Cash Management in Early Retirement

Less than two years away from early retirement, we wonder how much cash (if any?) we’d like to hold in a money market account. As many of you might have heard, we currently run a very tight ship with our cash management. We have no emergency fund – our entire portfolio is our emergency fund! But that’s easy to do while the paychecks are still rolling in and we maintain a 60% savings rate. Early retirement will be very different. How would we handle the cash withdrawals in retirement? How do we react to market fluctuations?

In the FIRE community, I often read that the solution (maybe even the panacea) for an equity bear market is to keep a certain percentage of the portfolio in cash (money market account) to sustain cash flows through a bear market. And we should point out that we are not the only ones thinking about this, as evidenced by recent popular posts on the PIE blog and on Retirement Manifesto (also check out the really cool infographic) dealing with this subject. Two to three years worth of expenses (presumably 5-10% of the portfolio) seem to be the numbers floating around (examples: 5% cash allocation for the PIE blog, The Retirement Manifesto recommends 2-3 years, ThinkSaveRetire uses 3 years), obviously calibrated to roughly correspond to the length of the average bear market.

How much of a difference does a cash cushion really make?

How big is the opportunity cost of holding cash when there isn’t a bear market?

Let’s take one step back and confirm really quickly the great risk we all face in the FIRE community: Retiring at the wrong time, right before the equity market takes a nose dive.

Let’s look at how a $1,000,000 portfolio would have performed at the following four retirement dates: 12/31/1996, 12/31/1997, 12/31/1998, and 12/31/1999. In each case, we assume a 3.5% withdrawal rate, 100% equities held in an S&P500 index fund (returns include dividends!), and monthly CPI-adjustment of withdrawals. Your real (CPI-adjusted) final portfolio value on June 30, 2016, would have been very different depending on the retirement date. Specifically, over the four retirement dates, only 36 months apart, you experience the entire spectrum of final real portfolio values:

  • from significantly growing your portfolio despite the two bear markets (1996): $1.506 million!
  • to roughly maintaining your purchasing power (1997): $956k
  • to seriously threatening your long-term viability (1998): $593k
  • and pretty much dooming your long-term sustainability for sure (1999): $402k
4 different retirement start dates. 4 very different outcomes!

A little side note: I sometimes read in the blogosphere that the 4% rule did just fine during 2000/2001 and 2008/9. Not true! Starting retirement on 12/31/1999 and withdrawing 4% (rather than 3.5%) would leave you only $263k in 2016. You will run out of money for sure, probably before the year 2025. The 4% rule will most definitely fail the 30-year retirement horizon. Forget about a 50-year retirement!

How to implement the Cash Cushion

This cash cushion approach sounds really appealing in theory but implementing it in practice, in my view, opens up a bit of a can of worms. Here’s why: In my opinion, there are two different ways of implementing this cash cushion and both have the potential to create some major headaches:

Method 1: we always keep exactly 2 years worth of expenses in a money market account. That doesn’t help us at all if there is an equity market drawdown. We may take money out of the MM account every month to fund our living expenses, but at that same time, we have to replenish that MM account out of the equity holdings. It’s “robbing Peter to pay Paul.” This method will essentially create a constant drag (lower average returns!) in the portfolio while still forcing us to do what we tried to avoid, namely, liquidating equity holdings during a drawdown. So, this can’t be what folks in the FIRE community mean when they advocate a cash cushion.

Conclusion so far: the cash cushion in retirement works only if we actively time when to draw down the cash cushion and when to replenish it again. The disadvantage is that we would have to do what we absolutely dread: market timing! If you are registered on the Bogleheads forum, you probably want to keep your market timing ambitions to yourself, or they might send the Spanish Inquisition after you. But for the sake of academic curiosity, here’s my proposal for actively timing the cash portion of the portfolio:

Method 2: a varying cash cushion in a money market account. And when I said that this cash cushion timing methodology is a can of worms, I wasn’t kidding. To do this in a sensible, systematic and replicable way takes a lot of assumptions! Common to all of our simulations are the following assumptions and parameters:

  • Initial net worth $1,000,000
  • The initial withdrawal rate is 3.5% p.a., so we withdraw 3.5%/12 on December 31, to fund the January consumption, then adjust the amount by CPI inflation each month.
  • We keep a cash cushion of x months worth of expenses in a money market account yielding the 3-month T-Bill interest plus another 0.25% annualized. Savvy shoppers that we are, we would have found an interest rate slightly better than the short-term T-Bill! The rest is invested in a stock portfolio (S&P500 index fund)
  • Every month we use the dividend income (=difference between equity portfolio total return and price return) to fund our expenses. The portion of expenses not covered by dividends is first taken out of the money market account.
    • During normal times, we replenish the money market fund up to the cash cushion target by selling a portion of the equity fund. This is identical to method 1 above.
    • If we face a drawdown of at least y% from the most recent peak of the S&P500 index we will refrain from selling the equity fund and rather draw down the money market account that month. Of course, if we ever exhaust the money market fund we have no choice but to sell equities to make ends meet.
  • One additional twist: Once the cash cushion is below the target and the equity index reaches the normal level again, i.e., comes within y% of the previous peak level, do we replenish the entire cash cushion all at once? To avoid the sale of one big chunk of equity holdings all at once, we set parameter z equal to the maximum number of months worth of consumption we transfer out of equities and into the money market account. Notice that if we set z=x we do replenish the entire money market shortfall all at once. If we wanted to do this in a more gradual fashion we will set this parameter to maybe 3 to 6 months. We see that this parameter can potentially make a huge difference because replenishing the money market account usually falls into the strong rebound phase after the drawdown. It’s potentially more advantageous to drag out this replenishment phase and let the equity returns run for a little bit longer before filling up the MM account again.
  • Simulation details:
    • Time span: varying start dates: 12/31/1996, 12/31/1997, 12/31/1998, and 12/31/1999.
    • End date: June 30, 2016
    • We assume that all realized capital gains are long-term and all dividends are qualified. Since we plan to stay in the lower two tax brackets in retirement and pay zero state taxes we assume that all equity income is tax-free.
    • Since the interest income will likely stay below the annual standard deduction plus exemptions we assume that even the interest income is tax-free. Since the average cash yield over this period was quite low that wouldn’t make a huge difference, though.

