Strategies - when to use your cash reserves

[MisterA]

My plan is to FIRE in May, after OMY-ing due to an awful 2022. I’ve fully hit my investments target, and have about 1.5 years worth of cash reserves for emergencies, or to sustain us during a future downturn. I want to use the cash to minimise the possibilities of a poor sequence of returns early on, but the question is “when to use cash reserves?” I realize that this is another crystal ball type situation.

My investments are virtually all in index funds, so I can’t start selling bonds, without redoing my investments. I recognise that I’m in a pretty good position, having come through the last 14 months relatively unscathed.

Most of what I read says that (from here) the outlook is rosy, but that it could be volatile for a while. So, do I use the cash early on to see us through any potential short-term volatility?

Or should I hold onto it, to see us through a future crash which might be short but more severe?

Apart from the downturn in the markets, inflation is also eating into my portfolios real value.

I think inflation is coming under control, so part of me thinks that we should use the cash early and let the investments recover. But I'm also scared about a possible future crash, and think I should keep my powder dry just in case. It could get much worse before things pick up.

I’m more interested to hear what others are doing or planning to do, as opposed to speculation about inflation and the economy (although I’d be grateful for any thoughts). Presumably, many people started to use their cash stache in January 2022.

Or I could do 50:50, and live off both the emergency cash and some investments, which would eke out the cash for about 3 years.

What to do?

[curious_george]

I have a similar amount in IBonds, which can be converted to cash at any time.

When I retire I'm planning on spending it down before touching investments, unless the shiller pe ratio is above 30.

If shiller pe ratio is above 30 then I will sell stocks until shiller pe ratio is below 30, then switch to IBonds.

If shiller pe ratio stays above 30 forever? I'm not worried about this scenario as it likely won't result in depleting investments before social security kicks in.

The IBonds are basically an insurance policy against stock market declines.

[MisterA]

I have a similar amount in IBonds, which can be converted to cash at any time.

When I retire I'm planning on spending it down before touching investments, unless the shiller pe ratio is above 30.

If shiller pe ratio is above 30 then I will sell stocks until shiller pe ratio is below 30, then switch to IBonds.

If shiller pe ratio stays above 30 forever? I'm not worried about this scenario as it likely won't result in depleting investments before social security kicks in.

The IBonds are basically an insurance policy against stock market declines.

Thank you, your comments were the type of thing I was looking for, and I think it's probably a good call. Although at the moment the Shiller pe ratio is hovering around the 30 mark, which tells us what we already know, I guess.

[seemsright]

We are planning on having 3 years in cash to live on.


 The plan is to draw yearly, if the markets are high, then we will only pull what we need to top it up.
 If the markets are down, we will wait to top up.

This will allow us to average the markets to what we need.

[PacificaFog]

Hoping to retire in the next 2 years or so and have started thinking about this in very general terms.  My thought in terms of pulling money out was first to change all dividends and interest to automatically get routed to my checking account since we’re paying tax on that income anyway.  But, we’ll need more than that for income, so I was thinking of doing quarterly withdrawals from my index funds.  Each quarter, I would look and see if the market is up.  If so, make the withdrawal in percentages that keep my asset allocation generally intact.  If the market is down that quarter, I’d pull from cash accounts instead.

Like I said, very general right now.  Also curious what other who retired in late 2021 / early 2022 ended up doing!

[VanillaGorilla]

Given that all SORR failures occur when you retired into a prolonged bear market (more like ten years than one year) - I fail to understand how a cash bucket strategy would ever help. Either you'll deplete your cash way before the end of the bear market, or you need a hilariously huge cash bucket (like 15 years worth, then inflation kills you).

For example, if your retirement started in 1970, the market was down in real terms for 12 years. In 2000 the market was down for 13 years before a consistent rise.

In my mind, the question is what your desired asset allocation should be, and how often to rebalance.

[curious_george]

Given that all SORR failures occur when you retired into a prolonged bear market (more like ten years than one year) - I fail to understand how a cash bucket strategy would ever help. Either you'll deplete your cash way before the end of the bear market, or you need a hilariously huge cash bucket (like 15 years worth, then inflation kills you).

For example, if your retirement started in 1970, the market was down in real terms for 12 years. In 2000 the market was down for 13 years before a consistent rise.

In my mind, the question is what your desired asset allocation should be, and how often to rebalance.

https://www.financialplanningassociation.org/article/journal/JAN14-reducing-retirement-risk-rising-equity-glide-path

This is generally where my thinking is on the matter.

