Author Topic: Using cash during market downturns  (Read 5720 times)

Mirwen

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Using cash during market downturns
« on: June 11, 2015, 06:55:11 PM »
My mother is getting ready to retire in a year or two and I'm helping her navigate her investments, pension, SS and plan her long term strategy.

Her total monthly income in retirement will be about $2k
about 80% of this will come from a pension plan with COLA and SS.
The remaining 20% will come from her 457, 401k and taxable accounts.

Because 80% of her income is fixed and cost of living adjusted, I have advised her to be very aggressive with the remainder. 

My advice specifically was this:  Keep three years (about $15k) of needed withdrawals in a cash equivalent.  Keep the rest in a midcap index or similar.  Draw from your investments when the market is going up or stagnant.  Draw from your cash if the market has dropped more than 10% in one year.  Once the market has returned to where is was before the drop, start replenishing your cash reserves.

She keeps asking if this is too aggressive considering that she is retiring and I keep pointing out that 80% of her income is fixed, so no matter how aggressive she is with the 20% she can't be aggressive overall. 

So my questions are:

Since she does need the 20% to live on, am I suggesting too aggressive a plan?
Is my advice to pull from cash when the market is down and not to replenish until the market recovers smart or a form of market timing?

DavidAnnArbor

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Re: Using cash during market downturns
« Reply #1 on: June 11, 2015, 07:18:52 PM »
So she needs $400 a month from her retirement account savings. Does this $4800 a year of withdrawals represent less than 3 or 4% of the total savings?

Mirwen

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Re: Using cash during market downturns
« Reply #2 on: June 11, 2015, 07:21:03 PM »
It is exactly 4% of 120K, which is what she expects to have in 1-2 years.

DavidAnnArbor

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Re: Using cash during market downturns
« Reply #3 on: June 11, 2015, 07:33:09 PM »
Well the usual disclaimers on here are that if investing heavily in the stock market it helps to have some flexibility in spending, which you are in essence trying to create by having the $15K cash bucket.
Perhaps I would invest in a mix of International and Domestic total Stock market index funds to have some diversity, and not just be in a Midcap US Fund.

innerscorecard

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Re: Using cash during market downturns
« Reply #4 on: June 11, 2015, 08:12:40 PM »
If she is asking if it is too aggressive than it is too aggressive. You can't impose your ideals and preferences on her.

waltworks

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Re: Using cash during market downturns
« Reply #5 on: June 11, 2015, 08:15:03 PM »
Hurray, it's the market timing post of the week!

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YoungInvestor

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Re: Using cash during market downturns
« Reply #6 on: June 11, 2015, 08:57:12 PM »
I wouldn't want to call my mother and tell that her investments are down 40%.

Frankly, if she thinks it might be too aggressive, then it clearly is.

Stick to something conservative, and if she mentions some wiggle room in the budget, then you might want to inch up the risk a bit.

forummm

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Re: Using cash during market downturns
« Reply #7 on: June 12, 2015, 09:29:51 PM »
Your mom wants to sleep well and not just eat well. She needs to be comfortable with the equity portion taking a 50% dive every once in a while. If not, and she sells it, that's terrible. Or if it makes her feel terrible even if it's just a small amount of her money, that's a consequence that has value as well.

Cash is a drag on a portfolio. And it's hard to know when to just start and stop the replenishing of that cash. Your rules are not necessarily optimal rules. It would be better to just have whatever percent in bonds and whatever percent in stocks (the ratio she's comfortable with), and just to rebalance that annually.

What withdrawal rate from her non-fixed income funds does she need?

Frugancial Advisor

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Re: Using cash during market downturns
« Reply #8 on: June 12, 2015, 10:08:53 PM »
Please keep in mind that your investment strategy and risk tolerance is in no way associated with that of your mother, who will have her own opinion.

You can lead a horse to water, but you can't force it to drink.

Remember that when you create a portfolio for someone who does not have the knowledge or experience that you have. You are doing a good deed by taking responsibility for her finances, but you are also signing up for a delegate duty which requires you to be fully aware of the consequences.

