Ok, the title is a little misleading, but the truth is that the more liquid assets you have available to you for the short to mid-term time frame, the less likely you are to be subject to the vagaries of Mr. Market. Most financial advisers will tell you that you need to make sure you have at least 6 months expenses in an “Emergency Fund”. This is especially important in the accumulation phase of your plan. If you hit an income bump (a layoff or unexpected job change) you want to make sure that you do not have to access your retirement savings in order to eat or pay the rent. But when you are late in the accumulation phase, or in retirement, the calculation is different. A big drop in the market can materially affect your plan, or your ability to soldier on if you are not sufficiently liquid at the time of the drop.
Because of where I am in the continuum, the calculation is a little different. I will have all of my retirement funds either in the broad market (or other similar investment that has a reliable long term prognosis – think peer to peer, or real estate) or in cash or cash equivalent, with the latter being what I propose to use to pay ongoing living expenses going forward. In evaluating my planned cash (really, liquid asset – some bond funds will be involved here, I looked at two numbers: First, what my necessary expenses in retirement would be (those I cannot live without like housing, taxes, insurance, food, medical etc.); Second, what my desired living expenses would be in retirement (all of the first ones, plus what I’d like to do such as travel, eat out more often, movies and theatre, etc.). The evaluation of these two numbers resulted in the second being about double (175% actually) of the first. My goal is to have 5 years for the necessary expenses which would translate to about 3 years of my desired expenses.
Why those numbers? We all know that markets go up and markets go down. Sometimes they stay sideways for extended periods of time. But, at least so far, the general direction of Mr. Market is up. After a big sell off the market most often begins to come back in 1 to 2 years at the most. What I want to do is to protect my investments so that I don’t have to sell them at the bottom of the market. By having the cash, or easily liquidated and reliable investments, on hand to meet necessary expenses for a couple of years, I keep from having to sell equities at a fire sale price in order to meet current requirements. I’m giving myself the breathing space I need for the market to recover, should there be a downturn (and there almost certainly will be).
As a part of this process, when times are good, or at least not too bad, I plan to sell what assets I need to in order to replenish my cash supply every year. If I have to wait a year to two for things to get better, my cash hoard will allow me to do that. This should allow me to sleep a bit more soundly. At least that is the theory. We’ll see what happens when the inevitable recession comes calling.
As to what I will do with 5 years of cash. I will keep one year in the bank in good old American money, and the other 4 I will stagger in a bond ladder of sorts by buying defined maturity ETFs that mature each year. I’ll get some interest on those (even in today’s low rate environment), and loss of principal is extremely unlikely. Defined maturity bond ETFs are funds that invest in bonds that all mature in the same year. So you could buy a fund that matures in 2020 and it will be comprised of bonds that expire in a tight time frame in 2020. I’ll write more about this concept in the near future.
The ability to ride out the ups and downs of Mr. Market gives me the best chance to be able to maintain my desired standard of living, and keeps me from having to cannibalize investments that have been temporarily disadvantaged by Mr. Market’s whimsical ways.
Until Next Time, FIRE On! – Oldster