Planning choice: perpetual ISA cash buffer vs asset reallocation in SIPP

sofm

Keeping a 3-5 year cash buffer seems common practice to avoid stock market crash leading to sequence of returns issues...

For planning, are there advantages in either of these two ways beyond just personal preference? 

a) Money market fund in ISA - never touched unless really needed.  Could be fixed term cash ISA instead depending on rates, or a mix.

b) Pure asset allocation within SIPP.  I think that means 3-5 years money market fund, and then the rest is equity/bonds.  In my simple example: say equity/bonds is all 60/40.  But could be 40/60 for another 5 years and then 100/0 for the rest.

Ah - for (b) - I guess UPFLS can come from the equity/bonds fund?   Examples I've seen withdraw from the MMF and then sell off equity/bond fund to top up MMF.  That seems no different, just more trades/paperwork.

I sense there is also a human-factors issue in both cases - when to pull the trigger to pull from cash buffer instead of equities...

Prism

If all you are aiming to do is remove an early sequence of return risk then one route is to simply spend the cash buffer first, don't replenish it and then move onto bonds and/or equities. The original Bengen study of safe withdrawal rates and drawdown didn't use a cash buffer at all. Are you sure you need one?

Linton

Prism said:

If all you are aiming to do is remove an early sequence of return risk then one route is to simply spend the cash buffer first, don't replenish it and then move onto bonds and/or equities. The original Bengen study of safe withdrawal rates and drawdown didn't use a cash buffer at all. Are you sure you need one?

sofm said:

Keeping a 3-5 year cash buffer seems common practice to avoid stock market crash leading to sequence of returns issues...

For planning, are there advantages in either of these two ways beyond just personal preference? 

a) Money market fund in ISA - never touched unless really needed.  Could be fixed term cash ISA instead depending on rates, or a mix.

b) Pure asset allocation within SIPP.  I think that means 3-5 years money market fund, and then the rest is equity/bonds.  In my simple example: say equity/bonds is all 60/40.  But could be 40/60 for another 5 years and then 100/0 for the rest.

Ah - for (b) - I guess UPFLS can come from the equity/bonds fund?   Examples I've seen withdraw from the MMF and then sell off equity/bond fund to top up MMF.  That seems no different, just more trades/paperwork.

I sense there is also a human-factors issue in both cases - when to pull the trigger to pull from cash buffer instead of equities...

We hold cash in our current accounts to cover the next 12 months and then PBs for further tax-free easy access.  We also have about 15% of our total liquid wealth in wealth preservation funds to back up the cash in the medium term. Ok not the highest returns but does that matter?  If your priority is high returns invest in 100% equities. On the other hand if you believe you have sufficient investments to last all your and your spouse's lifetime and your priority is a quiet life with minimum stress rather than dying rich keep things simple and dont devote too much effort to chasing maximum interest from cash.

Cash in a SIPP has two disadvantages.  Firstly  depending on your platform  it can take  up to 6 weeks before you can actually extract a one-off cash lump from a drawdown pension. Both our platforms only run the payroll once a month and need to know that you do want to drawdown and have the cash available in the account at least 2 weeks beforehand.. The second potential problem is that you are limited in how much cash you can drawdown in a year if you wish to avoid  higher rate tax.

Those who say that simulations prove you dont need a cash buffer, fine.  However come the next crash I will continue to sleep soundly at night.  The question I would ask them is are you sure you don't need a buffer?  An over-riding desire for returns could be a symptom of inadequate planning with over-ambitious assumptions.

Pat38493

To add to the comments, having a cash buffer of 2 or even 5 years, is still not enough to completely eliminate SORR risk, but if it helps you sleep at night it’s certainly a good thing.  As identified above, the big question is whether to systematically replenish the cash buffer by a balancing strategy, or to make judgement calls like “when markets are down I will rely on the cash buffer and not rebalance”.  In those cases, it’s probably better to set yourself a clear rule on how you define markets being down e.g. 20% drawdown from previous peak or suchlike.

Linton

Pat38493 said:

To add to the comments, having a cash buffer of 2 or even 5 years, is still not enough to completely eliminate SORR risk, but if it helps you sleep at night it’s certainly a good thing.  As identified above, the big question is whether to systematically replenish the cash buffer by a balancing strategy, or to make judgement calls like “when markets are down I will rely on the cash buffer and not rebalance”.  In those cases, it’s probably better to set yourself a clear rule on how you define markets being down e.g. 20% drawdown from previous peak or suchlike.

The way I do the rebalancing is to first look at my expected short/medium term outgoings and base the cash and Wealth Preservation allocation in £s on that.  Anything left over goes into the long term funds.   The total allocation can then be modelled for the long term and the overall factor and asset type allocations reviewed.  If it didnt work some compromise would be necessary, though this has never happened (so far).

There is no attempt to balance for the sake of it or because the market currently happens to be behaving in a particular way.  I am a firm believer in basing portfolio design and investment allocations on objectives rather than maintaining some arbitrary % split or short term timing of the market. 

As it happens the asset class allocation numbers tend to work out overall fairly close to a 60 equity /40 bond+cash split but that is pure chance rather than design.

As regards SORR risk the advantage of buffering is that it gives you time to calmly and carefully reassess and adjust your objectives and strategy if required.    This should only be a concern for say the first 5 years.  After 5 years if SORR has not happened your assets should be sufficiently ahead of plan so that a future down turn will be relatively easy to withstand. For most people most of the time SORR wont be a problem - look at the detailed results of SWR calculations.