Just a little remark: “cash - to stocks” is a very nice strategy, You buy low and sell high.
The only problem is the “cash” part, because it is almost sure to lose value.
I do this raising my debt level in bear markets because I don’t trust cash. Cash is trash!
I’m repeating @nabalzbhf - it’s in the allocation-rule. The captain tells me when to.use cash to buy stocks, and in good years to sell stocks to fill the safe deposit box with more crisp fresh CHF 1000 notes (in CHF I trust).
Having something like a 60/40 allocation, theoretically the 40% will/would/should last many more years than 1 or 2.
I don’t think that’s a fair comparison. If your asset allocation includes 10% cash, the assumption is that you never arrived at 3000 portfolio, but maybe at 2700 (lack of compound interest). If you switch from 100% stocks to 90% stocks right before a crash, it’s market timing.
I never unerstood the cash position logic, provided the portfolio is liquid. I decided not to have one.
I consider the opportunity cost of not being in the market with that cash greater than the risk of having to sell that cash amount during a crash.
Small emergencies I can cover with credit cards or by paying bills late.
For really large emergencies I believe you have to sell part of your portfolio anyway, no matter the timing.
It is not about emergencies, it is about Shannon’s demon.
In theory by rebalancing your cash/stock allocation you could make money even if the stocks go down. Because you automatically buy low and sell high.
That said, if stocks rise, what they do long term, you make more holding no cash. It may take away some volatility to rebalance.
Being forced to sell in a crash during an emergency - that’s the argument I always hear. Shannon’s demon I have to google first.
The main reason for holding fiat currencies in an investment portfolio is that the value of cash (in terms of buying power) obviously goes up during phases when the value of tangible assets (e.g. stocks, real estate, commodities) goes down.
So having a cash component has a stabilizing effect on a portfolio, meaning the overall value of the portfolio will not fluctuate as much as a portfolio without a cash component. This is particularly beneficial for short-term investments, or when a portfolio is drawn on for liquidity on an ongoing basis.
The longer the investment term, the less significant interim value fluctuations are, and the less benefit you will get from including a fiat currency component.
You can change your allocation at any time. Since I’m talking about retirement, it is perhaps likely that you are converting a large ‘cash like’ pillar 2 into stocks.
You will have whatever portfolio value you have at retirement and will need to make an asset allocation choice at that point as your pillar 2 fund becomes available.
This argument is totally fine. If some some says I want bonds or cash to reduce volatility: fine. What I don’t agree with is the argument that they hold a cash position for an emergency.
(and reducing volatility comes at the opportunity cost of missing out on the performance of the more volatile instruments like the stock market)
But that was never the topic of this thread, was it?
It’s about keeping money in your portfolio (not in your emergency fund). Just as you can hold gold in your portfolio and then make a profitable rebalancing when the stock market crashes.
I see I basically repeated @Mirager’s position, sorry.
You’re right. The question was how to use it, not if you should have one. Sorry again.
Most professionals will argue that volatility/risk is as important as returns. You care about returns given some risk.
And 100% stock is arbitrary, you could also be 200% stock.
In terms of how to allocate the cash portion of your portfolio (assuming your portfolio includes fiat currencies), there are pretty much four options that are widely available:
1. Fixed deposits (also medium-term notes for CHF): For CHF, at least, this is often the most profitable option, assuming you use the best offers. You can find the current best offers here.
2. Savings accounts: This is also a good option, if you optimize to keep your money at the bank that pays the most interest. You can find the current best rates here.
3. Money market funds: These haven’t performed very well in recent years.
4. Pension funds: Some may disagree, but I include an occupational pension fund (pillar 2) in the cash portion of my portfolio. In terms of yields, this is generally the most profitable for CHF. I would argue that if you have Swiss francs that you want to allocate to the CHF component, you could make voluntary payments to close gaps in pension fund benefits.
For a little while over the past 2 years, stockbrokers were paying decent interest on CHF balances. But those days are over, so there’s little point keeping fiat in brokerage accounts.
Some might consider forex positions to be an option, but that does not really align with the purpose of holding fiat currencies (to reduce volatility), and can also be a costly venture depending on leverage, etc. I would venture to say that government bonds can hypothetically be considered an alternative to fiat.
Not a big fan of argument by authority, but yes, I agree. If reducing volatility/risk is your goal, by all means have a cash position or less stock market exposure.
Absolutely. If 100% equities is too much volatility or risk, take less (or more, if your appetite for risk is bigger, as @cubanpete_the_swiss does with margin during crashes, if I read him correctly).
You could say this is a forced cash position most of us have (not liquid, but reduces volatlity - and maybe risk - of our overall portfolios).
Which was completely predictable. The nice part about fixed income instruments is their predictability - that’s why I (after my financial awakening) hardly ever invested in “advanced“ fixed income instruments.
Not to hijack the thread, but when looking at Rebalancing With Shannon’s Demon | The Personal Finance Engineer scenario 3:
Is it correct to say that this works only as long as none of the stocks go to zero?
When even one of the stocks truly goes to zero, the portfolio is worth zero, because the re-balancing (if followed to the bitter end) bought more and more of that stock?
In my way too premature thoughts about portfolio consumption strategies cash management plays an important part. I will try to give a short summary of my thoughts which are related to the topic.
As an introduction, the more I think about it, the more I am convinced that the key to portfolio consumption should be not the withdrawn amount, but the number of units of (for model calculations) one global stocks fund sold. This should prevent underconsumption and make sure that our money is mostly spent on us. While I love our children, I don’t think that leaving them 3 times more money than we had at the beginning of the portfolio consumption will do any good to anyone. So, withdrawal strategies I consider are set up to consume a significant part of the portfolio while we are alive. I deliberately take the risk of fluctuations in the amount of funds available for the chance of increasing them with the portfolio growth.
