When should I start living on cash instead of investments?

it's good to have cash reserves going into retirement that you can live on when the market drops but when exactly do you start to tap in to these cash reserves that's exactly what I'm going to show you in today's video hey everybody I'm James Canal founder root financial and I'm here to teach you how I get the most out of life with your money a lot of people intuitively understand that it's good to have some cash or at least some conservative stable investments in your portfolio going into retirement this is the part of your portfolio you can live on when the Market's dropping so you never have to sell stocks or loss the question though is at what point do I start living on these is after a certain percent drop is it when something happens when do I actually start pulling money out of my cash instead about my portfolio so let's go through a framework to think about so that you can understand how to think about that the first thing I want to point out is how are you defining cash for example let's assume that I have a portfolio of all stocks and I retire and I also have one year of cash set aside in my savings account at my bank well in that instance I truly think about that as having just one year of cash versus another person let's assume they retire and they have a 60 40 portfolio and they also have one year of cash in their Bank well they had the one year of cash they also have 40 of their portfolio that's in cash or stable Investments or at least relatively stable investments in in that instance I would actually think of that 40 as cash or cash like equivalents so the first point is how are you defining the cash here is it the first instance we're literally the only cash is the cash you have in the bank or is it the second instance where you have both cash in the bank plus cash in the portfolio to me I lump that 40 percent at least partially so as part of your cash bucket even if it's not in the bank if it's in your portfolio in a conservative relatively stable investment to me that qualifies more as cash than it does of course as a stock investment what about you though as you're listening what qualifies as cash in your mind is it just cash in the bank is it money in the portfolio is it something else be sure to drop a comment below because I want to understand how do most people think about in their portfolio the second thing to note is simple enough but your portfolio is meant to be lived on when you're designing a portfolio if you're balancing it right if you're diversifying it right you have stock Investments Bond Investments cash Investments diversification within all of them understand that your portfolio is meant to be lived on there's a lot of people and I saw this in 2022 and the market was dropping their portfolio dropped and so to them they didn't want to touch it one bit they wanted to live on cash in the bank and I get that I get the concern but for a lot of them I shared with them I said look your portfolio is meant to be lived on and not just when the stock market's up not just when the Market's returning 810 plus percent but every year that's why we diversify that's why we have bonds or cash or stable investments in the first place this is more of an emotional hurdle than sometimes a financial one or just feels weird to pull money out of your portfolio even as the portfolio as a whole is dropping but understand that when the four percent rule or guyton's guard rails or any other withdrawal strategy was put into play when the research was done it wasn't done under the assumption that you only pull money out when things are good it was done under the assumption that you're pulling money out every single year through good times and bad times your portfolio needs to be Diversified so that you can pull money out regardless What's Happening Now ideally you have the right withdrawal strategy so you're not just blindly pulling money out of whatever part of your portfolio but you're specifically and intentionally choosing the Investments that you're living on based upon their role in the portfolio and based upon what the market is doing but that's sometimes a hurdle to get over is understanding your portfolio is designed to be live on even when the Market's going down so with those two things in mind the third step is to Now understand with that context in place now when do we start living on cash in our portfolio well a couple things to note here if you have a very intentional allocation with your portfolio if that allocation has been determined by how much you need as part of your financial plan which is based upon your goals for your life you really shouldn't have to think about this too much now for example maybe you have 80 stocks 15 bonds five percent cash obviously Diversified within all of those but if you're constantly rebalancing back to that allocation well by default you're going to be raising enough cash every year to be living on stocks go up and they don't represent 80 percent of your portfolio anymore they represent 85. well you're going to sell five percent of that and put that in stocks or put that in bonds same thing is true with the bond portion or the cash portion if you set the right allocation to meet your income needs and you're rebalancing your portfolio and ensuring it's staying true to the allocation well in that example you're always going to have cash that you