Let’s see how different withdrawal rules would have performed over those 20 years. The different parameter settings we pick are:

  1. Equity only, no cash cushion: x=0. We are at the mercy of the S&P500 every month and have to withdraw all cash flow needs not currently covered by the dividend yield.
  2. Method 1 (no market timing): 24 months worth of cash cushion (x=24) but constantly and fully rebalance back to the target: y=1.00, z=24.
  3. With market timing: 24 months worth of cash cushion, a 5% drawdown cutoff, and full rebalancing when in a “normal” period (x=z=24, y=0.05).
  4. Same as 3, but replenish only up to 4 months worth of expenses into the MM account: x=24, z=4, y=0.05.
  5. Same as 4, but set a threshold of y=0.10.
  6. Same as 4, but keep only 12 months of expenditures in the MM account.
  7. Same as 4, but keep x=36 months worth of expenditures in the MM account. In light of the larger cash cushion we also increase the replenish rate to 6 months: z=6.

I run each of the seven parameterizations with the four starting dates, for a total of 28 simulations.


Final Portfolio Values (CPI-adjusted) on 6/30/2016
  • The different cash cushion models may or may not help compared to the 100% equity portfolio. The only consistent result is that Model 2 (constant cash cushion, no market timing) is the worst performer.
  • Model 4 seems to dominate Model 3 (about the same for 1996 but consistently better in 1997-1999). So, replenishing the cash cushion only gradually helps.
  • Model 4 pretty consistently beats Model 5 (10% draw-down cutoff). It helps to dig into the cash cushion when the market is down only 5%, rather than 10%.
  • Starting retirement in 1996, all cash cushion models (2-7) would have created a bit of a drag on performance. Not the end of the world because all portfolios were up by a lot.
  • In the 1997 scenario, Models 1 and 3-7 are shockingly similar; all within a few thousand dollars of each other.
  • The cash cushion models 3-7 would have significantly helped compared to the all-equity portfolio when starting retirement in 1998 and especially 1999.
  • But, of course, the cash cushion is no panacea. The advantage over the all-equity portfolio will not change the simple facts:
    • Starting in 1998 you’re left with only around 59-64% of your initial wealth, which is a big drawdown, almost too much to recover from, considering that equities are quite richly valued today. I don’t see a quick equity surge of 50-60% returns anytime soon to bring the portfolio value back to $1,000,000!
    • Starting in 1999 (right before the 2000 bubble) whether with cash cushion or without, the portfolio is doomed. Also, that’s despite the 3.5% withdrawal rate rather than the often quoted 4% rule. If you had started retirement in 1999 with a 100% equity portfolio, with or without the cash cushion, it’s not so much if you will run out of money, but when.

More results

Let’s look at the time series of the cash cushion size (measured in the number of months of consumption). I do that for models 3-7 (because model 1 has a constant 0 and model 2 has a constant 24 months, so not much to see there).

Cash Cushion time series for different withdrawal rules
  • All cash withdrawal and replenish rules reached their targets again before the 2008 crisis hit.
  • 2-3 years worth of expenses in a money market account (7%-10.5% of the portfolio) is a large cash cushion. It took a lot longer than 24 or 36 months to wipe out that cash cushion if we assume that we first consume the dividend yield: around 40 months with a 24-month cushion and 60 months with a 36-month cushion.

Next, let’s look at how Model 4, i.e., the 24-month cushion with all the bells-and-whistles (including the gradual replenishment) performed vis-a-vis the all-equity rule (Model 1) for the four different starting dates, see chart below:

Withdrawal Rule 4 does really well, compared to the all-equity portfolio. I didn’t expect that!

Before December 1999 you would have suffered a bit from opportunity costs (recall that the equity market went up by quite a bit in 1997, 1998, and 1999). But this cash cushion rule would have outperformed the all-equity portfolio for all retirement dates between 12/1997 and 12/1999. That’s a surprise. I always thought that the cash cushion only works if you perfectly time it, but the opportunity cost of having a cash cushion will wipe out all the gain if you keep the cash for too long before the bear market. But that’s not true. Even in 12/1997, with two more years to go before the market meltdown, the cash cushion approach would have eventually made up for the opportunity cost.