[Maximus28]

Given that all SORR failures occur when you retired into a prolonged bear market (more like ten years than one year) - I fail to understand how a cash bucket strategy would ever help. Either you'll deplete your cash way before the end of the bear market, or you need a hilariously huge cash bucket (like 15 years worth, then inflation kills you).

For example, if your retirement started in 1970, the market was down in real terms for 12 years. In 2000 the market was down for 13 years before a consistent rise.

In my mind, the question is what your desired asset allocation should be, and how often to rebalance.

You are correct, the cash bucket underperformed a targeted asset allocation approach in most of the deadly SORR events in recent history, but there are some situations where it did outperform. For the statistical best chance of hedging against SORR, a retiree should employ the glide path method where you start at a 60/40 AA at the beginning of retirement and gradually glide up to 80/20 or 100/0.

See this article for more information: https://earlyretirementnow.com/2021/09/14/bucket-strategies-swr-series-part-48/

[reeshau]

OP, what is your health insurance plan when FIRE'd?  If you are ACA, you won't want to live just on your cash--you will want to generate some income, particularly when you can do it at 0% LTCG.

You can drive yourself nuts thinking about when it is good or not-so-good to withdraw your investments.  Since you indexed, I assume you don't want to think about it that much.  In that case, I think @PacificaFog 's idea is pretty good: set a date on your calendar to make a quarterly judgement.  If things aren't terrible, make a withdrawal for the next quarter.  If they are (e.g. a global pandemic was just declared) draw down your savings, and mark a catch-up is needed some time in the future, to refill those savings.

I would also say that you should look to withdraw a certain number of shares per quarter, based on average value of the shares to get the dollars you need, rather than a set dollar amount.  If you do the latter, you are doing the opposite of dollar cost averaging: selling more at a lower price, and less at a higher price.

Of course, if you find over time that you have too much cash cushion, you could either reinvest it, or draw down cash until the fund is just large enough.  I retired in 2020, and was doing pretty well.  But it is no fun to think about having to withdraw, when nearly the whole year is bad, like 2022.  So, I do not think your cash cushion is too large to start off.

[Villanelle]

We are planning on having 3 years in cash to live on.


 The plan is to draw yearly, if the markets are high, then we will only pull what we need to top it up.
 If the markets are down, we will wait to top up.

This will allow us to average the markets to what we need.

The problem with this is defining what exactly is a down market, and when you will "top it up".  Without specifics, you are never going to know what to do.  Do you wait until you've used all cash reserves is the market never quite gets back to the high in those 3 years?  And what if the, at the 3 year mark, it plummets another 25%?   And how much do you pull to  top up, when?

This kind of strategy needs specifics.

[Loren Ver]

When DH and I retired we had cash and stock investments (index funds etc no bonds)*. 

Our cash amounts were a specific amount with a specific purpose, 2 years of mortgage payments and out of pocket maximums for insurance.  The two big things we really wanted to make sure we covered in a down market. 

We were/are using the ACA so we would need to take some money out of investments to hit the minimums but many of our expenses are negotiable. 

We chose two years because on average recessions are about 18 months, so we figured two years was a good amount. 

We deployed some of the cash last year to keep from needing to withdrawal too much from investments, as per the plan.  If needed, we will deploy more this year.  If not, will hold or start to refill as needed, depending on the market.

Money should have a purpose, and cash should have a reason or it just adds drag to the portfolio.

Loren

*We had some mutual funds give us a good payout a few years ago and bought some ibonds just for kicks.  They don't yet have a defined purpose, so are just hanging out.   Now that they have hit one year, I really do need to sit down with DH and figure out what their function is other than not adding drag as cash on our portfolio.   

[wageslave23]

Having a year or two of cash reserves might be a nice mental comfort but I don't think it means anything to save you from sorr scenarios. If you have a nest egg of $1 million and the market tanks 30% over the first two years. Then you are down to $700k less your $40k yearly withdrawals. If you have $80k set aside and 920k invested, yeah you save yourself the 30% drop on the $80k which is about $25k, but who cares when the rest of your stache is down to $725k less the 40k per year. The point being 30% of two years expenses are what's "at risk" compared to not have 2 years of cash reserves.  You need to think in terms of % of your stache, two years expenses is nothing when considering your AA.

