Wednesday, October 23, 2013

Cash Reserves in Retirement

This post is the fifth is a new weekly tradition of a video blog post made in cooperation with The Wealth Channel at the American College. This post is about another research article from the September 2013 Journal of Financial Planning. It is called, "The Benefits of a Cash Reserve Strategy in Retirement Distribution Planning," and is by Shaun Pfeiffer, John Salter, and Harold Evensky.

This is the last of the original recordings and will be the last one without any transcript. Actually, today I recorded four more and hopefully there will be some positive changes coming based on your feedback. 





For email readers, the videos never show up in the email, but you can see the video by clicking here.

15 comments:

  1. The paper would have been more useful for a retiree if the transaction fee was calculated on a percentage of assets (index fund management fee + Financial adviser fee) than a $30 per transaction cost.

    I am encouraged to see researchers start to take fees & taxes into account.

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    1. Thanks for the comment. Many studies do incorporate expense ratios / advisory fees as a percentage of assets. But this study wanted to get at a way for incorporating a cost every time a transaction is made. This is something different. Whether or not $30 is an appropriate number can be debated.

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  2. A few production comments. Most of the video shows your talking head, so this is more an audio production than a video production (not that there aren't many viewers eager to see you, of course). The only times it actually uses the video, it doesn't do it very well; for example, it puts one table from the article on the screen so briefly that I couldn't even find the numbers you were discussing in the table, much less look at the rest of the table (which is the reason to put it on the screen in the first place) -- and I've read the article you were discussing. Don't you have access to someone with video presentation experience? As a retired college professor (but not a video expert), I suggest: Open showing you; then bullet lists and tables on the screen while you talk; then close showing you. That would make much better use of the medium. But, as I say, I'm not an expert.

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    1. Agreed. Wade, your content is excellent, and I'll keep watching even if you don't make changes. But improvements on the video production and editing side of things could remove some distracting elements / help get your message across. I've had similar thoughts when watching a few of your earlier videos too... the content of which, again, is always great. Thanks for sharing your expertise.

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    2. Thank you both for the feedback. I will share your comments with the video team.

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  3. It seems the main result of the paper is to point out that more frequent transactions - monthly in the case of the RDCA vs yearly or so in the case of the CFR - add up, mainly through transaction costs and to a lesser degree through taxes (presumably because that there is less tax deferral). Wonder what happens at $10 per transaction, a more typical rate at many discount brokers.

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    1. That's a good question! I don't foresee trying to replicate this analysis anytime soon, but it would be worthwhile to get at how sensitive that assumption is.

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  4. I am a fan of Evensky's cash flow reserve strategy for income distribution in retirement. However, I am aware that Evensky espouses the total portfolio return approach and rejects the income portfolio approach. But my experience with income portfolio investing todate meets my objective and requirement well. I have retired for more than 5 years. I withdraw cash equivalent to 5% of my total portfolio for living expenses annually. My portfolio consists of 2 years of cash reserve,ie 10% cash and the rest are invested in high yield dividend growth equities (90%). My whole portfolio has a dividend yield of about 6 % ( on current portfolio value) . Since I withdraw only 5% annually , thus I have excess cash to invest into more dividend growth equities. So far the plan works very well and I did not have to sell any shares at all to fund the income distribution and my portfolio is in fact growing. I am not concerned at all with the volatility of the stock market prices and can sleep well at night.
    My investment strategy of investing in stocks with growing dividends means that I will never have to sell any stocks to fund retirement withdrawals. My wife and I would be able to leave an ever growing portfolio as estate to our adult children.

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    1. Thanks. The Evensky cash flow reserve system could be classified as a time segmentation strategy, but he prefers to think of it as a total returns portfolio with a risk management overlay of short-term cash holdings.

      I'm glad your strategy is working for you. Holding higher dividend paying stocks is certainly a popular strategy in practice which is under-researched, as it is hard to get appropriate data. Dividends, of course, can be cut, but William Bernstein has written that you should be able to consider 1/2 of your dividend payment as being pretty safe.

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    2. My understanding from watching Evensky's videos and reading his interviews on cash flow reserve is that he recommends investors should construct a portfolio that maximises the total return i.e capital appreciation + dividends, after considering the risk/return, rather than selecting portfolio based on income or yield only.

      My equity portfolio consists of over 30 well diversified stocks and over 80% of which pay increasing dividends every year. Thus even during the peak of the Global financial crisis of 2008 & 2009, total dividend income of my portfolio increases. My portfolio consists of 90% equities, which would be considered as very high risk , in the conventional sense, for a retiree of age over 60. Typically the rule of thumb of asset allocation would be 60% cash/fixed interest and 40% equities for a retiree. I am able to and feel comfortable to allocate 90% equities because of the stocks I invest in are dividend growth stocks. The share price may have dropped over 30% to 50% during GFC, but streams of increasing dividends keep coming in to pay for my living expenses. The share price volatility do not worry me and in fact I am always looking for price pull back ( bigger the better !) so that I can buy more stocks from the excess dividend income. I agree with Bernstein to consider a cut of half of the dividend payment to be pretty safe. I am a conservative investor, and thus I allocate 10% cash ( my portfolio does not have any bonds) as cash flow reserve to allow for any large unusual expenses ( buying a new car, overseas holidays... etc) or potential cut in portfoflio dividends income (though fortunately, it has not happened in the last 5 years) even though my portfolio yield of 6% exceeds my withdrawal rate of 5% per year.
      It would appear as a no brainer that during the distribution phase, a retiree should invest in high dividend growth stocks. This would not only provide him certainty of income streams but also allows him to allocate a larger percentage of his portfolio to equities to grow his portfolio and beat inflation. What I have written here is based on common sense and my personal experience and is not from any from finance theory, which may disagree with my assertion.
      You would find ( if you have not already come across) many articles on DGI (Dividend growth investing) in the website www.seekingalpha.com. Well regarded contributors of articles on DGI in the site are Chuck Carnavale, Bob Wells, Bob Johnson, David Fish ( who maintains a list of high dividend growth stocks)....

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    3. Thanks for the additional info about your strategy. This is certainly an area deserving of greater research attention. I'll try to pay more attention to this.

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  5. These videos are fantastic. Wish I had watched this before reading the paper. Thanks!

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  6. You got a great video posted here. Thank you so much for sharing. I believe that if the transaction fee was calculated on a percentage of assets, then the paper would have been more useful. By the way, I really like your blog. Keep up the good work.

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  7. such a informative video , i think , if the transaction fee will calculate on a parentage ,then the paper's will be more useful.
    Thanks

    Annuity Maryland

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