Author Topic: Are there any studies showing that "dry powder" in your AA actually is valuable?  (Read 2758 times)

ender

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I am intrigued by how many people on these forums make comments of the sort:

  • If there's a market correction, I have dry powder available to invest (whether cash, HELOC, etc)
  • I bought stocks when they were on sale

or a variant of that.

I am wondering if is there actually research or a plan for when to dump this dry powder into the market that shows it's actually a good long term plan (at least historically)? Some sort of heuristic that is along the lines of, "Holding X% cash that you only invest when the market drops by Y% in Z days is better than investing all of that cash" or something along those lines which historically would have actually worked.

Does any research into this from a historical perspective exist? Or is it all just glorified market timing without any research to back it up?

neo von retorch

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I do not have research to offer you.

I do have two common statements we use:

* The market is usually going up
* It's not timing the market... it's time in the market

Given the above, cash sitting around is much more likely to lose value to inflation than it is to give you a nice boost because you timed things well and were able to buy low (as a substantial portion of your portfolio.) In other words... having cash sitting around waiting for a correction is... timing the market.

Interest Compound

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If your goal is to increase returns, then no. The less money you have invested, the less your returns.

Even if you found a, "Holding X% cash that you only invest when the market drops by Y% in Z days is better than investing all of that cash" such a strategy would quickly stop working, as all the other traders/computers would see the same pattern and arbitrage it away.

YoungInvestor

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I'm pretty sure some studies have shown that a small allocation to bonds slightly increases returns while lowering risk, of rebalancing is done systematically.

I think it showed that 90/10 stocks/bonds had a higher return than 100/0. I would not be surprised if this extended to cash.

SeattleCPA

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This isn't exactly what you're looking for, but it connects.

First, if you look at the IRS statistics of the top quarter percent, something I've spent a lot of time doing, you see that those folks hold a lot of cash as a percentage of their net worth. Insight #4 in the following blog post gives the details:

https://evergreensmallbusiness.com/irs-wealth-statistics-paint-fascinating-picture-top-one-percent/

But this cash heavy thing makes sense if people are not passive investors but are opportunistic "absolute return" investors some of the time who can pick up great deals because they have cash to act quickly. Also, if someone is investing in leveraged investments or in illiquid alternative asset classes, having cash makes sense.

The returns from this sort of investing can be pretty impressive, something I illustrated here:

https://evergreensmallbusiness.com/small-business-investment-returns/

But this final comment: These angles wouldn't be very relevant for someone plowing money into index funds... using IRAs and 401(k) accounts.

tralfamadorian

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As one of people who made the "dry powder" comments, I was referring to real estate and other hard assets such as those I flip as a side business. Unlike the stock market, there are many inefficiencies in those markets and assets cannot be purchased piecemeal.

Holyoak

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Back in 2008-2009, I felt the US market was at a true binary point; If it goes bust no matter what I did it would not have mattered, but if (and I felt it would) go back as it always does, why not buy at what were truly once in a lifetime valuations...  So I dropped "dry powder", and have been rewarded very handsomely. 

I'm definitely a time in the market investor, and what I did 10 years ago I probably would do again in a similar, meltdown situation.  No real market research on my part, simply when you have martial law being considered, and folks were literally believing the USA would go bust, I saw swimming pools of blood in the streets, and channeled my inner Buffet.

SeattleCPA

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Back in 2008-2009, I felt the US market was at a true binary point; If it goes bust no matter what I did it would not have mattered, but if (and I felt it would) go back as it always does, why not buy at what were truly once in a lifetime valuations...  So I dropped "dry powder", and have been rewarded very handsomely. 

I'm definitely a time in the market investor, and what I did 10 years ago I probably would do again in a similar, meltdown situation.  No real market research on my part, simply when you have martial law being considered, and folks were literally believing the USA would go bust, I saw swimming pools of blood in the streets, and channeled my inner Buffet.

I'm not sure I understand... and maybe we don't disagree... but first of all I don't think that Buffet went out and just bought more stock. Didn't he go out and provide massive liquidity at a steep price to GE etc? Isn't, therefore, the lesson he illustrates this: In a crisis, buy a chunk of an overextended business at a deep, deep, special discount?