In this particular circumstance, it may benefit you to calculate the rate of return required to sustain the additional income over and above her pension/SS. After figuring out the required ROI, you can then begin to analyze which allocation would be most appropriate. With such a high percentage of expenses already being covered, she may only require a return similar to that of a low-risk (low-equity) portfolio which can offer the lower volatility she may be seeking.

forummm

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Re: Using cash during market downturns
« Reply #9 on: June 27, 2015, 06:32:48 PM »
Draw from your investments when the market is going up or stagnant.  Draw from your cash if the market has dropped more than 10% in one year.  Once the market has returned to where is was before the drop, start replenishing your cash reserves.

Why not just get a closed end fund that pays 7% or more, take 4% every year and reinvest the remainder?

Bad_LNIP, you can quote the prior comments by clicking on that quote button. That will make it easier for people to tell that you're quoting someone.

Mirwen

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Re: Using cash during market downturns
« Reply #10 on: June 27, 2015, 07:05:27 PM »
It's interesting what people grab onto and read into things.  My mother understands what the 4% rule is based on and understands that market drops of around 40% are built into this and are expected.  She seems to be OK with that when we talk.  She has been dabbling in the stock market since the late 1990s and although she hasn't had significant funds, she has made a few errors and learned from them I think.  Though I'm still trying to steer her away from individual stocks and managed funds sometimes.  I think I've finally converted her to Vanguard.

Her basis for asking if our 87.5% equities/12.5% cash is too aggressive is not because she is ultra conservative or risk adverse, but because she has read that retirement portfolios ought to be heavily in bonds.  I think the bond advice isn't good in the current market.

If my strategy of pulling from cash when there are large market swings is not efficient, what is better?  Should she pull 4.5% of current balance and supplement from/replenish cash accounts with overage/excess.  Would that work better?  Is there some other way of pulling from cash during downturns I'm not aware of?  I'm just making up these strategies based on my understanding that reducing spending during downturns extends portfolio life and that significant drops don't seem to last more than 3 years.  I don't know if I'm reinventing the wheel here.

We are meeting on Friday to go over her options including super conservative options like annuities.  I'd love any more insight into how to balance an account before draw down.  This is something that I haven't fully researched because I'm still a long way from retirement myself. 

forummm

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Re: Using cash during market downturns
« Reply #11 on: June 27, 2015, 07:23:49 PM »
It's interesting what people grab onto and read into things.  My mother understands what the 4% rule is based on and understands that market drops of around 40% are built into this and are expected.  She seems to be OK with that when we talk.  She has been dabbling in the stock market since the late 1990s and although she hasn't had significant funds, she has made a few errors and learned from them I think.  Though I'm still trying to steer her away from individual stocks and managed funds sometimes.  I think I've finally converted her to Vanguard.

Her basis for asking if our 87.5% equities/12.5% cash is too aggressive is not because she is ultra conservative or risk adverse, but because she has read that retirement portfolios ought to be heavily in bonds.  I think the bond advice isn't good in the current market.

If my strategy of pulling from cash when there are large market swings is not efficient, what is better?  Should she pull 4.5% of current balance and supplement from/replenish cash accounts with overage/excess.  Would that work better?  Is there some other way of pulling from cash during downturns I'm not aware of?  I'm just making up these strategies based on my understanding that reducing spending during downturns extends portfolio life and that significant drops don't seem to last more than 3 years.  I don't know if I'm reinventing the wheel here.

We are meeting on Friday to go over her options including super conservative options like annuities.  I'd love any more insight into how to balance an account before draw down.  This is something that I haven't fully researched because I'm still a long way from retirement myself. 

Just pick an AA and stick with it. If the market goes up, just pull your 4% from the portfolio and keep it 87.5/12.5. If the market goes down, just pull your 4% from the portfolio and keep it 87.5/12.5. Simple and easy. That forces you to buy low and sell high and keeps your desired level of safety in place constantly. Easy right?

dungoofed

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Re: Using cash during market downturns
« Reply #12 on: June 28, 2015, 05:21:58 PM »
Does anyone think one option could be for OP to put together an annuity her/himself?