  • Don’t get your hopes up too high! A cash cushion is no magic bullet against market fluctuations. I mean, come on, does anybody really believe that an equity portfolio will be down 60% but with a cash cushion of a few % you suddenly keep all your purchasing power? We didn’t and we confirmed our prior belief.
  • A constant cash cushion is a bad idea. It just creates opportunity cost. No surprise here!
  • Market timing works – to a degree! And it makes sense! By not selling equities when the market tanks you bet on long-term mean reversion. The market will always recover eventually.
  • Of course, the cash cushion will likely help if you find yourself right before the market tanks. But I was amazed that even in Dec-1997 and Dec-1998 when the S&P500 still had a very strong subsequent performance in the 1998 and 1999 calendar years, you beat the passive withdrawal strategy of a 100% equity portfolio. I was very surprised about this result! I learned something new and unexpected today!
  • Nothing is set in stone yet, but we might entertain keeping a bit of a cash reserve, come 2018! We will still do some more research on how robust these results are, but we may scale back our cash-aversion a bit.

We hope you enjoyed our research. Please leave your questions and comments below!

58 thoughts on “Cash Management in Early Retirement

  1. Well, let’s hope that the next bear-market doesn’t look as bad as the previous two. There is no easy way to preserve your purchasing power! Bonds would have helped in 2001 and 2008 but they seem so expensive today.

    1. Yes, bonds are expensive today. That’s why I do the exercise on the equity portion only. I don’t see how bonds can keep up their long run of good performance from yield depression much longer.

  2. Interesting results ERN. Need to understand this some more. The issue with all these SWR methods, whether 3.5% or 4%, is that there is no recalibration every few years wrt portfolio value. To continue WR strategy that starts either at 3.5 or 4% but pushes at 6-7% during Year 5-7 is doomed to fail. This is the time the retiree should be vigilant. That’s a real life feedback mechanism that WR models don’t consider.

    1. Thanks!
      I used be very troubled by the varying withdrawal rates, but I warmed up a little bit. After the market drops it’s ok to increase the % withdrawal rate a little bit because the market will likely recover. A rule based on the CAPE (or 1/CAPE=cyclically adjusted earnings yield) would do that.
      But I agree that it’s troubling when two investors with a $1m portfolio withdraw different amounts because they had different starting dates. That’s certifiably irrational.

  3. Very insightful data. We’re still debating how much of a cash cushion to keep in early retirement 2-3 years from now but are leaning towards a very small amount.

    1. Hi, Mr. Enchumbao! Sorry, your comments always get filtered out. Once a week I will find them in the spam folder. Just be patient. 🙂
      Thanks for your comment! Yeah, we’re also leaning towards 5-7%.

  4. I hate to disagree with you, because you do such beautiful work…but I just don’t get the same numbers as you. Granted, I’m not using monthly CPI, only yearly, and I’m trusting the source of the data and the calculations on portfoliovisulizer. Here are my analyses: Begin retirement on Jan 1 1997 and withdraw $35,595 during the course of the year to give you your 3.5% plus inflation of 1.7% (repeat every year, with increased withdrawal amounts to keep up with inflation) and at the end of 2015 you would have = ~$2.15MM with 7% cash/93% large cap blend ($70k cash of $1MM total = 2 years of $35k living expenses), = ~$2.1MM with 7% cash/73% large cap blend/20% total bond, = ~$1.96MM with 7% cash/53% large cap blend/40% total bond, vs ~$2.3MM with 100% S&P500.

    These data only go through 2015 (limitation of the website).

    The data are similarly better than your scenario for 1998, 1999, and 2000 retirement start dates. Interestingly, the 53/40/7 AA does amazingly well in all scenarios, and beats all other AA in 1998, 1999, and 2000.

    Are you perhaps using an alternate meaning of the 4% rule? Are you withdrawing 3.5% of the current portfolio value, plus additional for inflation at each withdrawal timepoint? Or are you doing as I am and using 3.5% of the initial principal, then each month/year calculating inflation and withdrawing a tiny additional more? For a retirement starting in 1997 I have annual cash withdrawals starting at $35,595 throughout 1997 and ending at $52,198 through 2015.

    Here are my calculations for 1998:
    and 2000:

    1. Hi drf,
      Our numbers are more or less spot-on consistent. I calculate the inflation adjusted final value. Example: model 1 starting on Dec 31, 1996. I get a CPI-adjusted figure of just under $1.5m. The raw, nominal number is $2.236m. Close to yours.
      I want to know how the final value compares to the initial $1m. There was quite a bit of inflation during that time!!!

      Regarding the other portfolio allocations: yes, bonds would have helped. But that’s because bonds had such a run and went from 6% yield to 1.5%. I doubt that we now go from 1.5% to -3%. Going forward, bonds will offer a lot less benefit than over the last 20 years. See here:
      What if we enter one of the bad bond return regimes again?

      Regarding the other allocations. Agree, we can always come up with tweaks here and there that lo better in the past. I realize Small-cap Value did well during certain times. What if someone didn’t know and accidentally used a large cap growth tilt? What if small-cap value now mean-reverts and under performs then index? None of these style tilts are reliable.

      Anyways, thanks for your comment

      1. Gotcha! I love it!!

        Buuuuuuut, we’ve already adjusted for inflation by increasing our withdrawal amount right? Then if you adjust for inflation again on the final dollar amount aren’t you double dipping?

        I calculated the CPI adjusted portfolio value, and yes we do get nearly the same numbers now. And when you calculate the % of your withdrawals compared to the CPI adjusted portfolio value the numbers look frightening: at the end of the first year of retirement you withdraw $35,595 which is ~2.84% of your inflation adjusted year end balance of ~$1.25MM. Not bad!!! Well under our 3.5% target. This swings dramatically when we get crushed by the 2008 bear market where at 2008 year end we withdraw $46,394, which is ~6.1% of our CPI adjusted balance of ~$760k. Yikes!!!!

