Cash: How Much

The simple answer is you need two years of liquid funds equal to the amount you take from retirement savings each year. That doesn’t mean you need to replace all the funds you use for two years. Your payment from social security, from annuities, or a pension will continue. You just need to replace the amount you take from savings. The two years of liquidity isn’t so you can survive armageddon–you’d need a lot more than liquid funds to do that. It’s so you can deal with market volatility without destroying your portfolio.

In our Retirement Financials in One Chapter chapter (presented by the department of redundancy department) we talked about the effect of volatility on the stock portion of your savings. If the market dives twenty percent and you continue to sell stock to support your lifestyle, you’ll be reducing the number of shares you have available to recover with. You’ll sell more shares than you usually would, and the result will be a portfolio that’s way out of balance. Even without selling shares you’re going to have to do some challenging things to your portfolio in a downturn. For example, if you determined that you’d need a 60/40 stock to bond split to make your savings last, and a downturn reduced the value of your stocks by 20 percent, your portfolio is now 68/32 bonds to stocks. The prudent thing to do is sell bonds and buy stocks. I know, that sounds mechanical and stupid, but if you run simulations on that heavy bond portfolio vs. your age you probably won’t like the result. It’s a tough thing to do emotionally, which is one reason it’s sometimes good to have an advisor –even if it’s a robot. It might help to consider that it’s the Modern Portfolio Theory version of “buy low, sell high”.

Doing the right thing is that much tougher if you continue to take money out of your portfolio when all hell is breaking loose. Two years of liquid funds ensure that you won’t have to do destructive things to your portfolio in order to just live. It’s the long-term version of not having money in the market that you need right away.

 

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The Retirement Trap Copyright © by Bill Babcock and Babcock, William. All Rights Reserved.

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