can live on it's the rebalancing that's going to determine are we selling stocks to get there are we selling bonds to get there are we using dividends and interest to constantly replenish that cash allocation these are the types of things that need to be set up up front but if you have that in place you don't really need to think consciously every time about when do I do this you just live on cash in your rebalance strategy and your withdrawal strategy determines how that mix of cash bonds and stocks is constantly leveled but you don't need to constantly make that decision of where money is going to come from now if you don't have that withdrawal strategy if hey everything's just there I don't know what I'm going to pull from first I don't even really know why I have each investment well you then have to use somewhat of an arbitrary number what would I choose I would probably choose something between 20 and 25 percent in other words if the market fell by more than 20 or 25 percent or once it hit those thresholds that might be my trigger to start living on cash why 20 to 25 percent there's a little bit of science behind it but more than anything if we start to live on cash at too low a threshold so so say for example anytime the market drops more than five percent we're living on cash we're always gonna be living on cash the market on average drops by more than 10 percent every single year now it doesn't do so every year but we average a correction every single year which is defined as a 10 pullback so if that's our trigger we're probably always living on cash so it's not going to really fulfill our withdrawal strategy if we wait too long say after the markets pulled back 40 percent well we're going to be depleting our stock portfolio because we're waiting for the market to drop sufficiently to start living on our cash which means we're selling when the Market's down 25 30 35 percent we're having to sell those stocks so keep in mind with this sometimes the way you manage a portfolio the way you withdraw a portfolio it's not an exact science there's no Precision to how long is a market downturn going to last exactly how much return am I going to get what's inflation going to be what are taxes going to be all of this is somewhat science and it's somewhat art and we have to realize that sometimes we're trying to protect ourselves from the market sometimes they're trying to protect ourselves from ourselves and so having some rules something that you can stick to something you can commit to assuming it's based in logic and based in an understanding of how things work applying those rules and following those rules that is more important than being perfectly and specifically right simply because you're never going to have the opportunity to do that we need to make sure that we have some guardrails around what we're doing and if we look at 20 to 25 percent as the trigger for what point we stop living on our portfolio and start living on cash that's probably a good in between scenario if you don't have the better option of having a portfolio allocation that's constantly rebalanced to what you need it to look like now quick reminder before we head to the fourth point of this if you haven't already subscribed make sure you do so because of a lot more content I want to make sure you don't miss it's released weekly but you won't see it unless you're subscribed so make sure you subscribe right now as we move on to the next point the fourth Point here is you may actually find the percent you need in cash to live on relative to bonds to live on our cash to live on that might start to decline over time let's look at an example for why this is the case let's assume you retire at age 65 but you're not going to collect Social Security until age 70. let's also assume you have a million dollars in your portfolio and you want to live on fifty thousand dollars per year Well what I typically recommend kind of as a starting place is your portfolio should have five years of living expenses set aside in a stable or relatively stable investment this could be cash this could be short-term bonds this could be other instruments like that but as we look at that if we have a million dollar portfolio we need fifty thousand per year 50 000 times five this is about 250 000 of that should be allocated to something that's a little bit more stable which means that of that million dollars 75 percent could be allocated to stocks or some type of a growth vehicle and 25 should be more stable let's look at what happens next let's assume you get somewhat decent returns or even average returns over the next five years so you're taking fifty thousand out per year from your portfolio let's assume you're growing by seven percent or so over time well five years from then your portfolio went from one million let's call it 1.2 million not only that but five years from then now Social Security kicks in let's assume your social security benefit is forty thousand dollars per year well if you need fifty thousand and forty thousand is now coming from Social Security there's only ten thousand that you now need from your portfolio so your portfolio balance is grown in your annual need from your portfolio has declined what does this mean from withdrawal standpoint well in the initial years you needed five percent per year from your portfolio so fifty thousand divided by a million that's how much you needed from your