        If you compare the CPI adjusted withdrawal to the nominal value of the portfolio though, you can breath a little easier. At the end of 1997 (year 1 or retirement) the % withdrawal of the same $35,595 from your nominal portfolio balance is only ~2.79% Yay!!! Even better than what we calculated above. And, when you compare 2008 year end, the % withdrawal of $46,394 is only ~4.3% of the nominal portfolio balance. Not too scary, right??

        When you count the years that your CPI adjusted withdrawal is less than your target of 3.5% of your nominal portfolio value it is = 15 out of 19 years. The 4 years where you had to withdraw more than your target of 3.5% were ~3.58% in 2002, ~4.3% in 2008, ~3.7% in 2009, and ~3.54% in 2011.

        Not bad, not bad at all. Why all the doom and gloom then?

        1. Thanks! Whew, you scared me for a while, but I’m glad we sorted this out.

          “Buuuuuuut, we’ve already adjusted for inflation by increasing our withdrawal amount right? Then if you adjust for inflation again on the final dollar amount aren’t you double dipping?”

          The way I calculate this is as follows:
          1: All portfolio values are in nominal dollars.
          2: all withdrawals are in nominal dollars, starting at about $2900 in the first month, then inflation adjust over time, to about $4400 in the final month. All the calculations along the way are all done in nominal dollars
          3: in the end I get a portfolio value of around $2.24m, which is translated back into 12/31/1996 dollars, so roughly about $1.5m.
          4: for the time series charts I also adjusted the entire time series of nominal portfolio values back to 12/31/1996 dollars.
          Certifiably, there isn’t double-dipping. 🙂

          Why the doom and gloom?
          When we start the exercise on 12/31/1999 you will seriously compromise the portfolio. Not a pretty picture!


          1. Excellent!
            I agree that 1998 and 1999 retiree’s should be scared (if they’ve withdrawn and spent according to the 3.5% rule their entire retirement to date). But the impact of even $3-5k a year of income for a few years should mitigate any portfolio failure risk.

            Now that we’re all on the same page, isn’t the real question here: “how much does inflation impact the early retiree/any retiree?”

            If you’ve saved for retirement, which includes spending on luxuries/hobbies, won’t technology, personal choices, a position of strength (still fairly massive portfolio, and vast quantities of free time) defray most if not all of the effects of inflation? I mean does a 1999 retiree really need to withdraw over $50k this year to have a luxurious lifestyle? Or could the 1999 retiree have lived wonderfully on $35k every single year from retirement until today?

            1. Haha, great.
              Sorry for being a stickler, but the 12/31/1999 retiree would have been screwed. No easy way out of that one. No CD ladder, no 3-5k per year side hustle, no high-dividend equity fund would have saved you.
              I did the calculation: earning $300 per month on the side, inflation adjusted, would have improved the nominal final value by $141,000, inflation adjusted that’s just about $100k in 2016. If you’re 600k (inflation adjusted) in the hole, a little bit of income on the side will not change the equation much. The 1999 retiree probably would have to go back to work full-time for a few years in between. A significant bond allocation would have helped, but you’d still be underwater in 2016 even with bonds.

              The inflation issue is a tough one. On the one hand I’m sure that as i age I will consume less of the things I consume today. So it may sound reasonable to slowly shrink consumption. But you also spend more on things that old folks like: healthcare etc. and tons of things that I haven’t even thought about.
              If Obamacare premiums keep going up by double digits that’s another budget buster. I’m almost tempted to increase my consumption faster than CPI in the simulations, out of an abundance of caution.

  5. Definitely an interesting analysis. I’m not entirely surprised by the results. I plan to take an approach that mixes something akin to model 4 with an income approach as backup. As I noted the other day on my blog I’m not a big fan of buying specific dividend stocks or dividend funds as I view them as overpriced. However in buying all large caps through an s and p 500 there is some income from dividends. Simultaneously I’m looking to the cash cushion to be invested in something like a cd ladder with early withdrawl clauses intact. The income between the two should lesson the amount of the asset drill down considerably. In an ideal world the income would exceed my needs and thus the only time I’d pull from a cash cushion would be if there was a recession impact on the income. That might be a bit high in terms of total dollars for others though.

    1. Thanks! I share the view that high dividend stocks have become a bit pricy recently. The S&P yields 2% p.a., which is not too bad.
      I also like the idea of a CD ladder since the cash cushion is drawn down only gradually if necessary. But I doubt this will save the day. 7% of the portfolio picking up a term premium of maybe 1% gives you 0.07% extra return p.a. If the portfolio can go down by 60%, that 0.07% won’t save the day. Also: we already assumed a 0.25% extra return on the cash portion by shopping around.

  6. ERN,

    thx for running these stats. This article makes the withdrawing approaches very tangible. Good material to think about.
    Me to, I like the 3,5% or even 3% withdrawal rate. In my long term plan, I keep working in some form or way till pension age. That should allow me to keep a low withdrawal rate both in the pre pension (me working) as in the pension phaze (getting a small pension).

    On the other hand, tis also makes me consider a DGI strategy. In that case, there is no selling of assets. It would however require a lot more assets to have a portfolio that produces 4pct in dividend return.

    As I have plenty of time before our FIRE, I will watch and learn…!