Assuming OP is:

1) earning an income
2) prepared to take on some market risk

Mirwen - thinking out loud here but I'm wondering whether you couldn't just find the terms of an existing annuity and offer to copy them for your mother. Something with a term (eg 10 years) and inflation-adjusted, using that as a base and do the figures to decide whether it would be feasible. Make the terms a little more favourable for your mother.

The most obvious risk of this is the market turning against you and you still being liable for your mother's monthly cheque so you need to do the calculations and see whether you could withstand a downturn yourself.

There are other risks such as if the money invested grew at a much faster rate than required to cover the annuity payments. Your mother (or siblings) may get resentful or angry or feel that you had taken advantage of her. Siblings need to be made aware of the terms (and maybe given the option to contribute), and your mother's will needs to be updated appropriately.

The only other point I'll add is that if you offer your mother an "inflation adjusted" option then you might want to hold some exposure to PMs as well. Again, make sure the numbers make sense.

I think if you did it right it could be beneficial for everyone involved. I don't think you'll find many supporters of this idea on this site because of the market risk that is transferred to you at the same time as the obligation for regular payments but there is cushion built in.

Mirwen

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Re: Using cash during market downturns
« Reply #13 on: June 28, 2015, 06:11:41 PM »
That's an interesting idea that I never considered.  My mother is single and I'm an only child, so we could do things a little differently.  She only needs the equivalent of $400 per month, so I would feel comfortable supplying that.  I would inherit any left over in any case, so I'm not sure it's a good idea for me.  Basically the only upside is that she could invest more aggressively with me covering her in the case of complete loss (unlikely).  I'd have to look at the tax implications too.  Thanks for the creative idea.  I'll have to look at it more carefully.

arebelspy

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Re: Using cash during market downturns
« Reply #14 on: June 28, 2015, 07:53:57 PM »
I've thought of the same thing, but it can introduce further complications into a family relationship. It's something to look into, but not do lightly.

If you're inheriting anything anyways, then that's good for you, as any lump sum left you keep, instead of the insurance agency. Obviously at that point you take on the longevity risk, but then you will have your mother around longer.
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Mirwen

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Re: Using cash during market downturns
« Reply #15 on: July 05, 2015, 08:56:58 PM »
My mom and I ran the numbers on several different scenarios.  In the end we both agreed that the best use of her $120k would be to purchase 5 years of service from her state pension and pay off the mortgage for her rental property.  The combination of these two things increases her income / lowers her expenses by about $700 per month or about 7.5% cashflow return.  The remainder will be kept as a cushion.  The pension is COLA so that is real return.  The real value of the mortgage payoff is lower, but it will allow her to retire earlier and pursue writing and other income streams.  I'm pleased she has a guaranteed income and I will still (hopefully) inherit the two houses.  I may start another thread about avoiding losing houses to medicaid.  I will pay her for the difference in her single life pension and dual life pension so that I will get half her pension after she's gone.

Thanks for the creative solutions.  I had a feeling we would do something a little different than just stick it in an investment account.  A year ago she was planning on retiring at 64.  Now I think she will retire next year, on or shortly after her 62nd birthday.  I'm really proud of my mom!  She's been a single parent and never made more than $36k annually and will still be retiring a little early.

arebelspy

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Re: Using cash during market downturns
« Reply #16 on: July 05, 2015, 10:02:39 PM »
That is a great solution.  Good call.
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.
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DavidAnnArbor

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Re: Using cash during market downturns
« Reply #17 on: July 05, 2015, 10:10:05 PM »
Suze Orman would be proud of you.

Interest Compound

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Re: Using cash during market downturns
« Reply #18 on: July 05, 2015, 11:28:07 PM »
Her basis for asking if our 87.5% equities/12.5% cash is too aggressive is not because she is ultra conservative or risk adverse, but because she has read that retirement portfolios ought to be heavily in bonds.  I think the bond advice isn't good in the current market.

Definitely market timing. Good job deciding against this!