[DK]

My plan is to FIRE in May, after OMY-ing due to an awful 2022. I’ve fully hit my investments target, and have about 1.5 years worth of cash reserves for emergencies, or to sustain us during a future downturn. I want to use the cash to minimise the possibilities of a poor sequence of returns early on, but the question is “when to use cash reserves?” I realize that this is another crystal ball type situation.

My investments are virtually all in index funds, so I can’t start selling bonds, without redoing my investments. I recognise that I’m in a pretty good position, having come through the last 14 months relatively unscathed.

Most of what I read says that (from here) the outlook is rosy, but that it could be volatile for a while. So, do I use the cash early on to see us through any potential short-term volatility?

Or should I hold onto it, to see us through a future crash which might be short but more severe?

Apart from the downturn in the markets, inflation is also eating into my portfolios real value.

I think inflation is coming under control, so part of me thinks that we should use the cash early and let the investments recover. But I'm also scared about a possible future crash, and think I should keep my powder dry just in case. It could get much worse before things pick up.

I’m more interested to hear what others are doing or planning to do, as opposed to speculation about inflation and the economy (although I’d be grateful for any thoughts). Presumably, many people started to use their cash stache in January 2022.

Or I could do 50:50, and live off both the emergency cash and some investments, which would eke out the cash for about 3 years.

What to do?

what do you consider volatile? or down market, etc? markets are going to hop around 10% up/down every yr pretty much so you just need to have the fortitude to sell and get cashflow regardless in a down market. what i think you want to watch out for are the big 25% drops, etc......but realize even in drops you will still likely get 1-2% in dividends so if you are going off the 4% rule you only have to make up that other couple percent and not have to sell anything. Also realize the 4% rule has those down years included and is still successful....

you might want to think about a protocol like i'm planning to do:
- a mix of cash/laddered cds/i-bonds representing 1 yr.
- the rest 100% into an index fund like VTI.
- monthly or quarterly sell to top off another month/quarter of spending needs IF the market hasn't sustained more than a 25% loss from it's high. drawdown the cash reserves if > 25% loss.

this way you don't have a lot of cash reserves getting destroyed by inflation, as well as not having to sell if you hit the couple times a decade rough patch of big losses.
it does mean you might have a bad year that eats through reserves and have to sell from stocks regardless, but that's a low probability event (and like i said, what the 4% rule already allows you to do). Once it goes above that loss threshold you wouldn't build back up the reserves either.....which could be unnerving, but you'll much more likely have your investments pop back up postive and then some and create essentially a infinite money generating machine.

the numbers are a bit arbitrary....if you want to use 1.5yrs and 20% instead, that would also work...just don't go into the 3yrs reserve paired with anytime the market isn't at an all-time high.

[mistymoney]

We are planning on having 3 years in cash to live on.


 The plan is to draw yearly, if the markets are high, then we will only pull what we need to top it up.
 If the markets are down, we will wait to top up.

This will allow us to average the markets to what we need.

The problem with this is defining what exactly is a down market, and when you will "top it up".  Without specifics, you are never going to know what to do.  Do you wait until you've used all cash reserves is the market never quite gets back to the high in those 3 years?  And what if the, at the 3 year mark, it plummets another 25%?   And how much do you pull to  top up, when?

This kind of strategy needs specifics.

I think the better question was just to ask what their specifics were, rather than assuming from the comment that they didn't have specifics.

[Villanelle]

We are planning on having 3 years in cash to live on.


 The plan is to draw yearly, if the markets are high, then we will only pull what we need to top it up.
 If the markets are down, we will wait to top up.

This will allow us to average the markets to what we need.

The problem with this is defining what exactly is a down market, and when you will "top it up".  Without specifics, you are never going to know what to do.  Do you wait until you've used all cash reserves is the market never quite gets back to the high in those 3 years?  And what if the, at the 3 year mark, it plummets another 25%?   And how much do you pull to  top up, when?

This kind of strategy needs specifics.

I think the better question was just to ask what their specifics were, rather than assuming from the comment that they didn't have specifics.

Which is why I asked questions, instead of saying, "this won't work because you didn't bother to get specifics."  I pretty carefully didn't say that.  I said this style plan needs specifics, and that there's a problem if you [global 'you'] don't have them. 

So maybe *you* shouldn't have assumed, and should have asked me to clarify. 

[RedmondStash]

I've been FIREd for a few years. What I do is maintain my AA. This year, I had a plan to live off just cash because I ended up cash-heavy last year after not making an expected major purchase, so that's what I'm doing. But if I wasn't cash-heavy, I'd just be selling whatever part of my AA was high relative to the rest.