    1. Yup, that’s the beauty of the high dividend stocks: you might get the dividend yield close to the withdrawal rate. There is still the risk that companies cut dividends (temporarily), but normally the cut in dividends is much smaller than the drop in earnings or the drop in the equity price. I am considering that, too, in combination with other income strategies, like option writing and real estate.

  7. Well I didn’t think I would see ERN espouse the value of cash. Ha ha! Terrific stuff.

    A number of posts ago you got us thinking about calculating our cash position only after accounting for the income floor pension ( yes, we are lucky to have it) and then the dividend from our investment portfolio. The differential from our annual expenses would then form the basis of a 3x multiplier to hold in cash. That is our plan. Your work gives us strategies to consider regarding timing of replenishment and of course factored into that is how much time we wish to spend on said strategy. We will have time for sure when we are not at the crochet club, bridge tournament or line dancing lessons at the local legion……

    Fine work and another read through (or two) is required for me. Take that as a compliment as always on your fine detailed work. You add a lot to the PF world so keep doing what you are doing!

    1. Yup, that’s what early retirement does to you, you might appreciate the simple things, like a money market account. If it’s only a few % of the portfolio, it may not be such an expensive form of insurance. Cheers!

  8. Fantastic stuff as always, ERN! And I’m honored to get a shout here – muchas gracias!

    There’s really no way around the reality that, if 1) you retire just before the stock market nosedives and 2) you have a substantial amount of your wealth in the stock market at that time, then you’re gonna be in lots of trouble. I think your models show that pretty convincingly!!

    And that’s really the thing that stands out in the analysis: It doesn’t matter what the cash position looks like since its loss-mitigation value is so small relative to the magnitude of broad equity market drawdowns, as you rightly point out. Considering just the worst-case 1999 retirement date, the total difference between highest portfolio result and lowest is around $100k, which, sadly, doesn’t do much for somebody staring down another few decades of retirement.

    In non-aberrant periods (and the dot-combustion was clearly an aberration!), something approximating a near-100% equities position would naturally be anticipated to outperform. But my view is that a maximum 75% equities allocation with the balance in real estate, alternatives and corp. bonds or munis provides the smoothest ride with an upward trajectory across most market conditions. And that kind of allocation enables selective withdrawal techniques designed to minimize “spending” the most devalued assets in the event of trouble. I mention this since the right kind of allocation is crucial in making something like a 3.5% withdrawal strategy work well. (The biggest problem with the 4% Rule isn’t the 4%; it’s the allocation.)

    The analysis here is top-notch. I especially like the way you varied cash cushion across the scenarios – a smart approach that, honestly, yielded much smaller deltas than I would have expected. It’s the fault of stupid and that darn E*Trade monkey…never shoulda let that monkey on TV during the Super Bowl! 🙂

    Great work – thanks!

    1. Thanks for your comment. The post wouldn’t be complete without your feedback! 🙂
      Yup, you got that right. If you’re doomed, you’re doomed. With the cash just a little bit less doomed.
      Haha, I remember the sock puppet. And the ETrade monkey (’99 Superbowl). In fact, the ’00 ETrade Superbowl commercial “This man has money coming out the wazoo” should have been the final warning to raise more than just 7-10.5% cash. But who knew back then???

  9. This is an excellent and terrifying analysis. Am I way off base in thinking that only selling assets once a year would have a significant impact that could alleviate some of these issues?

    1. Thanks!
      I am afraid it’s not going to do you any good to sell only once a year. In the end this will be at most a wash because you may get a small advantage when you sell in December 1999 before the big drop, but you also sell closer to the bottom in December 2008. Because you have more money sitting around as cash on average and the market goes up on average there is even a slight additional drag from opportunity cost.

  10. I love posts like this, the research is always so helpful and insightful. Plus I love hearing how other folks are thinking about the same problems I consider.

    I think this really hits home since we all lived through these decades, it makes it more real as to the possibility of it happening again. And I don’t like the prospect of retiring in December of 1999, even with only a 3.5% withdrawal rate! What this means to me is building in more cushion to my retirement accounts and being prepared to perhaps ease into retirement by working part time with some level of income or being prepared to go back to work in some fashion to supplement income down the road.

    I’ve definitely thought about how much cash to hold in a MM too. I agree, based on your analysis, that holding 3 years may be too much and makes no sense unless you are willing to draw it down to $0 in the bad times.

    Thanks for the analysis and the thought-provoking post.

    1. Thanks a lot. Yes, that brings back memories of the 2001 and 2008 bear markets. It wans’t so much a problem when we were accumulating wealth. You bought equities at a bargain price. But for people in retirement around that time: better have a big nest egg or some other income. 🙂

  11. I had been waiting for this one, and you didn’t dissappoint! A variable cash cushion does make some sense. It certainly makes more sense than the fixed cash cushion that is replenished immediately.

    It would be a separate analysis, but I wonder if the benefit of the variable / timed cushion would disappear if you held something other than a 100% stock portfolio, say an 80 / 20 allocation and rebalanced quarterly or annually.


    1. Thanks a lot! Great question! For the 80/20 allocation I would probably set up the allocation as 80+x/20-x with the same dynamic rule as before. No cash at all. Consumption is financed through the bond portfolio.
      Because bonds did so well overall (walk-down in yields) and they had a fabulous negative correlation with stocks, they probably would have done much better than a 100/0 portfolio. I know that a static 80/20 would have survived much better than 100/0 since 1999 and the 80+x/20-x would have likely done even better than the static.
      The big question is, though, how representative is this exercise for today? We have probably reached the end of the high bond return regime. If going forward, the big macro risk is a monetary policy mistake and inflation shock that 80+x/20-x might do pretty poorly. Probably a late 1960s to early 1980s episode would be the historical episode to use for that.

