The correct cash allocation for your retirement portfolio is zero


Your cash pocket has a real return of minus 8.4%. It should be empty.

If you’re retired or about to retire, you’ve probably heard the lesson about the “bucket of money”.

Put one to two years of expenses into a cash reserve, experts intone. This way, you are not forced to sell assets at an inconvenient time.

“Force your retirement against the vagaries of the market”, recently in the New York Times, is typical of the genus. It looks nice. Why, with two years of cash in hand, you can just ignore market corrections.

I think this advice is rubbish.

My opinion is that the correct amount of cash to have is the bare minimum – all you need to keep your checks from bouncing. As for spending needs for the next two years: Invest this money the same way you invest the rest of your portfolio.

To see what’s wrong with the cash tip as a buffer, try asking these experts a follow-up question: When am I supposed to replenish the bucket? Why should I expect this date to be a better time to sell?

Behind the specious allure of a silver bucket lies commercial fallacy. This mistake is the notion that you can improve your lot in life by intelligently timing your buying and selling. The fallacy allows many brokers to live well. That explains Robinhood. This accounts for most of the revenue from Coinbase Global, the crypto-casino.

The commercial fallacy makes cash-bucket fans implicitly assume that since they “won’t be forced to sell at an inopportune time,” their sales will occur at convenient times.

Is there really a way to detect in advance whether today or a year from now is the best time to liquidate a stock position? If there were, no one would have to worry about building a portfolio, or even working for a living. Why, we could all buy low and sell high and live off the gains.

I think keeping cash at zero, or fairly close to zero, should be your goal. Don’t sell your portfolio assets now in anticipation of bills to be paid in a year’s time. Sell ​​close to when you need cash.

What about finding money for an emergency? You need to replace a car, or your roof, when you didn’t expect it.

Think carefully. It’s not species you need is liquidity.

The typical settlement time for stock sales is two business days, for mutual funds and US Treasury securities one day. There are times when you need the money faster than that, like you’re in a jail cell trying to post bail, but they’re rare.

If you have a stack of financial assets, and probably are debating how to structure a retirement portfolio, then you have plenty of cash. You don’t need to have a percentage of your savings in a bank account or brokerage account earning 0.1%.

What about risk? Do you need cash allocation to reduce volatility in your portfolio? No, you don’t. There are better ways to reduce risk.

The problem with silver as a risk reducer is that it is a guaranteed loser. The nominal return, which is what that bank or broker is quoting, is pretty close to zero. Subtract inflation, which has been running at 8.5% recently and will likely average at least 3% over the next few years, and you have a true return to negative territory.

Here are four good ways to reduce portfolio risk.

#1. Switch from stocks to bonds.

A traditional mix is ​​60% stocks and 40% bonds. It may be too dangerous for you. Note that the Vanguard Target Retirement 2020 Fund, intended for cautious investors who are starting their retirement, is only 46% invested in equities.

#2. Shift from corporate bonds to treasury bills.

Corporate bonds pay better, but are riskier. Some go bankrupt.

#3. Switch from long-term bonds to short-term bonds.

Long-term Treasuries have been hammered lately. The Vanguard Long-Term Treasury ETF has posted a cumulative return of -20.5% since the start of last year, according to data from Morningstar. If that scares you too much, shorten the duration of your bonds.

#4. Moving from nominal bonds to real bonds.

Inflation-protected Treasury securities due in ten years are priced to offer a real yield just a hair below 0%. Buy one of these things and you take the guesswork out of the purchasing power of the assets you are setting aside now to spend in 2032. The price of the bond will fluctuate between now and then, but you know exactly where you are. you will find yourself if you hang on until the bond is paid off.

The problem with all of these risk-reducing moves is that they reduce your expected return. I would attribute a 60/40 mix of stocks and corporate bonds to an expected real return of 2% per year. Reducing the risk means reducing that number by 2%.

In the extreme risk reduction portfolio, a ladder of TIPS with maturities spread over your retirement, you push the real return to 0% or thereabouts. For the very risk averse, this is not a bad idea. A zero real return is much better than the real cash return, which is currently -8.4%.

Set a level of risk you are comfortable with and stick to it. Rebalance from time to time, selectively cashing in on allocation that is overweight, but don’t delude yourself that rebalancing will bring timing gains or increase your expected return.

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