This is a weird time because stocks, bonds, and cash are all underperforming relative to what I expected due to market drops, rising interest, and inflation. Did not know that trifecta could happen, so I learned something.

But that doesn't matter. I have absolutely no way of seeing or controlling the future. There's no point in trying to predict a bottom or a top or a timeframe. That's not something you can control.

What you can control is your AA, and the size of your stash. If you're having trouble staying the course right now, that may mean you need to adjust your AA, or you need to save more $$ in your stash. But it may also just mean that these are weird times, and you're panicking a little. It's okay if you are. Sometimes you learn more about yourself during difficult times than during easy times. And that can lead to some adjustments in your long-term plan. You never really know how you'll react to an adverse event until you're in it. If you're not sleeping well at night (SWAN), it's reasonable to figure out what AA changes might help you sleep better -- but after you make them, stick to them.

The best thing you can do is nothing. "Don't just do something, stand there." Set and forget. Remember you're in it for the long haul. The more you tinker with your portfolio, the more likely you are to make a costly mistake. So figure out what you have to do to be able to leave your portfolio alone in both good and bad times, while retaining your sanity.

[TomTX]

Having a year or two of cash reserves might be a nice mental comfort but I don't think it means anything to save you from sorr scenarios.

I think we need to make some distinctions here:

There's a world of difference between having "cash" reserves sitting in a 0% interest savings account, and having "cash" reserves in some combination of things that actually earn a return with nearly no risk. Examples would be things like iBonds, CDs, Treasury Bills and hopping between high interest savings accounts for the signup bonuses - all capable of yielding at least 5% currently. Sure, that's losing some ground compared to inflation, but not nearly as much as that 0% savings account.

[vand]

Personally, yeah, if it were me I'd use the cash relatively quickly and then see where my portfolio is at the end. Worst case scenario is that you use it all up and the come Xmas 2024 and the market is down further than where it is today - but then that basically means you're 3 years deep into a major bear market, which is considerably longer than the most bear market lasts, so the odds are much more stacked in your favour going forward, even if you are starting out with a smaller (cash-free) portfolio.

You will also get a chance during that time to see that if a very bad scenario unfolds then to return to work and pick up some extra income.  If the market really tanks then are you going to feel all that much better about using up your cash buffer from the get go, or if you delayed it by a little? It's going to feel pretty uncomfortable either way.  If you are the sort of person who has problems deciding when to use up your cash buffer then you should probably also have a flexibly attitude about getting some extra income during the first few years of retirement. 

[mistymoney]

Personally, yeah, if it were me I'd use the cash relatively quickly and then see where my portfolio is at the end. Worst case scenario is that you use it all up and the come Xmas 2024 and the market is down further than where it is today - but then that basically means you're 3 years deep into a major bear market, which is considerably longer than the most bear market lasts, so the odds are much more stacked in your favour going forward, even if you are starting out with a smaller (cash-free) portfolio.

You will also get a chance during that time to see that if a very bad scenario unfolds then to return to work and pick up some extra income.  If the market really tanks then are you going to feel all that much better about using up your cash buffer from the get go, or if you delayed it by a little? It's going to feel pretty uncomfortable either way.  If you are the sort of person who has problems deciding when to use up your cash buffer then you should probably also have a flexibly attitude about getting some extra income during the first few years of retirement.

this really encapsulates some of my difficulties around this issue. Sometimes you just have to go with good enough rather than torturing yourself with 2020 hindsight (or 2030 hindsight ;P).

I try to make a plan, then imagine what would break it, and tweak, etc. Look at the average and worse case scenarios......Which is good! But I go to far, because you can't make it foolproof for every possibility that could occur - longer than the great depression, deeper than the financial crisis, Major bubbles popping like dotcom.....

You just have to taget something that will easily take care of the average, and maybe the average plus a bit worse/longer, and understand that you'll just have to get creative if caught with something that greatly exceeds that.

[vand]

Personally, yeah, if it were me I'd use the cash relatively quickly and then see where my portfolio is at the end. Worst case scenario is that you use it all up and the come Xmas 2024 and the market is down further than where it is today - but then that basically means you're 3 years deep into a major bear market, which is considerably longer than the most bear market lasts, so the odds are much more stacked in your favour going forward, even if you are starting out with a smaller (cash-free) portfolio.

