The Ultimate Guide to Safe Withdrawal Rates – Part 12: Six reasons to be suspicious about the “Cash Cushion”

When we read about withdrawal strategies in early retirement, the cash cushion is often one crucial ingredient. Simply keep a little bit of cash sitting around on the sidelines, dig into that cash during an equity market drawdown and avoid selling equities until the next recovery. How much cash? Well, the Global Financial Crisis raged for “only” 18 months and the average garden-variety recession should last a year or even less. Thus, even if we assume that the equity market takes a little bit longer to recover it will take only very little cash and very little opportunity cost to achieve this. The whole issue of Sequence of Return Risk is solved! Who knew this was so easy? This is almost too good to be true! Well, unfortunately, it might be just that; too good to be true.

Here are our top six concerns about the cash cushion:

1: Funny accounting: We can’t keep our dividends and eat them too!

One tripwire to avoid is the following funny accounting mistake: For this example, let’s assume a 3.5% withdrawal rate and a 2% dividend yield. Great! We need only 1.5% to supplement our dividend income. So, a cash cushion of around 7.5% insures against a 5-year equity drawdown, right? Yes, but here’s one pitfall. We have to pick one of these two options:

  • Either we assume that we eat the dividends but then we need insurance against a longer event because without reinvested dividends the drawdown will take longer.
  • Or, we assume we don’t eat the dividends and they help us recovering faster from the drawdown. But then we’d need a bigger cash cushion because now we need 3.5% in cash for each year of drawdown we want to insure against.

Sorry for pointing out something so trivial, but you’ll be surprised how often we see folks making the mistake of double-counting the dividend yield, i.e., design the annual cash cushion size as withdrawal rate minus yield (i.e., assuming consumption of dividends) but then using the equity drawdown length of the Total Return Index, i.e., with dividends reinvested. As we show in the chart below, without reinvesting dividends the drawdowns can be painfully long (top chart). Several decades long, so good luck keeping enough cash around for that! When reinvesting dividends, the drawdowns are shorter (bottom chart) but also require more cash cushion per year, i.e., the whole 3.5% in our case, 4% per year for with a more aggressive withdrawal rate. There’s no free lunch!

S&P500 index: Price Index (top) vs. Total Return Index (bottom). Red shading = drawdowns lasting 36 months or longer. Pick your poison: Consume Dividends but face longer drawdowns (top), or face shorter drawdowns but we need more cash cushion per year (bottom chart)!

2: Drawdowns can last even longer when taking into account inflation

Another pitfall: The length of the drawdown can be substantially longer than some people assume. We need to reach not just to the previous equity market peak, but that peak plus inflation if we assume that we make cost-of-living adjustments in our withdrawals. That doesn’t make much of a difference, you think? Think again! Most drawdowns in the past have lasted substantially longer when taking into account inflation, see chart below.

S&P500 index: Nominal Total Return Index (top) vs. Real Total Return Index (bottom). Red shading = drawdowns lasting 36 months or longer. Drawdowns are longer when adjusting for inflation!

The bottom panel plots the real S&P500, with drawdowns of 36+ months shaded in red (nominal chart in the top panel for comparison). Since 1910, there were seven major drawdowns in the real S&P500 index. Some of them were back to back with a short reprieve in between, and each time it was too short to restock the cash cushion in preparation for the next bear market. So we might as well interpret them as one single event, which means that in the last 107 years there were four major drawdown events:

  • 6/1911 – 8/1924: 13 years and 2 months comprised of two drawdowns with a short 13 months of reprieve in between.
  • 8/1929 – 12/1950: 21 years and 4 months comprised of two drawdown periods with a short 13 months reprieve in between.
  • 11/1968 – 1/1985: 16 years and 2 months comprised of two drawdown periods with a short 1-month reprieve in between.
  • 8/2000 – 5/2013: 12 years and 9 months

In other words, over the last 107 years, we would have spent 60+ years in major, decade-long drawdown phases. Over the last 50 years, we would have spent almost 29 years in the red. So, pronounced drawdowns that require 10+ years of cash cushions are not the exception but the norm! Multiply the drawdown length above with our desired withdrawal rate (3.5%) and we get completely unrealistic, downright preposterous cash cushions of somewhere between 42% (12 years) to 73.5% (21 years). Ain’t gonna happen!

