Cash Need for Living Expenses?

[EdwardjK]

Happy Holidays to all!

I have just recently retired and am working through how I want to structure my retirement portfolio.  My current thinking is assign about 50% of my net worth to the PP, and about 50% to a variable portfolio consisting of about 60% equity and 40% bonds.

I am also thinking of putting aside about 3 years of living expenses in a money market fund.  This would be in addition to the cash assigned to the PP portion of my investments.

If I do all this, I'll have about 20% of my net worth in cash.  In a case of first impression, this seems excessive.

I am looking for your thoughts on whether I need to set aside cash for living expenses in addition to the cash in the PP.

Thank you.

Ed

[stpeter]

To me, one of the attractions of PP is that you don't need to set aside cash for 6-18 months of living expenses or whatever you're comfortable with - that's just built into the portfolio itself. However, you seem to want even more of a cushion, which I can't argue with since personally I'd prefer to avoid loss of principal. I don't recall that "the book" talks about PP strategies for drawing down funds in retirement, although of course there are plenty of theories about that in general (the old 4% rule etc.). It strikes me that one PP-friendly approach would be to move all gains from stocks, bonds, and gold into the cash portion, but I'm far from retirement so I haven't given a great deal of thought yet, myself.

[stuper1]

If I do all this, I'll have about 20% of my net worth in cash.  In a case of first impression, this seems excessive.

Ed,

Congratulations on your retirement.  The standard PP advice is to have 25% cash, so 20% doesn't seem excessive.  Typical advice around here is to hold even more than 25% cash if you want less volatility in your overall returns (say 40% cash and 20% in each of stocks/bonds/gold, or even more cash if you want less volatility).  Backtesting such a portfolio shows that returns are surprisingly still pretty good, but much less volatile.  That's no guarantee of future results, of course.  You may get more specific advice if you provide a few more details such as your approximate age and ratio of savings to annual expenses.

[EdwardjK]

Stuper1,

Thank you for your comments.

The moment that I pushed the "submit" button, I thought "Someone is going to say I should have 25% in cash".  So 20% may be low.  Lots of laughs.  I crack myself up.

OK, full disclosure.  My wife and I are 57 years old.  She is retiring in 2014.  Our total portfolio is around $6.5M and I estimate we need about $175K per year to live on.  Roughly one third of our portfolio is in tax advantaged accounts.  We have a $317K mortgage balance which I expect to pay off within 5 years.  Otherwise no other debt.

As stated, I am thinking of splitting our portfolio 50% in the PP and 50% in equities/bonds.

So there it all is.  Comments are appreciated.

[stuper1]

With that much savings you're in great shape.  The PP should yield about 5% real return on its own, which would basically cover your expenses.  The VP of 8% cash, 28% stocks, and 18% bonds will provide plenty of extra growth potential.  I'd probably go for less stocks and more bonds to be more conservative, but that's a personal choice.

Make sure you're well diversified institutionally.

Make sure you've considered estate tax planning.  Probably want professional advice.

[stpeter]

OK, full disclosure.  My wife and I are 57 years old.  She is retiring in 2014.  Our total portfolio is around $6.5M and I estimate we need about $175K per year to live on.  Roughly one third of our portfolio is in tax advantaged accounts.  We have a $317K mortgage balance which I expect to pay off within 5 years.  Otherwise no other debt.

Congratuations, it sounds like you're in great shape financially!

Personally I'd pay off the mortgage and find a way to spend less than $175k a year (I recommend the Mr. Money Mustache blog, which makes for educational reading about living more frugally). But to each his own and I certainly can't argue with your success.

[Tyler]

Congrats on the savings, EdwardjK.  I think you're on the right track with the passive approach.  That's 90% of the battle, especially if you're comfortable just sticking with whatever plan you choose and not over-thinking things.

Honestly, with that amount of money near 60 I think holding fist-fulls of cash is perfectly reasonable.  I'd actually be tempted to up my cash allocation well above 25% in your situation while cutting back on a few expenses just to put my finances on cruise control.  Why deal with adding volatility to your portfolio when you don't really need to?  At some point you need to be willing to declare financial victory and move on to more interesting things than maximizing returns.  ; )

As others have said, another big consideration at your stage and income/expense level is tax planning.  You might consider seeking out professional advice on how to structure your estate to minimize taxes.  And that could be one more reason to potentially consider holding more cash. 

