Author Topic: Cash as a hedge?  (Read 2693 times)

Tyson

  • Magnum Stache
  • ******
  • Posts: 2512
  • Age: 48
  • Location: Denver, Colorado
Cash as a hedge?
« on: August 02, 2016, 06:47:12 PM »
I've been reading up a lot on early retirement, and it seems like the big fear is the stock market taking a dump during the first 10 years of retirement, which causes you to be at risk due to depleting your investments during a down time in order to live. 

Why not just keep a year (or 2) worth of living expenses in cash for just such a case?  That way if the market tanks, you can live on the cash until things recover.  Within the context of a million dollar portfolio, $40k or even $80k is not all that much and it seems like it would be a great hedge, especially during those first 10 years of so of ER. 

ender

  • Walrus Stache
  • *******
  • Posts: 5545
Re: Cash as a hedge?
« Reply #1 on: August 02, 2016, 06:55:15 PM »
There are people who do that.

You can also buffer into laddered CDs, though right now they are pretty low returns 1% on $40k is still $400.

arebelspy

  • Administrator
  • Senior Mustachian
  • *****
  • Posts: 28295
  • Age: -999
  • Location: Seattle, WA
Re: Cash as a hedge?
« Reply #2 on: August 02, 2016, 07:34:38 PM »
Yeah, I don't mind a cash allocation.  I'd prefer it to bonds, personally.  Something like 95/5 equities/cash... maybe even 90/10.

Studies have shown it doesn't improve returns (i.e. the theory that you live on the cash when the market is down, to ride it out, then fill it back up with the market recovers is bunk) because most of the time the cash is just acting as a drag.  But it can help the sleep at night factor to know you have a few years of cash in the bank when the markets are crashing and everyone is saying the world is ending.
We are two former teachers who accumulated a bunch of real estate, retired at 29, spent some time traveling the world full time and are now settled with three kids.
If you want to know more about us, or how we did that, or see lots of pictures, this Business Insider profile tells our story pretty well.
We (rarely) blog at AdventuringAlong.com. Check out our Now page to see what we're up to currently.

Radagast

  • Handlebar Stache
  • *****
  • Posts: 1714
  • One Does Not Simply Work Into Mordor
Re: Cash as a hedge?
« Reply #3 on: August 02, 2016, 11:45:16 PM »
Series I savings bonds. Perfectly liquid after one year under all possible market conditions, no credit risk, guaranteed to never lose real or nominal value, no yield hunting with multiple accounts at various providers. Using 5% of your total should provide 3 years of living expenses in a bear market alongside dividends, or 5 years in a trendless market.

CanuckExpat

  • Magnum Stache
  • ******
  • Posts: 3004
  • Age: 37
  • Location: North Carolina
    • Freedom35
Re: Cash as a hedge?
« Reply #4 on: August 03, 2016, 01:37:40 AM »
You can also start off with cash/bond buffer at the point of retirement, slowly spend it down and not replenish it. The net effect is that your overall equity exposure rises over time, but you are somewhat more protected at the most vulnerable time: you end up simulating a rising equity glidepath:
Basing that on the work presented here:
Should Equity Exposure Decrease In Retirement, Or Is A Rising Equity Glidepath Actually Better?
Accelerating The Rising Equity Glidepath, With Treasury Bills As Portfolio Ballast?

BUT you have to keep in mind what you are giving up. Taking good summary from second article:
"A rising equity glidepath is ultimately a more conservative lifetime equity allocation, and as a result is giving up upside in order to protect against some of the worst possible retirement scenarios..Ultimately the accelerated rising equity glidepath detracts from safe withdrawal rates more often than it wins… however, the situations when it “wins” are all the situations when safe withdrawal rates are worst! In other words, the rising equity glidepath specifically gives up upside in most scenarios, to protect against downside in a subset of the worst ones. To this end, it is very much a “risk management” strategy and not a wealth maximization approach!"

There's also a bit of stuff in there about reducing your exposure to interest rate risk by going short term with treasury notes instead of bonds. Going cash ultimately reduces your interest rate risk altogether, at the downside of giving up possible capital gains in a declining interest rate environment. In the current environment, FDIC insurde high interest savings, etc might be a free lunch compared to short/medium term bonds, but that's a different issue of discussion.

mathjak107

  • Pencil Stache
  • ****
  • Posts: 558
Re: Cash as a hedge?
« Reply #5 on: August 03, 2016, 02:35:36 AM »
Yeah, I don't mind a cash allocation.  I'd prefer it to bonds, personally.  Something like 95/5 equities/cash... maybe even 90/10.