3: Don’t expect much help from consuming the dividends

What if we had consumed the dividends? As we said above, it’s a tradeoff. Consuming the dividends will lower the amount needed per year of drawdown but also create longer drawdown periods. Let’s plot how long the drawdowns last when we plot the real, CPI-adjusted price return only (without reinvested dividends), see below:

S&P500 index: Real Price Return Index. Red shading = drawdowns lasting 36 months or longer. Drawdowns last longer when dividends are consumed rather than reinvested!

The most recent drawdown would have lasted 14.5 years (2000 to 2015). During those 14+ years, the cash cushion would have to support the shortfall between a withdrawal rate of 3.5% and the dividend payments. Those dividends were, on average, only 1.5% of the index level in 2000, so we’d have to compensate for the remaining 2% with the cash cushion: 2% times 14.5=29% cash cushion. 36% cash cushion when using a 4% withdrawal rate. Good luck with that!

The 1970s recessions would have been very unpleasant for the cash cushion as well. A 24-year drawdown coupled with a drop in the real dividend (more on that below). We won’t even mention the multi-decade drawdowns between 1900 and 1960 because this cash cushion myth is pretty much busted!

4: When do we replenish the cash cushion?

Now assume we have just dug out of a multi-year equity drawdown and thanks to the cash cushion we never had to touch our equity stash. Great job! But now the cash cushion is zero! The equity portfolio has to do double-duty now: It has to generate enough returns to cover the 3.5% withdrawals, 2% or so inflation plus all excess returns to refill the cash cushion. How long will that take? It looks like there have been bull markets long enough to achieve that eventually: 1951-1969 and 1985-2000. But we won’t have any illusion that this is feasible after every single drawdown.

5: More funny accounting: Cash has a low expected return!

Let’s use the following example wehere we keep 5 years worth of withdrawals on the sidelines, 17.5% of the portfolio. But that means a $1,000,000 portfolio will have only $825,000 in productive assets and $175,000 in zero or even sub-zero expected real return (current return in a money market account or short-term CD is less than the 2% expected inflation rate). So, a $35,000 annual withdrawal is 3.5% of the overall portfolio but 4.24% of the equity portion. That’s getting dangerously high. One alternative would be to keep $1,000,000 in equities and save an additional $175k for the cash cushion. But now the effective withdrawal is not really 3.5%. It’s 35,000/1,175,000=2.98%. If the withdrawal rate is so low we might as well invest the entire $1,175,000 in productive assets (80-100% equities) and have a withdrawal rate of just under 3%, which seems pretty darn safe, even for a cranky old pessimist like yours truly, see our previous research on the topic. Specifically, in that post, we showed that a 3% withdrawal rate and a 75-100% equity share had a 100% success probability even for capital preservation, not just capital depletion, over 60 years.

6: Dividends can be cut!

Let’s assume we do withdraw the dividend income. In the past, there have been numerous occasions where dividends have been cut significantly during the recession and/or were eroded by inflation. Professor Shiller has a nice long time series on S&P500 dividends as part of the spreadsheet to construct his CAPE (even though dividends aren’t even used in the CAPE calculation). Don’t let the experience from the 2000s with only short and shallow dividend cuts fool you. There have been some nasty long drawdowns for the real dividend income in the past, see charts below. And those drawdowns in dividend income, you guessed it, coincide with the bear past markets.

Real Dividends in the S&P500. Not a straight line!
The 1999-2004 and 2008-2012 drawdowns were shallow. Dividends have suffered much more dramatic multi-year, even decade-long drawdowns in the past!

What are the alternatives?

Ideally, we’ll just stick with a simple dynamic withdrawal strategy, see Part 11. Rules based on the Shiller CAPE seem to check all our boxes: a) we don’t run out of money, b) muted volatility in withdrawals, and c) moderate drawdowns in consumption levels.

One could also keep a very small cash cushion knowing full well that during a big drawdown it will not last through the bear market. We did a case study in a blog post a while ago that assumed we have a 3.5% withdrawal rate, consume the dividends to stretch out the cushion even longer and keep 12-36 months of expenses in the cash cushion (3.5-10.5%). In each case study, we ran out of money before the market came back. When we started the exercise in December 1997, a little over two years before the market peak with a $1,000,000 portfolio, the equity portfolio without a cash cushion came back to $956k in 2016. With the cash cushion, the different parameterizations would have beat the equity portfolio by $3k to $17k. Not really that much. If we had started the exercise in December 1996 or before, the cash cushion portfolios would have all lagged behind the all-cash portfolio. Opportunity cost!