[Xan]

$175K/year isn't ridiculous, and this gentleman has more than earned the right to spend that in retirement.  There's absolutely no need to go all Mr Money Moustache.  He's got plenty of money.

[Pointedstick]

It isn't ridiculous, but I'm willing to bet there's substantial room for optimization that would increase the safety margin of the portfolio.

[EdwardjK]

Folks,

Thank you for your comments.  The $175K assumes I have to pay Federal and state taxes.  So the net is somewhere between $100 and $125K.

Two reasons we were able to save so much: (1) we were not lucky enough to have children and (2) we lived well below our means.

Please continue to send feedback.  Thank you.

[stpeter]

The $175K assumes I have to pay Federal and state taxes.  So the net is somewhere between $100 and $125K.

Oh, I prefer not to think of taxes as a voluntary household expense because I'd get too angry and depressed. :-)

[Ad Orientem]

A few points...

First, a good rule of thumb for retirees is to keep several years of living expenses in cash. Personally I favor five years worth of anticipated living expenses in cash or a near equivalent. With 20% of your nest egg earmarked I think you are in good shape there.

As for how much to live on in retirement; that is a choice that involves a number of different factors including lifestyle preferences, your level of financial reserves, what if anything you want to leave your heirs and how long you expect to live. The old rule of thumb for conventional retirees (those retiring at 65) was to live on 4% of your net worth. But this advice has been widely criticized here and elsewhere. It fails to take into consideration potential inflation, possible black swan events that could damage your portfolio, and increasing life expectancy among other things.

All of which said, and assuming a conservative portfolio and that you are not worried about heirs (you mentioned you have no children), here is some generic advice on what percentage you can safely live on in retirement...

5% (or more) High Risk... Unless you are retiring in your eighties or have just been diagnosed with a fatal illness you should plan on dining at the Salvation Army soup kitchen during the 2nd half your golden years.

4% Risky

3% Probably Safe

2% Extremely Safe

<2% Bullet Proof

As you are planning on living off of less than 3% of your net worth, I think you are probably on safe ground here.

Congrats on your retirement. May you enjoy many happy years.

[Tyler]

+1

The 4% withdrawal rate rule of thumb also has assumptions built in on the conservative side (such as always growing your spending at the inflation rate with no regard to investment returns) but in general I agree with Ad Orientum.  My only addendum is that your withdrawal rate is a percentage of your investment portfolio, not your net worth.  The distinction is important mainly in relation to the value of your home (which counts towards net worth but isn't an investment from a withdrawal rate perspective). 

[Ad Orientem]

+1

The 4% withdrawal rate rule of thumb also has assumptions built in on the conservative side (such as always growing your spending at the inflation rate with no regard to investment returns) but in general I agree with Ad Orientum.  My only addendum is that your withdrawal rate is a percentage of your investment portfolio, not your net worth.  The distinction is important mainly in relation to the value of your home (which counts towards net worth but isn't an investment from a withdrawal rate perspective).

That is a really good point. Thanks for the correction.

[sophie]

The cash portion of the PP isn't only about living expenses.  See the following thread for a detailed discussion of what happens to a portfolio during the drawdown phase, with vs without cash:

http://gyroscopicinvesting.com/forum/ot ... /#msg71974

Briefly, keeping a substantial cash portion makes a huge difference in the portfolio balance, since you are rarely/never forced to sell assets that have dropped in value.  Based on back-testing, 4% is extremely safe for the PP whereas a 50/50 stock/bond portfolio can easily run into trouble.  50/50 portfolios will also show far less growth compared to the PP.  Edwardijk, I suggest keeping the portion of your portfolio that you think you will need to draw on for basic living expenses in the PP, then the rest in the stock/bond portfolio.  Just make the PP large enough that you end up with 5 years living expenses in cash.

Since this topic keeps coming up can somebody sticky that thread?  It was a great discussion and back and forth with spreadsheets.

[MeDebtFree]

I am about 5-8 years away from retirement and have put a lot of thought and analysis into this.  The following is where my thinking is currently at (and is still subject to change).

