Cash buffer dilemma

Veloflyer

https://forums.moneysavingexpert.com/discussion/comment/81994824#Comment_81994824

Surely it depends if you are drawing on the equities - and if you are and the market crashes - I really cannot see how a cash pot in lieu of drawing on that pot can be anything other than advantageous.

kempiejon

If 100% equities and a £30k income requirement whether a 3 or 5 year pot has a bigger influence on a £750k portfolio that a £1.5M portfolio though.

MK62

https://forums.moneysavingexpert.com/discussion/comment/81994960#Comment_81994960

The Fidelity video is talking "on average", but you don't use a cash buffer to deal with that.....it's there to deal with the below average situations. If you could guarantee the next 30 years would be no worse than the historic average, then a cash buffer would never be needed........but you can't guarantee that.....or any other outcome.

mrklaw

https://forums.moneysavingexpert.com/discussion/comment/81994960#Comment_81994960

its worth watching the video. they gave examples of their ‘triggers’ - eg if the market is down >10% they dont’ draw from equities they draw from their cash buffer. If the market is up >10% from previous quarter they use equities to draw and replenish the cash buffer.

kempiejon

@mrklaw and

If the market is up >10% from previous quarter they use equities to draw and replenish the cash buffer.

and the I guess if the buffer is full indulge yourself or others or reinvest to more equities to grow the income machine taking some pressure off the buffer

OldScientist

https://forums.moneysavingexpert.com/discussion/comment/81994960#Comment_81994960

At the point of the equity crash I would agree, but there are opportunity costs of holding the cash buffer since the return of equities is, on average, greater. In other words, a large run up before the crash (as in Japan 1989 and in the USA in 1929 and 2000, holding the cash results in a smaller pot at the point of the crash than not holding it. There are a lot of moving parts to this which is why, IMV, modelling (whether historical or Monte Carlo) is important.

There have been a number of studies in the past with various outcomes.

For example, https://www.financialplanningassociation.org/article/benefits-cash-reserve-strategy-retirement-distribution-planning-OPEN found that cash reserves improved portfolio survival rates.

Whereas, https://blog.iese.edu/jestrada/files/2019/07/BucketApproach.pdf found it to be a sub-optimal approach.

I think that McClung also tested a bucket approach (which, IIRC, included corporate bonds as well as a cash bucket) and found little or no improvement over annual rebalancing.

I suspect that any effect is relatively small and critically dependent on the assumptions made in implementing the buffer.

Veloflyer

https://forums.moneysavingexpert.com/discussion/comment/81995007#Comment_81995007

Agreed - another reason why I have one. My point perhaps was why would you not have one if you have an equity pot?

MK62

https://forums.moneysavingexpert.com/discussion/comment/81995404#Comment_81995404

That rather assumes the cash buffer exists during the accumulation phase.......it might not..…many might generate the cash buffer from their pension PCLS when they retire, so there's no opportunity cost prior to retirement.

Post retirement, and reliant on drawdown, an early period such as 2000-2003 would very likely see the non cash buffered equity portfolio suffer a serious setback relative to a smaller equity portfolio with a cash buffer. Fair enough, the reverse is true if there's an early equity market boom, but that scenario is still a benefit, even if not quite as big a benefit as the non cash buffer portfolio would see.

There is an old adage about stock market investing........ don't invest money you'll need within 5 years or so......but it seems some are happy to ignore that warning in the pursuit of higher returns - in some cases, returns they don't actually need or, perhaps, even plan to use. I get that more is not undesirable, but once in drawdown, the greedy gene could easily turn out to be your worst enemy.

mrklaw

My plan is to build the cash buffer during the last two years of accumulation. gives the equities as much time to grow as possible and avoids selling equities at the end to generate the cash.

OldScientist

https://forums.moneysavingexpert.com/discussion/comment/81995471#Comment_81995471

I was only talking about during retirement not accumulation.

I am definitely not in the '100% equities' camp since the historical evidence during both accumulation and retirement is mixed. As I posted upthread, holding up to about 15% cash as part of rebalanced portfolio resulted in a slightly higher SWR for a UK retiree than holding 100% equities (although I didn't show it, 100% equities were also worse with US data - IIRC, the SWR is fairly constant from about 40% to 80% equities). I think my beef is with the separate 'cash buffer' (see note 1) since it (slightly?) reduces the size of the portfolio that withdrawals are taken from and, IMV, introduces unnecessary complexity since compared to rebalancing there are three rules for the buffer, 1) target size of buffer, 2) depletion, and 3) replenishment each of which is capable of being defined in multiple ways.

To take the 'depletion rule' as an example - a common trigger is that the cash buffer will be used if equities (or, perhaps the entire portfolio since it may also contain fixed income, gold, etc.) has fallen by a certain amount (e.g., 10% or 20%, or whatever). There are many options in how to define the amount of fall since it can be calculated in real or nominal terms and can be calculated over different timescales, e.g. over the last year (or other fixed period), since the last peak, etc..

Even something a simple as maintaining the target buffer size requires some additional decisions in implementation - e.g., if the buffer grows bigger than the target (e.g., if cash has had a positive real return - assuming the target size is defined in real terms - and the buffer has not been needed). Is this surplus spent, retained, or sent to the main portfolio.

As I said, the research evidence for the benefits of holding a separate cash buffer is mixed suggesting that the effect is a) implementation dependent, and b) small (either way).

Note 1. Except where it is used a a cash flow buffer to smooth income from a dynamic withdrawal strategy (e.g., see https://www.bogleheads.org/forum/viewtopic.php?t=284519 )