portfolio so that's how your investment allocation was formed the 7525 mix wasn't just an arbitrary mix it was an understanding of how much you need in conservative Investments for gross Investments to generate that fifty thousand per year well now five years later you only need ten thousand per year and your portfolio is worth 1.2 million in other words you need less than one percent per year from your portfolio to meet all of your living expense needs so how much do we need in bonds and cash in a 1.2 million dollar portfolio that has to generate ten thousand per year well you could look at it from the standpoint I just did locate ten thousand per year multiply that by five fifty thousand divided by 1.2 million call it around four percent per year in cash or bonds you can look at it that way the way I'd like to look at it though is just say okay even if we were 100 stocks hypothetically and before factoring in the emotional component of that those stocks regardless of the performance they're probably going to be generating some dividend call it two to three percent per year so if we had two to three percent per year of dividends that's fully covering and then some the 10 000 per year that we actually need from the portfolio so you could actually make a very compelling argument that you could be all stocks at that point because the dividend alone without you having to tap into the principal could fully cover everything you need to live on to supplement Social Security so in this case your need for cash went from call at 25 of your portfolio to zero percent of your portfolio now that's just the financial side the next question is how comfortable would you be with a 100 portfolio in retirement I know a lot of people that are fully comfortable with that not just comfortable with it they're doing it they have a large portfolio and it's all stocks because it meets their needs I know other people who would never be comfortable with that in a million years I would love to know from you as you look at this even if financially you didn't need to have any cash or Bonds in your portfolio would you feel comfortable with that what do you feel comfortable with an all-stock portfolio be sure to leave a comment below I'd love to hear what you'll have to say about that but in general you have to look at it from two standpoints what's my financial need for how much passion bonds and then what's my emotional Comfort level with whatever that allocation might be and adjust it accordingly now the fifth part of this is really kind of an add-on to the fourth point but understand that ideally your portfolio should be a cash generating machine well what does that mean your portfolio if invested properly there should be some combination of dividends and interest call it even just two or three percent per year that's just cash and that's cash that's hitting your portfolio so when we're asking hey when do I start living on the cash well the first thing is you're constantly having a new two to three percent or whatever your dividend or your yield is on your portfolio that's constantly being replenished in cash so if your need from your portfolio say only two or three percent you can live on cash without having to tap into outside cash you're just living on the cash that your portfolio is generating the alternative is you could live on outside cash and as your portfolio yield dividends and interest is being paid out you just reinvest that into more stocks and more bonds and more Investments that will continue to build your portfolio we have a tendency to look at things in too static of a mindset of okay here's my cache here's my bonds here's my stock yes they're going to fluctuate but not only are they going to fluctuate we have to realize they should be generating some level of Interest or dividends that's helping to replenish our cash that we can factor into our withdrawal decisions so when you look at it this is the framework I'd like for you to apply when it comes to when do I stop living on my portfolio or the stock portion of my portfolio and begin to live on cash start by defining how is Cash factored in how do you view cash understand that your need for cash and your need for certain portfolio allocations is going to fluctuate throughout retirement and then understand that your portfolio should be a cash generating machine and see how that informs the way you should take money out of your cash portfolio when the time is right now on top of just that your decision of when to pull from cash and when to pull from your portfolio should be very carefully intertwined with your Social Security strategy and to explain why I made this video right here that I hope you'll check out once again I'm James Knoll founder root financial and if you're interested in seeing how we help our clients at root Financial get the most out of life with their money be sure to visit us at www.rootfinancialpartners.com

Channel: James Conole, CFP®

Views: 49,621

Keywords: investing, retirement planning, tax planning, financial planning, retirement, personalfinance, taxes, dividend investing, financial planning at 50, how do I retire?, long-term investing, financial planning at 60, roth conversions, roth ira, IRA, individual retirement account, benefits of investing, pros and cons of investing, donor advised fund, financial education

Id: m8MmYNF9_zo

Length: 14min 29sec (869 seconds)

Published: Sat Apr 22 2023