Others have probably already done this but I independently did some computations on 3/5/10 year CAGR HBPP trailing returns and found the worst case returns were as follows (these are raw unadjusted returns):

  3y - 2.7% (1999 - 2001)
  5y - 5.2% (1998 - 2002)
10y - 6.3% (1992 - 2001)

For my situation, 5.2% returns are good enough so I am planning on having a running 5 years worth of living expenses in a CD and/or bond ladder and hopefully will never have to draw down my HBPP (I have seemingly good hardworking kids and don't mind leaving them a chunk of change....but that could also be subject to change...you never know  ).  My HBPP will still be 25x4  and the cash portion is in addition to my 5 years living expenses.

CAVEAT: I am worried, however, that future HBPP returns will be (on average) lower for the next many years and I may not get 5.2%.

Another thought I have is that if long term rates get high enough (say 5.5% to 6%) I may just lock in most of my net worth in LTT and keep, say, 20% in gold as an insurance policy against the potential evils (high inflation, currency debasement, government default, etc).  But this is nothing more than a swirling trade off in my head right now.

Anyway, great job on building your net worth and I hope you and your spouse have a long, healthy, and happy retirement.

MDF

[Pointedstick]

Another thought I have is that if long term rates get high enough (say 5.5% to 6%) I may just lock in most of my net worth in LTT and keep, say, 20% in gold as an insurance policy against the potential evils (high inflation, currency debasement, government default, etc).  But this is nothing more than a swirling trade off in my head right now.

This is just me, but if I was going to lock most of my portfolio into long-duration fixed income, I'd want the rate of return to be a hell of a lot higher than nominal 6%. I had a savings account that yielded that much a few years ago!

[MeDebtFree]

Another thought I have is that if long term rates get high enough (say 5.5% to 6%) I may just lock in most of my net worth in LTT and keep, say, 20% in gold as an insurance policy against the potential evils (high inflation, currency debasement, government default, etc).  But this is nothing more than a swirling trade off in my head right now.

This is just me, but if I was going to lock most of my portfolio into long-duration fixed income, I'd want the rate of return to be a hell of a lot higher than nominal 6%. I had a savings account that yielded that much a few years ago!

Amen!  The only reason it is still on the table for me is I am at an age and net worth where that would provide a VERY comfortable lifetime fixed income and would possibly relieve me of ever having to think about investments again (not that I necessarily want to stop investing, but just saying).

As for "yielded that much a few years ago"... I wouldn't be surprised if I never see 6% again in my lifetime.  The 30 year has not been at 6% since 2000 and from where I sit there is no way our government will ever allow those rates again due to our debt load and interest payments.  It could very well be that the current 3.9% on the 30 might look awfully good over the next few decades if we get down to Japan type rates for an extended period of time.  So, locking in at 6% will probably never be an option for me anyway  .

[Libertarian666]

Another thought I have is that if long term rates get high enough (say 5.5% to 6%) I may just lock in most of my net worth in LTT and keep, say, 20% in gold as an insurance policy against the potential evils (high inflation, currency debasement, government default, etc).  But this is nothing more than a swirling trade off in my head right now.

This is just me, but if I was going to lock most of my portfolio into long-duration fixed income, I'd want the rate of return to be a hell of a lot higher than nominal 6%. I had a savings account that yielded that much a few years ago!

Amen!  The only reason it is still on the table for me is I am at an age and net worth where that would provide a VERY comfortable lifetime fixed income and would possibly relieve me of ever having to think about investments again (not that I necessarily want to stop investing, but just saying).

As for "yielded that much a few years ago"... I wouldn't be surprised if I never see 6% again in my lifetime.  The 30 year has not been at 6% since 2000 and from where I sit there is no way our government will ever allow those rates again due to our debt load and interest payments.  It could very well be that the current 3.9% on the 30 might look awfully good over the next few decades if we get down to Japan type rates for an extended period of time.  So, locking in at 6% will probably never be an option for me anyway  .

So you think the government can stop interest rates from ever going up? Then why have they ever gone up?

[MeDebtFree]

This is just me, but if I was going to lock most of my portfolio into long-duration fixed income, I'd want the rate of return to be a hell of a lot higher than nominal 6%. I had a savings account that yielded that much a few years ago!