Second, while stock market values got low and people who stayed in the market profited, the people who really profited were those who had cash to buy distressed assets (maybe using leverage) at firesale prices... People who put, for example, $10,000 into a leveraged real estate investment and then saw the value of their equity increase to $300,000 over the next few years.

To return to the issue of 'dry powder.' I think the strategy isn't necessarily time in the market or being in the market... but having the financial resources and liquidity to exploit short-term opportunities.

GuitarStv

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Keep stocks and bonds in your asset allocation.  Rebalance regularly.  You automatically have 'dry powder' to buy more stocks as prices fall . . . that's what the bonds are for.  You automatically increase your reserves of 'dry powder' when stocks do well.

PDXTabs

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I am intrigued by how many people on these forums make comments of the sort:

  • If there's a market correction, I have dry powder available to invest (whether cash, HELOC, etc)
  • I bought stocks when they were on sale

Other than once when I went a little nuts I "never" keep any dry powder. I do however say that I purchased a bunch of stocks on sale, because I worked and contributed to my 401k from July of 2007 through today. So, I buy stocks when they are on sale, and I love it. But I also buy stocks when they are expensive, because I'm not smart enough to time the market.

DreamFIRE

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A couple relevant references on this matter:

Six reasons to be suspicious about the “Cash Cushion”
https://earlyretirementnow.com/2017/03/29/the-ultimate-guide-to-safe-withdrawal-rates-part-12-cash-cushion/

Research Reveals Cash Reserve Strategies Don’t Work… Unless You’re A Good Market Timer?
https://www.kitces.com/blog/research-reveals-cash-reserve-strategies-dont-work-unless-youre-a-good-market-timer/

Travis

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If your AA consists of a small E-fund and your stash is of a respectable size, then jumping at those opportunities is probably a blip on the grand scale of your investment history.  In 20 years how much will it matter in a $1.5MM portfolio that one day in April 10 years ago there was a 10% correction and you put an extra $1000 into it? Maybe you sped up FIRE by a week?  I have no hard data to back this up, but I'm sure somebody more mathematically inclined could run a few simulations.

Radagast

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If your AA consists of a small E-fund and your stash is of a respectable size, then jumping at those opportunities is probably a blip on the grand scale of your investment history.  In 20 years how much will it matter in a $1.5MM portfolio that one day in April 10 years ago there was a 10% correction and you put an extra $1000 into it? Maybe you sped up FIRE by a week?  I have no hard data to back this up, but I'm sure somebody more mathematically inclined could run a few simulations.
Basic math for me (all I can handle). 10% of 1000 is 100, and the stock market doubles every ten years, so $400 in 20 years, but you can't count the principal 100 twice. So your hard work and market timing gave you $300 compared to buying at the top. You gained 1/5000 of your FIRE goal. 5000 =250x20 years. 250 working days in a year. You saved a day.

I do not know of any studies showing a cash fund increases value in the long term, especially in accumulation, unless you are good at timing.

Eucalyptus

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The idea of "Dry Powder" is to help avoid early sequence of return risk. Cash will only work to some extent, and, would be better to be used in the first year or so of FIRE. The first couple of years are where most of the risk of failure comes from (EG you enter FIRE and immediately there are one or two Bull years).


Read up on it. Eg, I would recommend starting here:
https://www.kitces.com/blog/understanding-sequence-of-return-risk-safe-withdrawal-rates-bear-market-crashes-and-bad-decades/


There are many ways to avoid this issue. For example, having at least one or two years of bonds, and/or gold, and/or cash (ie 5-10%) in your portfolio at-the-start of FIRE. If you experience negative returns, spend them down (this pretty much happens with rebalancing anyway) and don't be afraid to spend them all taking your allocation up to 100% stocks. There's no need later on to go back selling off stocks to get your bonds, etc, back. This is a "rising equity glidepath". The beauty of this is that you can also do it in accumulation. Ie a long way out from retirement, stick to 100% stocks, only aquiring bonds, gold, etc, at the last chance before retirement.