My first naive proposition to sell the same number of units of accumulating global stocks fund was met with a very reasonable argument: when you start, the value of a unit is much lower than in 10-20 years with distributions accumulated. So let’s say you count for 50 years of portfolio consumption (well, I do), you liquidate every year 2% of the original amount of fund units in the portfolio. Even in a perfect model market, where one fund unit grows by 5% each year, the value of one unit grows by 50% in 9 years and doubles in 15 years. So, with this methods, at the beginning you massively underconsume, just at the time when you rather want, and capable, to profit from your wealth, and later your portfolio grows faster than you can spend.
So it clearly needs some gliding path to account for the fact that while you want to, calculation-wise, spend your entire portfolio in 50 years, the value of fund units is different at different times. You can of course model it as a geometric sequence: the value of unit increases by 5% each year, so you just need to sell 5% less units each consequent year. But for long sequences you end with a simple and trivial result: if you expect 5% appreciation every year, you should sell 5% of the current value of the portfolio every year. In a perfect situation, the value of your portfolio stays constant - you don’t consume it, but “merely keep it for the next generation”. But I want to actually consume it!
One “natural” mechanism of creating such a gliding path that I came up with is to use distributing funds of global stocks and every year collect dividends from all (remaining) fund units as well as sell some, a fixed amount of units, e.g., corresponding to 2% of the starting portfolio size. This way, a part of the income generated by fund units still held is not reinvested, but consumed way before they are sold. With time, the number of units generating dividends is decreasing, but the value of each unit is still increasing, although not as fast as with dividends reinvested. At some point, the value of units sold each year becomes greater than the initial value of sold units plus collected dividends.
Some simulations are in progress.
Now about the use of cash in such withdrawal strategies:
In this strategy, a certain fraction of initial portfolio is reserved as cash. It is regularly and uniformly added to the “income” from stocks generated as described above. After it’s gone the rest of income is provided by stocks only.
For example, you reserve 10% of initial portfolio value as cash. The rest is invested in a distributing global stocks fund, and you know how many fund units correspond to 1% of the initial portfolio value (i.e., total number of fund units/90). The first month is January, but the cash flow from the portfolio starts only in March.
This setup would correspond to initial annualized withdrawal rate of 3% + dividend yield, around 4.8%.
After 10 years cash is gone, and the rest of income is provided by stocks only.
All in all, the strategy is set to run for 45 years (i.e., last holdings of stocks will be sold 45 years after start).
This approach would somewhat correspond to “bond” or “cash tent” in withdrawal strategies popular in USA, although they do it somewhat differently, I think.
The same approach can be used with other diversifiers, such as gold or broad commodity fund. You reserve a certain portfolio fraction, sell every year a preset amount of units, no matter the price, and add it to your income stream. The main characteristics of a “diversifier” is that it is consumed relatively fast, and the long term growth is generated by stocks.
Advantages: easy to implement. The fraction of cash in the portfolio is decreasing with time, which improves long term yield.
Disadvantages: inflexibility. Once the cash is consumed, available funds fluctuate almost like the stocks market, although the dividend component should add some stability. While I expect such fluctuations, I also want to be somewhat in control.
You choose a certain term, for which you keep money to spend in cash. I am thinking about 3 or 5 years. Then you start with a certain fraction of your initial portfolio in cash. The cash from the buffer is withdrawn every month and refilled by dividends and selling proceeds from the stocks part. The amount spent is adjusted regularly, e.g., once per quarter or year. The timing just needs to include both spending and refilling steps.
Let’s say you go for 3 years (36 months) buffer and the initial cash value of 15% of the initial portfolio value. The rest is invested in a distributing global stocks fund, and you know how many fund units correspond to 1% of the initial portfolio value (i.e., total number of fund units/85). The first month is January.
This setup would correspond to the initial withdrawal rate of 5% p.a. and is set to run for 45.5 years.
Advantages: still quite easy to implement. Available funds are changing with the evolution of the portfolio value, but these fluctuations are dampened by the buffer. On the other hand, you automatically get more money to spend when the portfolio is doing well - remember, my goal is to prevent underconsumption!
Disadvantages: high and permanent cash component. You don’t spend cash with time, it is always in the portfolio. You also need to manage it with respect to depositor guarantee and so on.
High allocation to cash decreases long-term yield - but you can also stop playing if you have won.
A certain, rather high fraction of initial portfolio is reserved as cash. You define how much you want to withdraw from the portfolio, and if the “income” from stocks generated as described above is not sufficient (it won’t be for many years), you add the missing amount from the cash reserve. At some point, the income from stocks alone reaches the desired level of withdrawals, so you don’t need the reserve anymore.
While the idea sounds simple, it is difficult to calculate how much of cash reserve to start with. I am playing around with it, but even with the perfect model market, there is a complex interaction of multiple parameters: target withdrawal (as the percentage of initial portfolio value), dividend yield and CAGR. It can “fail”, meaning you run out of cash reserves and can’t maintain the desired withdrawal amount while the income from stocks have not reached this level yet - but you don’t spend all your portfolio too early, like in fixed withdrawal amount strategies.
Advantages: well, theoretically is should be very flexible and with decreasing cash component, that improves long-term yield. But this is only if you get through first 20 years or so.
Disadvantages: complexity even in model calculations and unpredictability of real development.
Not sure when I can do something serious about the last one. But hey, I am glad to share some ideas and personally I have time to figure things out.
I think this isn’t an issue in practice because if you have an ETF as one (unlikely to go to zero) and cash as the other (again unlikely to go to zero) and even if one does go to zero, if you re-balance annually, you can’t buy the zeroed item anyway (and you probably need to take some drastic action before then anyway), so you are left with just the remaining component.
