wider than conventional bonds....thinking wealth preservation funds, like PAT, CGT, Ruffer etc.....the current strategy from central banks to cap nominal bond yields in a period of rising inflation certainly doesn't encourage me to hold much in the way of conventional bonds in a portfolio. 

Thanks I'll look into such funds

Linton

MarkCarnage said:

If you wish to work in this way you could increase your cash and use the rest of the allocation to create a more focussed portfolio to cover the second half of the 7-10 years.  You would benefit from some return to provide medium term inflation matching but should not increase risk to chase anything more.

This is what I was getting at with the suggestion to look wider than conventional bonds....thinking wealth preservation funds, like PAT, CGT, Ruffer etc.....the current strategy from central banks to cap nominal bond yields in a period of rising inflation certainly doesn't encourage me to hold much in the way of conventional bonds in a portfolio. 

I agree as it is what I do.  However I did not want to get into active vs passive arguments so if the OP could achieve the same objective in another way, fine.

MarkCarnage

Linton said:

MarkCarnage said:

If you wish to work in this way you could increase your cash and use the rest of the allocation to create a more focussed portfolio to cover the second half of the 7-10 years.  You would benefit from some return to provide medium term inflation matching but should not increase risk to chase anything more.

This is what I was getting at with the suggestion to look wider than conventional bonds....thinking wealth preservation funds, like PAT, CGT, Ruffer etc.....the current strategy from central banks to cap nominal bond yields in a period of rising inflation certainly doesn't encourage me to hold much in the way of conventional bonds in a portfolio. 

I agree as it is what I do.  However I did not want to get into active vs passive arguments so if the OP could achieve the same objective in another way, fine.

Me too. I do have quite a significant cash holding too, but in part to meet known large expenses in the next 12-18 months. I agree that this is but one option, but I do think that the conventional mantra of bond holdings needs to be challenged in the current environment.