https://www.kitces.com/blog/should-equity-exposure-decrease-in-retirement-or-is-a-rising-equity-glidepath-actually-better/


https://www.kitces.com/blog/accelerating-the-rising-equity-glidepath-with-treasury-bills-as-portfolio-ballast/


:-)




privatefarmer

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when you know that exact time to put all your "dry powder" into the market, let me know. the fact is, if it were that easy, everyone would do it. find someone who had significant money to invest in early 2009 and ask them if they "knew" it was a good time to throw everything into the market. the reason why the market crashes is because the vast majority of investors want out of the market so are you that confident that you will be one of the very few who will be saying "no, you all are wrong, this is the perfect time to invest"? I'm not trying to sound rude, I'm just saying all the evidence shows that market timing is nearly impossible, there are no "systems" to accurately predict the market, so you might as well accept that the best thing you can do is throw money into the market whenever you have the chance and leave it in there for many decades.

privatefarmer

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I am intrigued by how many people on these forums make comments of the sort:

  • If there's a market correction, I have dry powder available to invest (whether cash, HELOC, etc)
  • I bought stocks when they were on sale

Other than once when I went a little nuts I "never" keep any dry powder. I do however say that I purchased a bunch of stocks on sale, because I worked and contributed to my 401k from July of 2007 through today. So, I buy stocks when they are on sale, and I love it. But I also buy stocks when they are expensive, because I'm not smart enough to time the market.

correction : it's because you are SMART ENOUGH to not TRY to time the market

tomsang

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My dry powder is in the form of Lines of Credit and 401k loans. I have access to several hundred thousand of reasonably priced debt to make bargain purchases. I have used all or part of this on a number of occasions with great success. I have probably increased my networth by at least $500k, based on jumping on opportunities.

There have been times when I needed to come up with $125k in a month. I pull up our bank accounts and note that I have $388. The wife asks, “How is this going to work?”  When it is done she just shakes her head. At first she was confused because I would tell her regularly that we can’t afford something, which she believed as we had little in our checking account. Now she just accepts that it will get done. She now does not believe that we don’t have the money for whatever she is fancying, so I am losing that benefit.

I am in the process of pulling together $375k for an investment property. This one is definitely stretching our financing and borrowing capacity, but it appears to be nearly complete.  This is coming together in less than a month.

signhere

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I don't have any research to back it up but I always want to have a portion of my portfolio in dry powder to take advantage of opportunities when they arise.

It really depends on what kind of investor you are. I would guess that the vast majority of people in this forum are invested conservatively and these types of opportunities do not present themselves.

Some examples for me in the past have been crypto, staking professional gamblers in +EV games, personal loans.

Would not recommend keeping a stash on the side for when the S&P dips, obviously.
« Last Edit: April 27, 2018, 09:36:06 AM by signhere »

tralfamadorian

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My dry powder is in the form of Lines of Credit and 401k loans.

Are you LOCs collateralized or unsecured?

bacchi

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Rebalancing is the answer. Sell bonds, buy stocks.

tomsang

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My dry powder is in the form of Lines of Credit and 401k loans.

Are you LOCs collateralized or unsecured?

Both. 401k collateralized by 401k.  The rest is unsecured.  I used to have a Heloc, but I sold that house.

privatefarmer

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My dry powder is in the form of Lines of Credit and 401k loans. I have access to several hundred thousand of reasonably priced debt to make bargain purchases. I have used all or part of this on a number of occasions with great success. I have probably increased my networth by at least $500k, based on jumping on opportunities.

There have been times when I needed to come up with $125k in a month. I pull up our bank accounts and note that I have $388. The wife asks, “How is this going to work?”  When it is done she just shakes her head. At first she was confused because I would tell her regularly that we can’t afford something, which she believed as we had little in our checking account. Now she just accepts that it will get done. She now does not believe that we don’t have the money for whatever she is fancying, so I am losing that benefit.

I am in the process of pulling together $375k for an investment property. This one is definitely stretching our financing and borrowing capacity, but it appears to be nearly complete.  This is coming together in less than a month.