Cash Cushion Time Series during the 2000s: 3.5% Withdrawal Rate, consume dividends, keep 3.5%/7.0%/10.5% in cash. We’d exhaust the cushion in each recession. (From our post in October 2016)

Another solution would be to use the dynamic withdrawal scheme, called “Prime Harvesting” proposed by a fellow called Michael McClung (see nice summary here). Instead of cash, you hold safe government bonds (10 years maturity) with a higher yield and some diversification potential. Simply draw down the bond portfolio before touching the equity holdings when there’s a drawdown. That’s an interesting and intriguing strategy and we will write more about it in the future.

Some folks suggest to juice up the expected return of that cash cushion with higher yielding assets. That might lower the opportunity cost but also increase the risk. We read suggestions for keeping the “cash” in Preferred Stocks, Junk Bonds and (I am not making this up) REITs. Of course, all of them had nasty drawdowns in the 2008/9 recession. Not much of a help as drawdown protection!


The Cash Cushion approach is really caught between a rock and a hard place. Either the drawdown is so long that you can’t possibly have enough cash to make it through or the drawdown is short enough that the cash cushion likely wouldn’t have made a big difference. We are not convinced!

We hope you enjoyed today’s post. If you use a cash cushion please share your experience below.


45 thoughts on “The Ultimate Guide to Safe Withdrawal Rates – Part 12: Six reasons to be suspicious about the “Cash Cushion”

  1. Intriguing post! Very though-provoking! I had no idea that it took the market so long to recover in the past.
    Just one question: is the chart “Real Price Return Index” accurate? Looks like it increases very little in 145 years (1->20 in 145 years = 2% real per year).

    Liked by 1 person

    • That chart is accurate. It’s because in the early preiod stocks made hardly any return through price appreciation but offered much larger dividend yield. So, in other words, $1 invested in the stock market in 1871 would have grown to $12,000 (inflation-adjusted!!!) with dividends reinvested but only a little more than $20 without dividends. Crazy, isn’t it?!
      Thanks for stopping by!


  2. That alarming (nearly all red) chart showing real drawdowns when dividends are consumed reminded me of Robert Frey’s “180 years of market drawdowns” (

    The tl;dl is: markets are usually down. Just like your bleeding charts show.

    An summary of the talk at claims we’re in a 20%+ drawdown nearly 1/4 of the time!

    Which leads to the real question is: how do we ever manage? We’re constantly losing money!

    Liked by 1 person

  3. I just read the book Asset Dedication last night, which underneath it all, is largely about having a cash cushion. It was frustrating to read because they don’t address any of the problems that you identify. And they are problems that seem so obvious to me (and you and others)!

    Having a cash cushion is one of those ideas that “sounds great on paper” but the people who suggest seem to have never once tried actually backtesting it. Sure, backtesting doesn’t guarantee anything…but it is a hell of a lot better than some vague handwaving bullshit.

    The whole “when do you refill the cash cushion” is so poorly addressed by most proponents it is crazy….


    • Thanks, Justus! Exactly my thinking: The cash cushion mostly works when you have the cushion available right at the perfect time before equities take a nosedive. And then the cushion protects you against only one bear market if we don’t address the issue about when to replenish it. A whole lot of handwaving out there, as you say. 🙂
      Many thanks for commenting!


  4. You are my favorite economist for a reason! And you actually may be more of a cranky pessimist than me!

    Help me get my head around this though, because aren’t the bleeding charts reflecting the impact assuming we retire at the peak? Not that we can time it perfectly, and sequence of return risk is real, but is this basically the worst case scenario?

    Liked by 1 person

    • Ha, thanks Green Swan!
      100% correct, these are worst case scenarios of retiring at the peak. But: Even retiring years before the peak can wipe out your cash cushion. That’s when the growth before the peak was subpar. For example, in the charts you notice that the pre-1970 peak was in 1968/69. But between 1965 and that peak the stock returns were so low, they hardly compensated for the withdrawals. So, any retirement year between 1965 and 1969 would have gotten your cash cushion in trouble.

      Sorry for being so cranky! 🙂


      • Gotcha, I’m on the same page as you regarding the cash cushion. You converted me on that point a while ago. I just wanted to make sure I was tracking with you as the charts paint a bleak picture.