Amen!  The only reason it is still on the table for me is I am at an age and net worth where that would provide a VERY comfortable lifetime fixed income and would possibly relieve me of ever having to think about investments again (not that I necessarily want to stop investing, but just saying).

As for "yielded that much a few years ago"... I wouldn't be surprised if I never see 6% again in my lifetime.  The 30 year has not been at 6% since 2000 and from where I sit there is no way our government will ever allow those rates again due to our debt load and interest payments.  It could very well be that the current 3.9% on the 30 might look awfully good over the next few decades if we get down to Japan type rates for an extended period of time.  So, locking in at 6% will probably never be an option for me anyway  .

So you think the government can stop interest rates from ever going up? Then why have they ever gone up?

The government can do whatever they want with interest rates (can anyone say QE?).  At times throughout history they have basically set them whenever and wherever they felt like.  Other times they let the normal rate market forces decide for themselves.  Rates were forced up by the government in the 70s and 80s to combat inflation.  They are forcing them low now to reduce borrowing costs to supposedly stimulate borrowing and thus the economy.  For a visual, here is a look at the 30 year since 1977.

http://finance.yahoo.com/echarts?s=^TYX ... ttype=line;

Also, I believe there are only 4 basic levers that can be used to get out of the huge debt we have: default, inflation, growth, and/or lower borrowing costs for some extended period of time.  Default is not out of the question but I think (hope) that is unlikely.  Growth here seems that it will be tepid for quite some time.  That leaves inflation and lower borrowing costs.  I think you are going to see some of both and interest rates could possibly be governmentally forced low for a lifetime.  There are, of course, limits to what the government can do if things get really get out of their control but in general they can, and have, forced interest rates to whatever levels they want based on their assessment of economic conditions.

[I Shrugged]

I haven't read all the replies, but we are similar in age, situation, and finances to you.  We have not found it at all necessary to keep a separate large amount for living expenses.  The PP's cash and near-cash holdings serve that purpose.  Of course we still have a local bank account for convenience and all.

Our living expenses are about as high as yours too.  We think we are frugal, but that's a joke.  We find the yield on our PP generates more income than we spend, though.  So the PP is growing, which is good.

[Libertarian666]

Amen!  The only reason it is still on the table for me is I am at an age and net worth where that would provide a VERY comfortable lifetime fixed income and would possibly relieve me of ever having to think about investments again (not that I necessarily want to stop investing, but just saying).

As for "yielded that much a few years ago"... I wouldn't be surprised if I never see 6% again in my lifetime.  The 30 year has not been at 6% since 2000 and from where I sit there is no way our government will ever allow those rates again due to our debt load and interest payments.  It could very well be that the current 3.9% on the 30 might look awfully good over the next few decades if we get down to Japan type rates for an extended period of time.  So, locking in at 6% will probably never be an option for me anyway  .

So you think the government can stop interest rates from ever going up? Then why have they ever gone up?

The government can do whatever they want with interest rates (can anyone say QE?). At times throughout history they have basically set them whenever and wherever they felt like.  Other times they let the normal rate market forces decide for themselves.  Rates were forced up by the government in the 70s and 80s to combat inflation.  They are forcing them low now to reduce borrowing costs to supposedly stimulate borrowing and thus the economy.  For a visual, here is a look at the 30 year since 1977.

http://finance.yahoo.com/echarts?s=^TYX ... ttype=line;

Also, I believe there are only 4 basic levers that can be used to get out of the huge debt we have: default, inflation, growth, and/or lower borrowing costs for some extended period of time.  Default is not out of the question but I think (hope) that is unlikely.  Growth here seems that it will be tepid for quite some time.  That leaves inflation and lower borrowing costs.  I think you are going to see some of both and interest rates could possibly be governmentally forced low for a lifetime.  There are, of course, limits to what the government can do if things get really get out of their control but in general they can, and have, forced interest rates to whatever levels they want based on their assessment of economic conditions.

I guess reductio ad absurdum only works with people who care whether their statements are absurd. Never mind.

[MeDebtFree]

I guess reductio ad absurdum only works with people who care whether their statements are absurd. Never mind.

Wow...my apologies.  I was trying to be sincere.  I don't proclaim to be an expert.  These are just my opinions/observations based on my little humble understanding of how things work.  I welcome your insights...perhaps I can learn something.  Thanks.