You will also get a chance during that time to see that if a very bad scenario unfolds then to return to work and pick up some extra income.  If the market really tanks then are you going to feel all that much better about using up your cash buffer from the get go, or if you delayed it by a little? It's going to feel pretty uncomfortable either way.  If you are the sort of person who has problems deciding when to use up your cash buffer then you should probably also have a flexibly attitude about getting some extra income during the first few years of retirement.

this really encapsulates some of my difficulties around this issue. Sometimes you just have to go with good enough rather than torturing yourself with 2020 hindsight (or 2030 hindsight ;P).

I try to make a plan, then imagine what would break it, and tweak, etc. Look at the average and worse case scenarios......Which is good! But I go to far, because you can't make it foolproof for every possibility that could occur - longer than the great depression, deeper than the financial crisis, Major bubbles popping like dotcom.....

You just have to taget something that will easily take care of the average, and maybe the average plus a bit worse/longer, and understand that you'll just have to get creative if caught with something that greatly exceeds that.

Yes, and if you really want absolute certainty then there is always the option of an annuity.

Then there's also halfway products like a fixed term annuity where you buy a certain amount of income for a fixed number of years with a guaranteed pot given back to you at the end.

[ChpBstrd]

+1 to the equity glidepath strategy mentioned by @TreeLeaf and @Maximus28 .

I'll add that bonds yielding 5.25-7% should look pretty good to a person with a 4% WR.

"Losing ground to inflation" is a red herring unless the person making the claim presumes to know how the next few years of inflation will turn out, not the past. Such an attitude would only be justified if said person had a solid record of predicting inflation for the past few years. For all we know the US will soon enter a Japan-like deflationary cycle and then those bonds would seem brilliant.

In any case, consult earlyretirementnow.com to view hardcore statistical backtesting of the equity glidepath strategy. Your retirement is incredibly vulnerable to SORR right now, but you could avoid that risk.

Your Investment Policy Statement (IPS) should state your target AA through your first few years, your final AA, and any criteria that would cause you to use emergency funds or change your AA off-schedule.  For example, you might say you'll allocate X% more toward stocks if the S&P500 drops 30% below its most recent high.

[MisterA]

OP, what is your health insurance plan when FIRE'd?

I'm in the UK, so (theoretically) I don't need health insurance.

Given that all SORR failures occur when you retired into a prolonged bear market (more like ten years than one year) - I fail to understand how a cash bucket strategy would ever help. Either you'll deplete your cash way before the end of the bear market, or you need a hilariously huge cash bucket (like 15 years worth, then inflation kills you).

Yes, I agree with this. I do think that a small percentage of cash is a good thing as part of my globally diversified portfolio (or even just as an emergency fund), but the question remains 'when and how to use it'. A question possibly answered by @vand

Personally, yeah, if it were me I'd use the cash relatively quickly and then see where my portfolio is at the end. Worst case scenario is that you use it all up and the come Xmas 2024 and the market is down further than where it is today - but then that basically means you're 3 years deep into a major bear market, which is considerably longer than the most bear market lasts, so the odds are much more stacked in your favour going forward, even if you are starting out with a smaller (cash-free) portfolio.

You will also get a chance during that time to see that if a very bad scenario unfolds then to return to work and pick up some extra income.  If the market really tanks then are you going to feel all that much better about using up your cash buffer from the get go, or if you delayed it by a little? It's going to feel pretty uncomfortable either way.  If you are the sort of person who has problems deciding when to use up your cash buffer then you should probably also have a flexibly attitude about getting some extra income during the first few years of retirement.

Agreed, this is probably right for me, as in 2 years time I'll only be 3 years away from state retirement benefits. But, I'm never going back to work, not a chance (due to my age and the fact that I'll never earn as much as I do right now)!

I've fully embraced the passive investor methodology and have a globally diversified indexed portfolio, with asset allocation in the expected range. According to the (slightly naive) 4% rule, 'do nothing and stay the course' is the answer. My needs are less than 4%, I have flexibility, cash reserves and other income streams - some of which are phased.

2021 and 2022 were potentially the worst years to FIRE. And when I FIRE in a couple of months we'll be well into 2023, so hopefully I'll have dodged the worst of it, especially if I live through the next 2 years spending cash. But as has been pointed out, there is very little that you can do anyway other than continue working and increase your stache, and I've already done some of that. Even now, we're passing beyond the average length of time for a downturn. If I draw on the cash for 2 years, I'll be 3.5 years since the start of the bear market. If it continues beyond that, I'll just have to take my chances.