        My plan is to retire after a massive downturn… 🙂


  5. I came across your blog a few weeks ago and really appreciate your perspective, I’ve found some great new insight here. I started reading up on safe withdrawal rates a while ago, and convinced myself that 3% for a retirement anytime before 65 (and perhaps after 65) is a number I’m comfortable with. I arrived at that number by haircutting returns and running monte carlo simulations with these reduced returns and historical volatility, as well as really studying historical periods where the 4% rule failed or came close to failing (1929…, 1905…, 1966). I’ve read articles correlating Shiller CAPE with SWR’s, but your work is the most in depth of what I’ve found. I’m a CPA by trade, and have had some involvement with the financial reporting function at a Fortune 500 company for the past 20 years, and I understand (because I have lived) changes in accounting standards, as well as higher scrutiny by auditors and regulatory authorities. I’ve seen good articles where people argue that a true “apples to apples” CAPE is lower than what is indicated. However, absent a massive (and probably impossible) project to actually go back and restate S&P 500 earnings on a consistent basis, these are just educated guesses. My gut tells me we’re not in doomsday territory, but we’re still at the high end of historical valuations, so here is one more great reason to lower expectations and plan accordingly. Just curious, are you planning to explore the CAPE of other asset classes in future posts? I know that MSCI EAFE, emerging markets, and small cap value all have a lower CAPE than the S&P 500, but it would be interesting to see your perspective applied to a portfolio diversified across these asset classes. I’m probably not going to see anything to convince me to increase my initial withdrawal rate from 3%, but I view a diversified portfolio as a way to make my 3% rate a little bit safer.

    Liked by 1 person

    • Thanks for sharing your thoughts!
      Agree: Today’s market sustains higher a CAPE (lower CAEY) than in history. So, we’re not in “doomsday territory” but merely in “lower expected return” territory.”

      I haven’t looked at other than SP500 CAPE data recently. But I definitely agree that some “diversification” away from U.S. Large Cap might be a good idea. Both in the backtest and going forward. For example, I added the Fama-French Small and Value factors in the Google sheet (see part 7) for people to experiment. I found that small stocks and/or value would have sustained higher SWRs in the past.

      Thanks for stopping by!


  6. Big ERN,
    You are slowly but surely destroying any semblance of productivity when I am at w*rk. Your posts have triggered an unrelenting OCD WRT withdrawal rates. Maybe I need help withdrawing from withdrawal rate research. But, how can something so wrong feel so right?!?!?!?

    McClung, McClung, McClung. What a book to feed the soul of a devout econometrician. Good stuff, counterintuitive stuff, lots of “What you talkin’ bout Willis” stuff. In case you haven’t run across it, he has a website for his book (cleverly named where you can get the down-low on some of his ideas by a simple download of a spreadsheet. It lets you calculate your initial withdrawal rate as well as see Prime Harvesting in action. I still need his book to properly navigate the genius McClung has immortalized in workbook format, but someone of your financial perspicacity may be able to deftly maneuver through its rows and columns without the assuaging support of such trivialities as ink on paper.

    McClung also has some interesting links on his website. Arguably the best IMHO, EREVN has blog that further feeds my SWR OCD ( and are just 2 juicy exemplars). These along with other EREVN entries provide very tasty food for thought. Good stuff.

    Liked by 1 person

  7. Thx for showing the need for good planning…

    Have you ever considered a dGI approach where you live solely of the dividends? That way, you risk is the sustainability of the dividends.

    My personal plan runs more along the line of keeping a job – half time or so – and use the portfolio to fund travel. That drastically lowers my needs. Agreed, it means work till pension age. Thing is: I do not hate my job right now; I fact, I really like it. Ideally, I am home whne the kids have vacation. that means work about 65%

    Liked by 1 person

    • I am intrigued by the DGI strategy, for sure. But my concerns are that a) currently the yield in the S&P500 is much lower than my required withdrawal rate b) high-yielding dividend stocks had a pretty nice run and potentially look a bit expensive and c) dividends have been cut and have stagnated in the past and have been eroded by inflation.
      The solution would be to diversify, just like your plan: keep multiple sources of income. I’d like to add more to rental investments, too!


  8. Ok, so if you were about to retire, what would your strategy be? I’ve got the 3.25% SWR locked down… so I’m somewhat confident but I’m trying to find that sweet spot – do I just revert back to old personal finance rules and have 3-6 months of cash on hand?