Studies have shown it doesn't improve returns (i.e. the theory that you live on the cash when the market is down, to ride it out, then fill it back up with the market recovers is bunk) because most of the time the cash is just acting as a drag.  But it can help the sleep at night factor to know you have a few years of cash in the bank when the markets are crashing and everyone is saying the world is ending.

having cash buffers yields pretty much the same results as not , providing you do not get whacked with a moderate  extended downturn early on .

after the first up cycle , yep , no difference but getting hit first is like a trader having a string of losing trades in the beginning .

a rising glide path or the higher cash flow rates from using an spia with your own investing  are good defense's for mitigating the early hit .

we went with a rising glide path . so far we are glad we did as so far there was not enough gains to cover spending since we retired so we are burning principal up front .

although we are retired a year this week i was part time prior so we we were spending down the year  prior to retiring .

but after an up cycle cash buffers are only comforting to the mind .

i use 2 years cash on hand since my mind likes it . so far no assets other then cash have had to be used  but by our 3rd year we will have to create more cash  likely from sales unless distributions and dividends pick up .

but in reality not reinvesting them is still spending them down .

« Last Edit: August 03, 2016, 02:38:42 AM by mathjak107 »

Frankies Girl

  • Magnum Stache
  • ******
  • Posts: 3262
  • Age: 82
  • Location: The laboratory
  • Ghouls Just Wanna Have Funds!
Re: Cash as a hedge?
« Reply #6 on: August 03, 2016, 02:50:05 AM »
Dr Doom posited this and then ran through the scenarios on his blog:

https://livingafi.com/2014/05/09/drawdown-part-1-the-basics/
https://livingafi.com/2014/05/12/drawdown-part-2-simulation/
https://livingafi.com/2014/05/18/drawdown-part-3-strategy/
https://livingafi.com/2014/05/28/drawdown-part-4-examples/

He actually worked through several instances of using a cash buffer instead of drawing off of the portfolio, and came to the conclusion that it is mostly psychological comfort, and while there are event timelines where the cash buffer does succeed slightly better than the all in portfolio, holding a large cash buffer likely will be a drag unless you are conservative on your drawdown % and you have saved the cash over and above the minimum portfolio sizing to support the %.

Biggest takeaways for me:
Quote
When you’re holding cash, the greater threat isn’t sudden drops.  It’s slow deterioration of spending power followed by a sudden drop and then an unsteady, slow recovery.  In these cases, the cash does nothing to fix the root problem, which is lack of real underlying growth.  Only growth will save the day in these scenarios, and when it finally arrives, you may have too much in cash to reap the benefits that you need to save your retirement from failure.

It functions as a drag during times of high inflation, and can impede overall portfolio growth because those funds are not in the market.  Ultimately holding cash is a luxury that should be considered only after the standard 30X annual spending target has been exceeded.

But I'm also holding about a year's worth of cash for the same reasons he goes on to explain. ;)

mathjak107

  • Pencil Stache
  • ****
  • Posts: 558
Re: Cash as a hedge?
« Reply #7 on: August 03, 2016, 03:26:14 AM »
our cash is always being spent , we live on it . so really the only cash sitting idle is the 1 year in reserve since we are spending the current years cash .

if i had to worry about getting 1% on what is relatively such little cash i doubt i would have been in shape to retire the way we would want .

worry more about the tax structure you are creating or your investing strategy and you will likely be much farther ahead  than worrying about small amounts of cash
« Last Edit: August 03, 2016, 03:28:35 AM by mathjak107 »

Tyson

  • Magnum Stache
  • ******
  • Posts: 2512
  • Age: 48
  • Location: Denver, Colorado
Re: Cash as a hedge?
« Reply #8 on: August 03, 2016, 11:16:51 AM »
Dr Doom posited this and then ran through the scenarios on his blog:

https://livingafi.com/2014/05/09/drawdown-part-1-the-basics/
https://livingafi.com/2014/05/12/drawdown-part-2-simulation/
https://livingafi.com/2014/05/18/drawdown-part-3-strategy/
https://livingafi.com/2014/05/28/drawdown-part-4-examples/

He actually worked through several instances of using a cash buffer instead of drawing off of the portfolio, and came to the conclusion that it is mostly psychological comfort, and while there are event timelines where the cash buffer does succeed slightly better than the all in portfolio, holding a large cash buffer likely will be a drag unless you are conservative on your drawdown % and you have saved the cash over and above the minimum portfolio sizing to support the %.

Biggest takeaways for me:
Quote
When you’re holding cash, the greater threat isn’t sudden drops.  It’s slow deterioration of spending power followed by a sudden drop and then an unsteady, slow recovery.  In these cases, the cash does nothing to fix the root problem, which is lack of real underlying growth.  Only growth will save the day in these scenarios, and when it finally arrives, you may have too much in cash to reap the benefits that you need to save your retirement from failure.

It functions as a drag during times of high inflation, and can impede overall portfolio growth because those funds are not in the market.  Ultimately holding cash is a luxury that should be considered only after the standard 30X annual spending target has been exceeded.

But I'm also holding about a year's worth of cash for the same reasons he goes on to explain. ;)

This was really helpful - thanks!