Portfolio , Retirement

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This post has nothing to do with asset prices, valuation, or timing the market as the title may have led you to believe. It has to do with investor psychology and behavior. Over the years I’ve wondered if certain types of people would be happier if they didn’t invest in anything but cash. Not ‘better off’ mind you just happier and still able to meet their financial goals – like a successful happy retirement. Then I said, “I have the data for that analysis”. Let’s take a look at the kind of people I’m talking about. You’ll probably see a bit of yourself in my description. Then let’s see what kind of retirement such a person could reasonably expect and some strategies to make it better.

I think we all know the type of person I’m alluding to. Most investors have some of these traits. Constantly worried about any kind of investment. Stocks – they’re always too expensive or so cheap it’s an indication of some forthcoming dire event and thus they must continue to go down. International stocks – same thing, even worse. Bonds – even the mighty US government is going default for sure. Any day now. Gold – sure, we gotta have a lot of that but I need to check the prices three times a day. And anytime prices go down it’s manipulation. Inflation – we’re constantly falling behind in standard of living. At the extreme, always worried about large inflation any day now. Yield – the need to reach for yield and check news every day that may affect the income stream. Price fluctuations of any significant amount are a sign to take action and seek refuge. Logging in to investment accounts way more than neccessary and checking account balances. Glued to financial news of any kind. Tweaking investments all the time always looking for the better bet. In general, constant unease about the future and definitely not able to sleep comfortably at night. I may be exaggerating a bit but I know quite a few people, young and old, that would fit a large part of this description. And I think a large part of these people can overcome these behavioral obstacles, especially by adapting an automatic investment process or system like the ones I discuss on this blog. But I also often wonder if some people would be better off just sticking with investing in 100% cash and never taking any investment risk. They would be much happier. Let’s take that as a given and see how much could such a person expect to reasonably withdraw from their cash portfolio in retirement (which also determined what size portfolio such a person would need to retire). Let’s find out.

Using the database I use to calculate SWRs (see here for an example), I replaced the US 10 year bond returns with the historical series for the US 3 month T Bill from 1929 to 2014 to represent cash returns. This is a pessimistic return series to use for cash returns but it’s the best series with that much history. Normally, even in environments with very low US T Bill rates an investor can get cash returns out to 1 year that are quite a bit higher. For example, even with today’s low T Bill rates of 0.14% or so you can get a 1 year CD at many banks yielding over 1%. Below are the historical SWRs (Safe Withdrawal Rates) for a few scenarios with a 100% cash portfolio.

swr all cash portfolio

The historical SWR for a 100% cash portfolio is 2.3% using a normal inflation adjusted spending model. That is quite a lot lower than the 4% from a 60/40 US stock bond portfolio but definitely do-able. And definitely a portfolio that would have allowed for many more restful nights. The rest of the table shows what the SWR would be with some tweaks to the spending model. The FCM  (floor-ceiling) model adjusts inflation adjusted spending down during bad return years. The spending adjustment column uses the historical fact that retirees’ spending increases less than inflation, between 1-2% less than inflation in fact. Using these better spending models increases the historical SWR to 3.34%. Doesn’t sound too bad now does it? Not too far off from the old 4% rule. But how realistic are these spending scenarios?

In my opinion and in my experience the above spending scenarios are easily achievable. Think about what people did before easily accessible and low cost investment options. Investing was something reserved for the wealthy or least very well to do. It’s only in modern times that investing is so widespread and accessible. How did your parents or grandparents plan and survive retirement? If they were like my grandparents they planned and survived retirement through a combination of saving a lot and not spending a lot. There was never any investment talk. Getting them to trust bank CDs took almost 10 years! Yet they made it and were quite happy along the way. Sure, they could have been ‘better off’ but they wouldn’t have been as happy. Now lets turn to a modern and more tangible example, me and my wife Nina.

From our base spending level in 2005, we spent 53% less in 2014. Yes, that involved a massive life change. By choice. You can read out it on Nina’s blog and even watch a little video about it. But it was for the better. Infinitely better for us. Oh, and that is in nominal terms. In real dollars, we spend 70% less (inflation has grown 2005 dollars by 20%) than we did in 2005. OK, that’s cheating a bit. At least in the ability to generalize from a very specific and personal choice. So, lets take our spending change since we started RV’ing in 2010. In 2014 we spent 10% less than we did in 2010. Inflation is up 8% since then. In real dollars that means we spend 18% less than we did in 2010. That’s over 3% a year. Obviously that can’t go on forever. And we’re pretty much at the bottom of the curve so to speak. Any further dramatic changes would require a reduction in quality of life which is not acceptable to us. Going forward our goal is to keep spending flat in nominal terms. Worst case to keep pace with inflation. I think that is pretty achievable. Our example just goes to show that controlling your spending so that it grows less than inflation is certainly achievable and not just data from some impersonal random study.