    Liked by 1 person

      • I agree with that sentiment. I just can’t help but think I’m retiring at the very worst moment for sequence of returns risk but hoping my 3.25% withdrawal rates makes that moot. I don’t want to work for money anymore, blog or otherwise, so I’m trying to think things through as carefully as possible to prevent me from activating any back up plans. The good news is you already thought this whole thing through and have data to back it up and addressed all my concerns plus several others I hadn’t even considered. Thanks for sharing all your awesome observations, data and analysis.

        Liked by 1 person

  9. This is a wonderful series of articles. I am recommending in my own blog that people definitely need to read all of these posts. I think my biggest nit to pick is with your cash criticisms. Three of your concerns have to do with how dividends are spent and accounted for over time and whether those dividends could be cut in the future. I don’t see this as a problem particular to holding cash. A miscalculation of this type will cause a problem with any mixed asset portfolio analysis that includes stocks. Maybe I am missing your point? Your concern that inflation erodes the value of cash and the low return of cash also seems to hold cash to a different standard than the other asset classes. Inflation subtracts from the real returns of all assets. I am posting an article tomorrow that uses FIREcalc (I cross checked with cFIREsim too) to show that holding something like 20% cash has little impact on portfolio success. I found very similar results for holding 20% intermediate bonds instead. I think if you swap cash for bonds in your 30 year scenarios you won’t see much difference, which indicates the inflation/low return concern is not unique to cash. (I have not looked at a 60 year scenario, so I defer to you on that.) Finally, I agree that replenishing the cash cushion should not be a goal. My view is cash should be used to buy more stocks if/when the stock market crashes in the early part of retirement (the most vulnerable period), and that cash reserve should not be replenished after that. Importantly, I am talking about a severe crash (e.g., in excess of a 30%), not minor variations where one would attempt to time the market, which is essentially impossible. Thanks for the great analysis throughout this series.


    • We both seem to be in agreement on most issues:
      Keeping too much cash/bonds throughout your retirement would hamper your success rate. But I can endorse an initial bond/cash allocation that you slowly reduce. Either through a glide path to 100% equities (or close to 100%) or through something like Prime Harvesting (see part 13).
      Whether bonds or cash works better depends on the time period. In the 1930s and the 2000s, bonds offered great diversification benefits. In the 1970s it was the other way around: Because of the inflation shock bonds got hammered, cash did better. Going forward, if you believe that bonds can keep their negative correlation with stocks and bond yields move up only very slowly, you’d be better served with bonds. If bond yields go up too fast, you’d be better served with cash (see last week’s post on bond diversification)

      I am most definitely not holding cash to a different standard. I’m holding it to the exact same standard. All returns I use are total returns (dividends, interest included) adjusted for inflation.

      Thanks for stopping by! Let me know when your post goes online. Would like to take a look!


  10. Very nice article! I’m holding much more cash/bonds than I’m comfortable with right now. As karlsteiner1 mentioned, your analysis is pretty much the same for bonds vs cash at this point with such low returns on bonds. You need business ownership (stocks) over many decades to beat the real retirement risk of inflation. But in the comments I see you mention a “cash cushion” is something you’d support for sequence of returns risk with a rising equity glide path. That would be an interesting future post for you to write (hint hint).

    This is my strategy. Have a larger cash position going into retirement (early retirement lifestyle expenses plus covering potential moving costs and a new vehicle). I’m well aware that from a purely investment return perspective I will likely suffer but it manages the sequence of returns risk. 5 years after retirement I expect to be 90-100% stocks and real estate again. Although if the market hits a 20% drop before or right after I retire, I probably won’t be able to resist putting the cash back into the market so it could end up being beneficial. Who knows what will happen though. The market could easily go up a lot in the next few years.

    Regardless, I agree cash is about 100% the wrong move looking at long term investment returns, but I do think it plays a critical role in the period right before and right after retirement (especially after years of good market returns) to manage sequence of returns risk. We just need to remember to reduce our cash holdings over the next few years instead of trying to always have a cash cushion in our portfolio. A dynamic cash cushion approach.

    Liked by 1 person

    • Agree! As long as folks don’t hold the excessive cash cushion forever and jeopardize the long-term sustainability I’m ok with that. But even then I’d hold 80% equities (or equity-like investments) in the beginning and transition to 100%.


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