SIPP Cash Buffer Handling

Pat38493

Agree with Zagfles - most of the research in this area seems to show that having a large cash buffer doesn't actually help the end result in the long term.

However it doesn't really hinder it either very much so it's a choice of whether you think it will help you sleep at night knowing that you have a couple of years in cash at all times.

Theoretically it could help a lot if you manage to deploy it, and then start filling it up again, at exactly the right time, but in the end that is a market timing decision which you are unlikely to be able to totally right.

zagfles

Linton said:

zagfles said:

BritishInvestor said:

Doglegger said:

I think a similar question has come up before but I couldn't find the threads so apologies if it's coming up again.

I retired last April and started taking my works DB. Come next month I intend to crystallise my SIPP and start taking a monthly top up from that. I will keep 3 years worth of drawdown held in cash in the SIPP.

My question is, how do others handle the cash buffers in their SIPP? I understand it's there to get you through any potential bad times until recovery but what if markets continue to be bullish or even stand still? Are there any rough rules on how far to deplete before topping up again? I'd got the idea of a 3 year buffer from the forum but hadn't thought of the caretaking of that until now.

Look back in history at the genuine bad times and how long they last, and it might make you question the point of the cash buffer.

Yes having a cash buffer seems to be more an emotional comfort blanket than anything else, I don't know of any research that shows real benefit from having one. Strategies like "prime harvesting" seem to be better ways of dealing with ups and downs of the markets - it's a similar principle but on a much longer term basis. 

If having a buffer is merely an emotional comfort blanket couldn't the same be said about having a 60/40 asset allocation rather than 100% equity?  

Not really, any more than any multi asset investment pot. Not that I'd use static asset allocation in drawdown anyway, dynamic may be better but a 2-3 year cash buffer doesn't appear to help much. Longer term thinking is needed IMO. 

In real life you have to deal with the ups and downs of the market in some way, ideally with minimal cost, effort and disturbance to day to day life.  The question is how.

Well obviously. It's been discussed to death here. 

cloud_dog

IF I were going with a sizeable cash buffer I would consider drawing my income from there and simply top it up from realised investments, that way at least some of the cash will not be suffering from inflation erosion.

Linton

cloud_dog said:

IF I were going with a sizeable cash buffer I would consider drawing my income from there and simply top it up from realised investments, that way at least some of the cash will not be suffering from inflation erosion.

Yes.  Though I would include topping up ongoing SP, annuities etc and income from dividends etc.

Aother way of looking at the problem is Liability Matching Asset Allocation whereby  your assets are structured  appropriately for the timeframes in which they will be needed.  This ends up with much the same solution.

If you need some of your holdings for long term inflation matching why include bonds at all?  Bonds are more useful for the medium term.   I believe it is foolish to satisfy short term needs from a high equity portfolio and then make it work by adding in ad hoc and rather arbitrary management techniques like Guyton-Klinger or short term patches like a small buffer.

zagfles said:

Linton said:

zagfles said:

BritishInvestor said:

Doglegger said:

I think a similar question has come up before but I couldn't find the threads so apologies if it's coming up again.

I retired last April and started taking my works DB. Come next month I intend to crystallise my SIPP and start taking a monthly top up from that. I will keep 3 years worth of drawdown held in cash in the SIPP.

My question is, how do others handle the cash buffers in their SIPP? I understand it's there to get you through any potential bad times until recovery but what if markets continue to be bullish or even stand still? Are there any rough rules on how far to deplete before topping up again? I'd got the idea of a 3 year buffer from the forum but hadn't thought of the caretaking of that until now.

Look back in history at the genuine bad times and how long they last, and it might make you question the point of the cash buffer.

Yes having a cash buffer seems to be more an emotional comfort blanket than anything else, I don't know of any research that shows real benefit from having one. Strategies like "prime harvesting" seem to be better ways of dealing with ups and downs of the markets - it's a similar principle but on a much longer term basis. 

If having a buffer is merely an emotional comfort blanket couldn't the same be said about having a 60/40 asset allocation rather than 100% equity?  