      Lots of follow up work to do. This post just scratched the surface!

      1. The best option moving forward might be to hold 2yr (or shorter duration, depending on what your broker allows you to trade) treasury futures in combination with your 100% stock portfolio. Some AA like you’ve mentioned before (100% ES futures / 120% 2yr Treasuries). That way you still have bond exposure (and hopefully the non-correlation that we would like it to provide), and less exposure to rising interest rates. Then you hold municipals instead of cash as collateral (again, like you’ve mentioned before).

        Hopefully a recipe for continued stock market success.

        p.s. What are your thoughts on doing the above, plus a weekly short put on ES? Too much, or just right?

        1. Great comment! Some of what you do is what I actually practice. I prefer the Muni route because the interest is higher and tax-free. So far, the Munis have lost some since the peak, but that’s the cost of doing business. Overall the Munis did what they are supposed to over the last few years: some extra income for the margin cash, it’s tax-free and there a slight negative correlation with equities and short equity put options.
          The 2Y-Treasury bonds (or bond futures) would have very low volatility (much lower duration than 10Y bonds!). Low vol is usually good but not here: if the asset has a negative correlation with stocks you want a high volatility (or you’d have to leverage the low-vol asset by a lot) to get the maximum bang for the buck.
          Anyways, thanks for stopping by. Great comment, dfr!!!

  12. Maybe this is too simplistic but at a 3.% withdrawal rate if I calculate I need 1M to retire then I will work till I have 1M + 3 years living expense.
    Keep the 3 years living expense in cash and draw it down only in a bear market till it is 0.
    After it is 0; then start selling equities.

    Also it might help to have a floor/ceiling strategy whereby in a bear market you don’t take the Paris vacation and instead travel to South America.

    Hoping someone can poke holes in my plan so we all can learn

    1. The reason why this doesn’t work is that the 2001 and 2008/9 bear markets were too long. In real terms it took the S&P500 13 years (!) to come back to the 2000 peak again. If you use cash for 3 years and then replenish the cash cushion you’d still do so when the S&P is way below the starting point.
      3 years of cash might get you through a garden variety bear market with a quick recovery but not 2001 and 2008/9.

    1. That’s a good one. I agree that the equity share should increase over time in retirement. That’s because the older you get, the lower is your implicit short bond position of future payments. They use a different rationale, I believe, but this is how I would rationalize an increasing equity share in retirement.
      But then again: I’m 100% in equities right now and plan to be when I retire. So for me personally their research doesn’t apply. 🙂

  13. First my plan: Have a million dollar portfolio that throws off 4% in dividends. This will not be YOC but actual $40k for the monies in invested assets (so over time it could really be 1.2 million + or -). Total dividends will grow at or faster than inflation. (Bucket Two)

    This would be a stock portfolio of 30 to 50 stocks that are on the Champions/Contenders/Challengers list that have long histories of increasing dividends. The amount of money being thrown off can be adjusted by more savings, i.e. need $80k a year then shoot for ~$2 million portfolio.

    Have two years worth of expenses in MM, laddered CD’s, or whatever the highest interest paying safe instrument that is available. (Bucket One)

    Have bucket two (dividend stocks) replenishing bucket one (the two years worth of expenses as described above.

    I feel this approach will allow me to adequately adjust to any dividend cuts or suspensions from the bucket two portfolio and I can sell and redistribute as necessary. My bond portfolio will be social security.

    One thing I have noticed over the past 10 years on the Early Retirement Forum is that when panic hits (2008-09) even people who had planned on withdrawing their 3.5% per year suddenly seemed ok to only withdraw 3% (or less) and tighten the belt ‘because this time it is different’. It seems that when the economy/stock market is tanking then the spend less/cut back behavior comes out even though based on all the studies you can still pull out your planned 3.5% plus inflation even in the worst year and still be ok for the 30 year time period, in practice, people don’t.

    1. The high dividend ETF that I checked out (Vanguard: VYM) fell by just as much or even slightly more during the 2008/9 bear market (even with dividends included!!!). Unfortunately, I found no return data before 2006.
      The whole talk about high dividend stocks is a big fallacy because even stocks that maintain their 4% dividend yield will not pay you enough when they fall by 50% (0.5*4%=2%). Unless they suddenly & miraculously increase the dividend yield to 8%. But that didn’t happen in 2008/9.
      You can always come up with some great dividend stock picks after the fact (hindsight is 20/20), but I actually think that without hindsight bias your dividend strategy would have terribly backfired: you might have had excess exposure to financial stocks and REITs, both of whom got hammered even more than the S&P500 in 2008/9.
      Are you certain you’re the stock-picker who can find names with lower drawdown and higher dividend yield (i.e., avoid all value trap stocks)? Good luck!

      But I agree that a lower withdrawal rate would be one way to weather the storm.

      1. In actuality it is much simpler. When a company is paying 4% dividend right now, even if the stock price falls 50% the dividend stays the same. If I bought a share of PEP for $100 and its dividend was 4%, I will still get the $4 if the share drops to $75 or $50 or conversely $125.

