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  • Doug Oosterhart, CFP®

The War Chest of Cash: Planning for Bear Markets in Retirement

Some sources claim that people need 6-12 months of living expenses saved in their emergency fund (cash) throughout their working years. But what about retirement?

Let's start by saying that the actual dollar amount any given person needs is subjective, so when an article says you need X dollars, that doesn't work. For example, someone that lives on $100,000 per year in retirement probably needs a different dollar amount than someone living on $1,000,000 per year.

It's important to look at what you need on a monthly or annual basis and decide on how many *years* of income you may need. For example, if someone needs $100,000 to cover their living expenses in retirement and they want to have 3 years of cash on hand, they would have a goal of $300,000 in cash.

What's "cash?"

Cash can be a lot of different things. It could be short term bonds, CD's, cash in the bank, money market accounts, etc. The overall characteristics are that cash instruments do not experience much volatility (they don't move up and down with any wild movements) and they also do not keep pace with inflation. So by holding any cash at all, what is the goal?

For starters, it provides peace of mind knowing that there is a portion of your assets that aren't subject to big changes. It can also provide safety during downturns. The last thing you want to do is turn a paper loss into a real loss because you were strapped for cash and had no other choice. There is a trade-off. The fine line of holding too much cash and running out of money because your dollars don't keep pace with inflation vs. holding too little cash and causing an event where you have to liquidate assets that could be down on paper due to a market decline.

So what should you do?

At a minimum, holding 2 years of income in cash is a good starting point in retirement. Should the market go down, you have the ability to live off of cash and you don't have to sell investments that are down. Somewhere between 2-5 years of cash and short term bonds are where a lot of my clients stand. They recognize that they are giving up potential returns for peace of mind if/when the market goes down.

There isn't an investment out there that provides "high" returns with low volatility, so as investors, people need to decide what they prioritize most. If they are unable to handle the potential for paper losses, a higher cash position is probably needed. If they hate the thought of "missing out" on potential gains, then they have to be willing to accept a high risk/reward. There is no perfect world.

Holding 2-5 years of income in cash allows for investors to worry less about their other dollars that are invested. Most bear market downturns since 1926 have lasted less than 2 years, so maintaining at least 2 years of income is important.

Generally speaking, when investors enter retirement, their portfolio is probably the highest it's ever been (or close to it). There is nothing wrong with having a changing goal for the amount of cash you have. Some people decide to start retirement with a higher amount of cash (5+ years of income) and then actually lower their amount of cash/bonds later. It sounds weird since most articles claim older investors should always be less risky. In reality, once people retire, they learn what they *actually* spend vs. what they were projected to spend, so they need to be agile with their planning.

Cash is a tool that is very important in planning. There isn't a magic number that all people should have and investors' goals are allowed to change.

However, investors need to know that holding too much cash can be just as detrimental to the plan as holding too little. Clarify your goals, clarify your tolerance for volatility, and assign a goal for every dollar in your portfolio.

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