[Libertarian666]

I guess reductio ad absurdum only works with people who care whether their statements are absurd. Never mind.

Wow...my apologies.  I was trying to be sincere.  I don't proclaim to be an expert.  These are just my opinions/observations based on my little humble understanding of how things work.  I welcome your insights...perhaps I can learn something.  Thanks.

Well, if you really don't know that governments can't just set interest rates at any level they want forever, then it's never too late to learn.

If that were possible, then there would never be a hyperinflation or a depression, because governments never want those things to happen.

However, these things do happen sometimes, so there must be limits on what governments can do.

Most governments have to worry about their debt if they spend more than they tax for more than a short period of time. This is because the people they owe money to will start to get nervous about lending them more money with no obvious way of repaying the debt already incurred.

However, governments that have the "exorbitant privilege" of effectively being an issuer of a reserve currency can get away with this for a much longer time because governments of other countries will tend to keep their currency in reserves rather than turning it in as soon as they get it. This allows the issuing country's government to spend in excess of their income for much longer than other governments could do.

Does this mean reserve currency governments can spend as much as they want forever without interest rates going up? No, because at some point the other governments will realize that they are being taken advantage of and make other arrangements.

In my opinion, we are at the beginning of such a shift, with China a main player among the other governments. Once this really gets rolling, the "exorbitant privilege" of reserve currency issuance may disappear very quickly, and then the real costs of the US government's profligacy will become apparent.

[MeDebtFree]

I guess reductio ad absurdum only works with people who care whether their statements are absurd. Never mind.

Wow...my apologies.  I was trying to be sincere.  I don't proclaim to be an expert.  These are just my opinions/observations based on my little humble understanding of how things work.  I welcome your insights...perhaps I can learn something.  Thanks.

Well, if you really don't know that governments can't just set interest rates at any level they want forever, then it's never too late to learn.

If that were possible, then there would never be a hyperinflation or a depression, because governments never want those things to happen.

However, these things do happen sometimes, so there must be limits on what governments can do.

Most governments have to worry about their debt if they spend more than they tax for more than a short period of time. This is because the people they owe money to will start to get nervous about lending them more money with no obvious way of repaying the debt already incurred.

However, governments that have the "exorbitant privilege" of effectively being an issuer of a reserve currency can get away with this for a much longer time because governments of other countries will tend to keep their currency in reserves rather than turning it in as soon as they get it. This allows the issuing country's government to spend in excess of their income for much longer than other governments could do.

Does this mean reserve currency governments can spend as much as they want forever without interest rates going up? No, because at some point the other governments will realize that they are being taken advantage of and make other arrangements.

In my opinion, we are at the beginning of such a shift, with China a main player among the other governments. Once this really gets rolling, the "exorbitant privilege" of reserve currency issuance may disappear very quickly, and then the real costs of the US government's profligacy will become apparent.

Thanks for your response.  It was insightful.

I must admit that when I made the statement

The government can do whatever they want with interest rates...

I was using a bit of hyperbole (again, my apologies).

For clarification, my intent of the statement was to imply the US government has the ability to, and does, set interest rates via  the federal funds rate, the discount window, and programs like QE that influence treasury auctions.  Paul Volcker blasting the fed funds rate in the late-70s/early-80s and the current Bernanke (and I guess now Yellen) QE program stand out in my mind as clear examples of the government "doing what they want" with interest rates. Based on that clarification, I still think that is a fair, rather than absurd, statement.

It seems we do have some common ground in that I also stated at the end of my original post that

There are, of course, limits to what the government can do if things get really get out of their control...

which seems to align with your statement

Well, if you really don't know that governments can't just set interest rates at any level they want forever, then it's never too late to learn.

It seems we are both saying that the government can (and does) set/control interest rates but only up to a point where other market forces take over when things get too out of whack (I don't see, however, anywhere I stated or implied anything about setting rates at any level "forever", not sure where that inference came from).

Anyway, thanks again for the response.  Any other insights you may have are always appreciated.

Peace!

MDF

PS) And my apologies to EdwardjK for this "thread gone wild, off-topic side discussion".  In answer to your query, I still stand by the 5 years of living expenses thesis.