Not really, any more than any multi asset investment pot. Not that I'd use static asset allocation in drawdown anyway, dynamic may be better but a 2-3 year cash buffer doesn't appear to help much. Longer term thinking is needed IMO. 

In real life you have to deal with the ups and downs of the market in some way, ideally with minimal cost, effort and disturbance to day to day life.  The question is how.

Well obviously. It's been discussed to death here. 

It looks like we actually agree.   You seem to be rubbishing any form of buffer whilst I am trying to look at it more positively by seeing how the concept can be extended to do something more useful.

NedS

If you are 100% invested in equity, you will already have a natural yield of around 1.5% if invested globally, and higher if you have home bias. If the portfolio contains some bonds or other income producing assets, the natural yield will be higher, maybe ~2% overall.

If you have a natural yield of 2% and are in drawdown at a SWR of 3.5%, you are only selling 1.5% of portfolio assets each year (or need 1.5% cash buffer to prevent having to sell assets). Keeping ~5% of your portfolio in a money market fund yielding in excess of 5% does not seem unreasonable and could prevent the need to sell assets in drawdown for maybe 3 years. Top it up whenever investments have increased by >20% and use it whenever investments are down by >20%

The biggest issue I see whenever cash buffers are discussed is the complete lack of clearly defined rules around when to use them. If you draw on them too early, you just end up depleting them on the way to the bottom, only to find yourself in a position of having to sell assets at the worst possible time at the very bottom of the market. So there needs to be clearly defined rules that exist to mitigate the worst possible outcomes.

Hoenir

For many people to understand their own personal risk tolerance there needs to be a market correction that extemds for a 5/6 year period. Views are best formed from experience of having endured the experience hands on. When there's continual upward market momentum very easy to be become blase and feel totally relaxed. 

Notepad_Phil

NedS said:

...

The biggest issue I see whenever cash buffers are discussed is the complete lack of clearly defined rules around when to use them. ...

I use natural yield so the cash buffer automatically gets used up whenever the current yield doesn't match my income needs. Just make sure that you don't go chasing high yield above all else and ideally majority of assets are in simple global index funds. 

But if I was to use Total Return then I'd probably make up something along the route of calculating at the start of retirement how many units of each fund needed to be sold to match my income needs and then only sell a maximum of that number of units every year - then if markets have dropped the unit price will have fallen and so the cash buffer gets used automatically that way. High inflation and prolonged market drops might derail this approach, but then high inflation and prolonged market drops are going to derail any approach.

Obviously having a cash buffer needs you to work longer than possibly needed i.e. you need to have enough in investments to meet your income needs and then work longer to build up that cash buffer (which ideally you'll never need to use) so the larger the cash buffer the less practical it becomes for many

Doglegger

cloud_dog said:

IF I were going with a sizeable cash buffer I would consider drawing my income from there and simply top it up from realised investments, that way at least some of the cash will not be suffering from inflation erosion.

This is what I'm doing with it. It's the maintenance of it that I was concerned about. However, after reading the replies I may deplete until at a level I'm comfortable with. I had always looked at 18months of buffer but a post I did from a few years back had me convinced 3 years was the sweet spot. I do think I'd like some cash in there to draw from and topping up as and when if the markets allow. 

MK62

There's an old saying that you shouldn't invest in equities any money you might need within 5-7 years.......yet in drawdown, a 100% equities portfolio is doing just that.......and in drawdown, it's not might need, but rather will need.

There's also another saying that any money you know you'll need within 2-3 years shouldn't even be in the market at all.

So, I'd argue that while a 100% equities portfolio might be ideal for a eg a 25yo building a retirement fund, it's perhaps rather less so for a retiree. That's not to say it won't work, it might, but there's a materially significant risk that it won't.

Of course, you can choose to ignore the above, but don't kid yourself that you aren't taking a risk, just because, on average, equities have performed better........there's a lot of risk hidden in the phrase "on average".

Pat38493

The ERN blogs has researched this in huge detail and concluded that having an 80/20 bonds stock mix and drawing only from that works just as well as any other approach and better than most.  This research though is mainly focussed on 40+ year retirement timeframes.