        The key is good dividend payers (high dividend payers tend to not be as stable) who have a history of paying dividends and not only paying the dividend but have been paying them without interruption and in fact increasing them year over year. You can find 107 of them that have been doing that for over 25 years and 226 that have been doing it for 10-24 years. Names you might have heard of like AT&T, Clorox, Coke, McDonald, P&G, etc.

        It seems in practice if you would have had 25 companies in 2008 in a well diversified portfolio (i.e. only 2 or so in banking and roughly evened out in value) you could have lost the full dividend from the 2 financial stocks and still broken even or had a slight increase from the other 23 companies that raised their dividend. But if you were prudent, you would have sold your position in the financial stocks when they announced their dividend cut and redeployed elsewhere. You might have lost some principal but not one of them went to $0 the day the dividend cut was announced, it took a few months.

        You might ask what about the other companies, well quite a few still raised their dividends, even if they only raised it by $0.01/year, it was still a raise and in those years where there was 0% inflation (according to the government) you were getting more than that.

        I have only been through one recession with major skin in the game and it was easy to keep plowing money in as I am still accumulating, but would it be so easy if I wasn’t earning a paycheck? Don’t know, but worst comes to worst, since I would have the same monies either way I could always switch to a total value approach 🙂 The benefit to me of a DGI is not spending the shares and having a perpetual income machine.

        1. “You can find 107 of them that have been doing that for over 25 years and 226 that have been doing it for 10-24 years. “

          Your fallacy is that 25 years ago you didn’t know which of the thousands of stocks will end up as the 107 dividend payers that never cut dividends. It’s called hindsight bias, and sad to tell you, you suffer from it, mucho mucho.
          The dividend flow from the VYM ETF dropped by 30.8% (4q rolling windows) from peak to bottom (2008 to 2010). So there were plenty of companies that did cut dividends during the crisis. There are plenty of companies that went out of business. I’m sure plenty of folks had Lehman Brothers and Bear Sterns and other failures in their portfolio. They never cut dividends either… right until they went out of business! How do you know how to avoid the lemons like that the next time around?

          “But if you were prudent, you would have sold your position in the financial stocks when they announced their dividend cut and redeployed elsewhere. You might have lost some principal but not one of them went to $0 the day the dividend cut was announced, it took a few months.”

          That sounds too good to be true. And it is too good to be true. The high-flying dividend payers will be brutally punished when they announce their first dividend cut. It’s too late to sell then because the price is already down.

          1. “Your fallacy is that 25 years ago you didn’t know which of the thousands of stocks will end up as the 107 dividend payers that never cut dividends. It’s called hindsight bias, and sad to tell you, you suffer from it, mucho mucho.”

            What you fail to recognize is that 25 years ago there were 73 of those companies that had over a 10 year track record of paying increasing dividends already and even more of those had up to 35 years of continual increasing dividends. Yes! there are companies that have paid 60 years of increasing dividends. I think I could have made a diversified portfolio with 25 of those 73 (and never would’ve had a decrease since then).

            “The dividend flow from the VYM ETF dropped by 30.8% (4q rolling windows) from peak to bottom (2008 to 2010). So there were plenty of companies that did cut dividends during the crisis. There are plenty of companies that went out of business. I’m sure plenty of folks had Lehman Brothers and Bear Sterns and other failures in their portfolio. They never cut dividends either… right until they went out of business! How do you know how to avoid the lemons like that the next time around?”

            One problem of VYM is back in 2008 it had 30% of its top ten holdings in financial stocks, if the whole portfolio was set up that way, I’m surprised dividends only dropped by 30%. That would be the equivalent of my 25 stock portfolio having almost 8 of them financial stocks. Doesn’t sound too diversified to me. So I wouldn’t have that many. Sure the is a chance that some could go to zero, but hopefully you are watching your portfolio and the news that is coming out of your news feed. Even if there wasn’t a dividend cut to warn you, hopefully all the news blips saying that Bear Sterns is in the shitter that came from 12/2006 thru 3/2008 would have triggered something. Its not a set it and never watch it again portfolio.

            “That sounds too good to be true. And it is too good to be true. The high-flying dividend payers will be brutally punished when they announce their first dividend cut. It’s too late to sell then because the price is already down.”

            I’m not sure if you think 3 to 5% are high flying dividend payers or if you are more in the 10%+ range.
            Usually when there is a dividend cut announced there is a drop in price but it doesn’t drop to zero. Take COP for instance, it announced a dividend cut from $0.74qtr to $0.25qtr on 2/4/2016. On 2/3/16 it was $38.63 per share, news of dividend cut on 2/4/16 and on 2/5/16 the price was $32.90 per share. Sure a nice haircut, but did it go to zero? Will you not be able to sell all your remaining share(s) and reinvest elsewhere? Or maybe since the 66% trim on the dividend was only a change of $1000 in your annual income it will now be on probation and you are going to watch it closer because you think gasoline and oil products will still be around for a few more years. Since your other remaining companies increased their dividends by an average of 4% the actual difference in last years income and this years is about $70.00 I think I might be able to handle that this year.

            It looks like on this topic we’ll just have to agree to disagree 😉

            1. Yeah, let’s agree to disagree. But just to be sure: I most definitely wish you best of luck. That’s because I also hope that in the next recession dividends will be cut only very mildly so they can sustain my retirement cash flow.

              1. Thanks for a very interesting article, also surprised by the conclusion that even in the rising stock market the cash cushion is optimal and doesn’t produce a drag! I wanted to add to the discussion on dividend strategy as I also plan to fund majority of my passive income in ER from blue chip dividend growing stocks.