I hear you brother. my wife has exactly zero interest in investing so I handle it all, which I don't mind at all. However, she also wasn't happy when she found out about me using >50k in margin to invest while I'm telling her we can't afford 5k for landscaping... in the end, I closed my margin account, figured I have enough leverage just w/ my >500k mortgage, and have decided not to mention any expenses unless they are over a certain amount, which has drastically reduced the friction in our marriage. Lose the battle, win the war.

tralfamadorian

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Both. 401k collateralized by 401k.  The rest is unsecured.  I used to have a Heloc, but I sold that house.

If you're willing to share @tomsang , I would like to hear more about your unsecured LOCs. Do you have several smaller ones or a couple larger ones? With the big banks or small banks/credit unions? Did you have previous banking relationships with the institutions beforehand?

There was a really nice triplex that I saw yesterday where a cash offer would have/could be of significant advantage. While I was touring it and talking with my realtor, the conversation on here came to mind.

tomsang

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Both. 401k collateralized by 401k.  The rest is unsecured.  I used to have a Heloc, but I sold that house.

If you're willing to share @tomsang , I would like to hear more about your unsecured LOCs. Do you have several smaller ones or a couple larger ones? With the big banks or small banks/credit unions? Did you have previous banking relationships with the institutions beforehand?

There was a really nice triplex that I saw yesterday where a cash offer would have/could be of significant advantage. While I was touring it and talking with my realtor, the conversation on here came to mind.

This thread lays out a bit about what I have done to make money using debt:
https://forum.mrmoneymustache.com/welcome-to-the-forum/dream-house-foreclosed-on-by-bank-need-250k-cash-to-buy-how/msg1933318/#msg1933318

Anytime I am in a situation where I don't believe that I will be needing credit(credit score), I actively look to expand my credit and credit denominator.  IE, apply for additional credit cards and lines of credits.  During that phase, my credit score may drop by 30 points or so, but typically it rocks back up within a few months.  In some cases higher than when I started as my utilization decreased as I increased my denominator. 

There are hundreds of banks and credit unions in any given city.  The trick is to see who has unsecured LOC's. Not all do.  In some case it makes sense to open a deposit account there and then go back six months or more to apply for the LOC.  I currently have Wells Fargo, BECU, Bank of America. Not too obviously to me, it is easy to get an unsecured credit card, but harder to get an unsecured LOC.  So if you are trying to get these lined up before apply for credit cards.

BECU also offers a great rate for the first $500 of savings and checking. Currently they are giving out 6.17% APY.  So a no brainer to drop $500 in wait a year and go back and ask for an unsecured LOC.   https://www.becu.org/landing/member-advantage.  I am sure other credit unions have starter rates as well.

I am fortunate that I have been employed at the same place for 20 years, make a great living, and have flawless payment history.  So, I am able to go in and get $50k LOC or credit cards.  Typically I ask for more, but they usually come back at $50k.  Probably a banking thing. 

The other thing that I thought was interesting is when I use a zero interest rate check for 18 months.  They ask what you are using it for. I found that when I explained that I am going to buy a rental house, they had more issues vs. if I said that I am going to consolidate debt.  So now I tell them that I am going to consolidate debt, which makes it easier.

Between wife and I, we have approximately $450k in unsecured LOC's and credit cards. We also have $100k in access to 401k loans.  We also have over a million in home equity that we can tap, with more hassle.

My average cost of debt is in the low 4% by utilizing the zero interest for 18 months credit card checks as well as some favorable credit card rates.  Unless, I am buying something significant all credit cards are paid off in full each month.  Typically, I can have large purchases paid off or refinanced into 4% mortgages within 6 months.

If you use a Line of Credit or Credit Card 100% for an investment purchase, then you may be able to expense the interest paid. Don't taint the interest by throwing a coffee on the balance. :)

So with that being said, my checking account is typically zero as I can usually find a LOC to pay down saving me 4% to 7%.  I also tend to go buy something if I have money in my account and unused LOC's.

I have had years where two or more opportunities have got me excited enough to jump on and other years where nothing has been exciting enough.  Patience is key, having your access to debt ahead of time is key, having the ability to evaluate opportunities and reject most opportunities is key.

Good luck!

tralfamadorian

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This thread lays out a bit about what I have done to make money using debt:
...

Thank you for your detailed response!