We’d like to remind Forumites to please avoid political debate on the Forum.
This is to keep it a safe and useful space for MoneySaving discussions. Threads that are – or become – political in nature may be removed in line with the Forum’s rules. Thank you for your understanding.
Cash buffer?
Comments
-
I find myself in a somewhat similar scenario as the OP, and my main question is around 'when do I top up said cash buffer?' - in theory when stock markets are 'high' (or at least, not 'low') I should sell to maintain the buffer, but I don't really have a satisfactory measure of 'high' or 'crash' etc. - these tend to be short term metrics and if there is a crash, there's no way of knowing how long it would go on for and thus force a sale anyway when cash buffer runs out. I need to find some kind of rule.
0 -
In his book, McClung posited one possible rule for refilling (not specifically for cash buffers, but can be adapted) where each time stocks are up 20%* they are rebalanced into fixed income (or cash). Rebalancing from fixed income to stocks is not done.
* Not sure whether this is in real or nominal terms.
Personally, we hold cash as part of the fixed income component of our, rebalanced to a fixed allocation, portfolio. If stocks fall then more of the withdrawal will come from fixed income and vice versa, so this avoids the necessity of separate rules. Historical backtesting of cash buffers has found mixed results (e.g., see or https://www.financialplanningassociation.org/article/benefits-cash-reserve-strategy-retirement-distribution-planning-OPEN ) since it appears, not surprisingly that the outcomes depend on the rules adopted. Even in positive tests, the effect on the outcomes seem to be small compared to, for example, the allocation between stocks and fixed income.
4 -
And more importantly, up by 20% from what baseline? The value when I start to take from my cash buffer? That would imply the buffer should last around a std dev or so from 20-average annual performance/years, which is several years.
I think I prefer your strategy - it will still involve selling stocks when they are 'low' but not quite as much.
0 -
The baseline is the start of decumulation, and is inflation adjusted. Though it suggests bonds rather than cash as the buffer. It's quite a cautious approach, perhaps starting with a 60/40 allocation, and always drawing from bonds/cash never equities unless the portfolio has become 100% equities, which would only happen after something like a 10 year bear market. (which historically has been a good time to be in 100% equities)
See here, you can download the essential parts of the book free:
Book Review: Living Off Your Money by Michael McClung - Monevator
5 -
It should be noted though, that the lower the equity allocation in the overall portfolio, the lower the need for a cash buffer (notwithstanding what appears to be the once in a lifetime large drop in bond values back in 2022), since the fixed income allocation can usually act as a proxy.
Timing is also key (not that you can do much about it though)……with an equity heavy portfolio, if a crash (which is what a cash buffer is there to help with) occurs early in the period in question, the buffer will be more effective than if it occurs later…….simply because the bigger equity component in a non-buffered portfolio will cause that portfolio to grow faster in £ terms than the smaller equity component in the buffered portfolio (assuming the returns on equity exceed those on cash……which, tbf, is usually the case)
A cash buffer is not a panacea though…….it will help in some situations, but in others it won't, and in some it will hinder. Nobody knows when the next equity market crash will occur….it might be next month, next year, or in 10 years time……but in the end it's up to each to see what effect such a market crash would have on their retirement and whether a cash buffer would help or hinder in each instance.
2 -
Having a cash buffer to deal with a market crash, might mean never replenishing that buffer - the key is whether that buffer, by the time it runs out, leaves you in a better position than if you hadn't had it.
It might also mean never depleting it…….there's no way to know upfront……and in that case you might be in a worse position than if you'd never had it…….worse in the sense that your end portfolio value might be lower, but if you haven't depleted the buffer, then you haven't had need to, which means plan success in that sense - even if the end value is lower, it's still positive (as if it wasn't you'd have used the buffer)
2 -
I think the main point is to not blithely continue to eat big chunks out of a largely equity-based fund while equity markets are on the ropes. You want to avoid damage to the value of those funds for the longer term. So if you can't manage through the lean times on reduced income from the equities fund, having other funds such as cash and bonds will help to see you through.
🐻 A little FIRE lights the cigar1 -
What's your rule for 'on the ropes' though? Say you're 3 years in to deaccumulation and then there's a 20% fall.. you're likely still up compared to your baseline when you started deaccumulation (from historical global equities.. no guarantee).
1 -
No hard and fast rules. But a 20% fall is significant and would call for a similar reduction in withdrawals from those funds so affected.
🐻 A little FIRE lights the cigar1 -
I find it hard to cope without rules - the alternative is gut feeling which I don't think is great for finances! But your approach seems to be to mirror withdrawal rate to what happens in the funds in the same period/short term. If withdrawals are frequent enough I can see the merit, assuming income needs can be that flexible.
0
Confirm your email address to Create Threads and Reply
Categories
- All Categories
- 355.6K Banking & Borrowing
- 254.8K Reduce Debt & Boost Income
- 456.1K Spending & Discounts
- 248.2K Work, Benefits & Business
- 605.7K Mortgages, Homes & Bills
- 179K Life & Family
- 263.5K Travel & Transport
- 1.5M Hobbies & Leisure
- 16.1K Discuss & Feedback
- 37.7K Read-Only Boards