                First, I’ll try to address the hindsight bias. I found the earliest version of the Div Champions spreadsheet mentioned by ed69 is dated Dec 2007 which is perfect timing to see the impact of the Great Recession. So I looked at what happened to 139 stocks with >24 year streak of annual dividend growth on the Dec 2007 list over the next 9 years by comparing it to the Dec 2016 list. Here are the results:
                – 37 stocks (27%) reduced/eliminated their dividend by -77% on average; 24 of them were in banking/insurance sectors (no surprise!)
                – All but 4 cuts happened in 2008/09 (again no surprise)
                – 19 of 37 stocks experienced cuts >90% of 2007 level
                – For completeness, additional 11 stocks had at least one year of no div growth and 12 stocks dropped off the list due to M&A (acquired by another co, etc). So the list of ‘champions’ shrank to 79 excluding any new companies being added during this timeframe as they achieved 25 years of growing dividends
                – Income impact: if all 37 stocks cut their dividend in one year and the remaining 102 stocks have had zero div growth (worst case and not reflecting what actually happened in 2008-09 as the cuts were spread out over 2008-10 and only 11 stocks had a no growth year in a 9-yr span) the div income from an equally weighted portfolio of 139 ‘champion’ stocks would have dropped by -21%. In reality, this portfolio would have likely had two years of ~-8-10% drop in div income followed by strong recovery. As evidence, remaining 102 stocks increased their quarterly div by 94% on average from 2007 to 2016.
                – Principal impact: I did not compare price performance for this list of 139 vs. the index
                – My conclusions: if Great Recession results in a ~-10% drop of income for two years in a row then garden-variety recession should not dent div income that much in a diversified portfolio of blue-chip dividend growing stocks even while the index takes a 20-30% hit. I’d expect a flat to slightly negative div change during future cyclical recessions with an occasional greater hit to income from the big ones like we just had. As anecdotal evidence from my portfolio, when the energy stocks took a hit in 2014-16 my overall portfolio income continued to grow (albeit at a slower rate) even though I had three stocks cut their dividend -74%, -76% and -89% (and managed to sell one more ahead of the cut without any principal loss).

                Second, I believe fundamentally div investors are trading in higher growth for higher inflation-protected current income. For ER crowd that seems to be a good trade-off. Dividends are much ‘stickier’ than principal which is subject to significantly higher volatility (-30% drop in the index is not uncommon). On the other hand, div stocks generally have lower beta and on average grow slower than the rest of the market/index.

                Third, I see a behavioral advantage to passively collecting dividends vs. executing ongoing sales of principal to fund my living expenses in ER. I’m certain that once my paycheck stops I will become more risk averse even if I trust all the studies about 3-3.5% WR being safe and all. I’ll be able to mentally absorb a small reduction to my current income a lot better than the distress caused by selling into a -30% drop in the index. If the latter scenario happens soon after ER (dreaded sequence of returns risk), many people (including me) would probably try to cut living expenses by more than 5-10% (which is not going to go well with the family and I would lose some sleep over it) 🙁

                Finally, I’m sure you’ve seen all the studies pointing to dividend stocks outperforming the index over long-term (which I attribute to the discipline it imposes on the management not to waste cash on new marginal projects, M&A, etc). I’d appreciate your take on those studies and my notes above – maybe a subject for a future post? 

                1. Wow, thanks for putting that all together! Very intriguing results, indeed. If you can pull that off, generate the entire cash flow need from dividend yield alone and the payments go down by “only” 21% top to bottom and you avoid digging into the principal during the GFC, that sounds like a good plan. My concern would be this: Dividend stocks have become a crowded trade. There is no guarantee they will behave so benignly again in the next recession. Just a thought…

  14. So disappointing. I’ll just give up my early retirement dream and plan to work until 70 and spend a lot now in a trip to Bahamas….I’m just tired..the more you save the more you need…I’m done and this post was the last drop!

  15. I would love to see a similar analysis where, instead of using a cash cushion, you use a HELOC as the cushion. This avoids the lost opportunity cost of holding cash when the market is up, at the expense of paying interest while carrying the balance (which may require selling some equities during the market drawdown to cover the interest).

      1. I counted on a HELOC as an alternative to cash savings. Now at that time I was working full time, and still had a mortgage plus a $100K zero balance HELOC, but my total LTV was about 60% or less, based on the inflated valuations of that time.

        After the Big Recession hit, my lender froze my HELOC. I then was sitting there with next to no cash and no options other than credit cards or pulling from retirement accounts in case my job evaporated… which it threatened to do, weekly. There were layoffs every month.

        After a considerable number of sleepless nights, I decided my plan was to cut out all nonessential spending, stop prepaying the mortgage for a while, and pad up my cash savings to at least 6 months or a year of expenses. I would take in a renter or two if I was laid off. I’d find a way.

        Fortunately I was never laid off, but that cash cushion allowed me to quit worrying every day about what the heck I would do to survive an unexpected job loss and not lose my house and farm.

  16. ERN, you get *so* little wrong when it comes to retirement finances. But your 5 year old prediction above that “The 4% rule will most definitely fail the 30-year retirement horizon” looks (almost certainly, writing this 8 years before the finish line) to be one of those rare cases, at least for equity allocations between 20% and 80%. According to the SWR sheet, even 95% stocks looking like it will end up working… 😀😏

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