The other aspect of future spending is that most people have some type of retirement or pension income that begins in later years. This is mainly social security. So, in order to get a truly realistic picture of the future we need to forecast cashflows on a yearly basis. Then we can get a true picture of what SWRs would look like from a 100% cash portfolio. Kind of like I talked about in this post . Let’s consider a 65  year old couple just beginning retirement, delaying social security until 70, a median social security income of that covers about 40% of their expenses, and controlling their spending so that it grows at 1% less than inflation. Taking this cash flow model and applying it to the historical returns from a 100% cash portfolio gives us a worst case SWR of 4.13% for the 30 year retirement period starting in 1942. Not so harsh a retirement after all. Even in 100% cash. And definitely many more restful nights than an equity heavy portfolio.

In conclusion, sometimes taking an extreme position can be quite thought provoking and insightful. Admittedly, that is what I’ve done here. It was also a bit tongue in cheek. I’ve shown that even with a 100% cash portfolio a reasonable retirement can be had by focusing on the other side of the equation, spending, and using some more realistic retirement assumptions. People have been doing it for a long time. A lot longer than they have been investing in broadly diversified portfolios across world wide asset classes and markets. And maybe this thought experiment allows us to worry a bit less about our investments and have some more restful nights for just having thought through these alternative scenarios.

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12 thoughts on “ Maybe you should be in 100% cash

  1. Good stuff, Paul. When is the worry not worth it? You definitely have to be the right personality type to actively (or semi-actively) manage investments. Ice water for blood types (talkin’ to you, engineers) have the “just the facts ma’am” rigor and training for this kind of back-tested programming: instead of moving electrons or bits, it’s dollars or cents. Research, read, theorem and proof. Mix generously with patience and discipline. But for me you really hit the nail when you attack the spending side. The black swan’s shadow is always present. Learning to live more simply, even as a short term exercise, is surely a wise thing to do. Cheers.

    1. Thanks Bernie. Attacking the spending side is definitely energy well spent. But so is the other side. I have found that engineers can be among the worst investors. Unless they’ve discovered automatic or quant investing. Financial markets are not like physical laws unfortunately. The statistical and probabilistic nature of financial markets drives engineers crazy.

      And you’re absolutely right that learning to live more simply is a very wise thing to do.

      Paul

  2. I suspect that anyone who switches from an active trading strategy to a once-a-month ETF momentum strategy will be eased into accepting that it isn’t necessary to constantly follow financial media or always be searching for the next best trading strategy. I made the switch at the beginning of November and, although I am guilty of looking at the markets daily, I realize that I am not going to make any trades, if any, until the end of the month. For me, that has a way of relaxing one’s financial mind.

    1. Very true Fred. And true also for buy and holders who make the switch. I have found that buy and holders are actually the worst of the worry warts.

      Paul

  3. Really enjoy how you present the facts and not the generalities that are used in most of the financial services world. There were lots of stories about retirements ruined and people needing to go back to work when the stock market melted down. I don’t recall our parents and grandparents doing the same as a result of their very conservative money management; of course going hand in hand with that was their responsible approach to their spending.

    1. Thanks Steve. There is definitely a lot wrong with the financial services industry. The lack of true risk management being one the foremost.

      Paul

  4. What an interesting exercise since we all react differently to perceived risk.

    We really became risk averse following a job layoff back in 83, three months on the job hunt and then finding a new one at a 50% reduction in pay. From that we vowed to always live as if we only had one income source.

    So from then to now we lived modestly and saved as much as possible. Even when times were better we also had a very conservative asset mix. When we chose to retire early in 2008 had we not been conservatively invested we likely would have sustained losses that would have put an end to that idea and resulted in a lengthy extension to our working lives.

    My sense is that we could have done better and perhaps much better but who knows.

    Unfortunately, that mindset extends into everything that we do and is a difficult habit to break.

    I have longed to buy a used Foretravel class A and yesterday we spent 5 hours going over one, it was exactly what we wanted and yet we can’t seem to make the leap.

    Life is an experiment in which you often don’t have the time to employ the lessons learned.

    1. Very true. Thanks for for sharing part of your story Jim. We always ‘lived’ on one income during our working careers as well. And it is the main factor that got us to where we are today.

      We all need to find that balance between sleeping well and investing for the future. Everyone has a different balance or tipping point.

      I too love old Foretravel class As. I often look at them longingly.

      Paul

  5. Saw your RV interview first and was pleasantly surprised to learn that you are the first RVing couple I’ve seen who seems aware of — and educated in — investing. My own background includes a MA in finance and 40 yrs of investing, but I’m delighted to see an RVing couple where there’s a sophisticated awareness of the need to keep your investments hard at work even if you are retired.

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