Cash management in early retirement has turned out to be a rather stressful endeavor.
When I first negotiated my severance and left corporate America it was easy to know that I still had money coming in for awhile.
But eventually all gravy train runs dry, and then I was left figuring out an action plan.
For those who have never withdrawn from their portfolios, it can get complicated fast when trying to determine the best approach for selling, managing capital gains, taxes, estimating dividends, figuring out which assets to sell, etc.
At the end of the day, we all want to sleep easy at night, but to do that you need a solid plan.
Comfort Levels
As we all know, “personal finance is personal…”
What that really means is that your comfort level and mine are not the same.
When it comes to withdrawing from your investment accounts it is all about comfort.
By the time you have retired you are likely looking at one of the following scenarios:
- You have cash flowing assets that fully cover your expenses
- Your portfolio is large enough to adhere to the 4% rule in which you can live off a set percentage to comfortably fund your retirement
- A combination of both
The holy grail of early retirement would be accomplishing both #1 AND #2, whereby your portfolio can continue go grow without any cash management issues to worry about.
But for many early retirees, myself included, we have achieved early retirement with a weird and ever changing combination of both.
Retirement Withdrawal Strategies
Unless your cash flowing assets cover your expenses as with scenario #1, you are going to need to pick some sort of strategy to withdraw your money and ensure that you can remain solvent even during the worst of times.
There are various withdrawal strategies. They include, but are not limited to:
- A Cash Cushion/Cash Wedge
- The Bucket Strategy (Bucketing Cash, Fixed Income, and Long-term Investments)
- The 4% Rule
- Dynamic Withdrawal Strategy (dynamic withdrawals based on market fluctuations)
For a thorough analysis of all the potential withdrawal strategies, I recommend Early Retirement Now’s SWR Series.
He has run numerous scenarios on many (if not all) of the withdrawal strategies and analyzed their impact on sample portfolios.
No matter which withdrawal strategy you pick, you still have some work to do – you’ll need to figure out when to sell, how much to sell, and what to sell.
AND You Also Need to Sleep at Night
People do not want the mathematically optimal strategy. They want the strategy that maximizes for how well they sleep at night.
– Morgan Housel, The Psychology of Money
When it comes down to it, no withdrawal strategy, no matter how financially sound will be bulletproof.
EVEN if it is financially sound, you still need to be able to sleep well at night.
Your job is to figure out what you can and cannot sleep with.
I am with Morgan on this one – I’m not as concerned with maximizing my returns, I want to maximize my happiness!
Our Cash Management Plan (Right Now)
So in order for me to get the best sleep at night, I have come up with the following cash management plan:
- We purchased a cash flowing website
- We’ve allocated between 1-2 years worth of expenses in cash and we periodically rebalance our portfolio using this spreadsheet
- We set up monthly automatic deposits that move cash from our investment account to our checking account
Website Cash Flow
Anyone who has been following some of my articles on purchasing the website knows that it has been more volatile than expected.
So while our plan intended the website to cover many months worth of expenses, the volatility has changed the plan.
Instead of attempting to live off cash flow from the website, we are now shifting to reinvesting back into the business, with quarterly reviews to see if any distributions make sense.
This also brings more clarity to our cash management plan, because instead of relying on the business to pay our expenses some months, we can are simply running the business as a business.
Cash Allocations & Rebalancing
In line with our initial early retirement withdrawal strategy, we are continuing to hold between 1-2 years worth of cash.
Cash continues to be a defensive position in our portfolio and despite inflation, I sleep better at night by having it.
Now that we’ve removed the website from the equation (cash management wise), it’s been easier to try to predict future dividends and handle for rebalancing.
Monthly Automatic Deposits
And that brings us to monthly automatic deposits. This is largely what sleeping well at night is all about.
When you are no longer relying on a paycheck, and don’t have any cash flow coming in, this is the key IMO to sleeping well.
If you have a year worth of expenses, would you rather? a) Watch your bank account slowly deplete every month? b) Get paid every month “as if” you were working?
For us, we prefer option (b).
I would rather get a paycheck every month from myself, than watch my savings account deplete for an entire year (again it is all psychological).
We hold our cash reserves in our investment accounts, and we setup monthly automatic deposits that flow into our checking account.
I know for a fact, that for us, the monthly automatic deposit is a key component of the plan.
It helps you to sleep at night, and keeps you in a psychologically safe place.
The monthly automatic deposit works for us, because it simulates a paycheck, and allows you to continue to manage your budget as if you were working.
Wrapping Up
Our cash management plan likely has its flaws, but the ability to sleep at night cannot be understated.
Setting up automatic monthly deposits has been huge in creating comfort and helping to adhere to our budget.
Sure, we could do something else that would likely maximize our investments, but I prefer to maximize my happiness – plus I love my sleep.
I like the thought of having your investment accounts flow to your checking accounts, great idea! I think seeing your savings deplete each month would be devastating as a retiree. I will not put myself in that position until I’m sure my passive income will cover my monthly expenses. Not quite there yet, maybe 3-4 more years.
Yeah, it’s so much that it is devastating, but it “feels” wrong. We are used to making money and adding to savings, not depleting it.
So psychologically this really helps both my wife and I feel better (and also because we both know we are still in a time when we need to be flexible given sequence of return risk).
It’s always good to read about how others in the community are handling decumulation.
I have been in decumulation since 2018 and use The 3 Bucket Strategy. On the surface it appears very simple: maintain cash bucket one whilst holding a diversified pool of more volatile assets in buckets two and three to take advantage of investment growth.
There are numerous variations out there, and using the 4% Rule for decumulation, I settled on 2 years of income in bucket one with a 60/40 equity to bond portfolio split for everything else in buckets 2 and 3, with annual rebalancing (sell high, buy low).
That sounds straightforward enough, but things start to get complicated when it comes to bucket maintenance: when do you refill the cash bucket 1, and from which bucket?
Keeping it simple:
• If stocks are up, I sell stocks.
• If stocks are down and bonds are up, I sell bonds.
• If both stocks and bonds are down, continue to draw down Bucket 1 with no refill.
• Rebalance buckets 2 & 3.
• Wait until buckets 2 & 3 recover from a down market, then refill bucket 1.
This has served me well over the years 2018 – 21 giving good levels of annual returns. This year, with both equity and bonds being down, I can sleep soundly at night knowing I have two years’ worth of cash to live on by which time bonds should have recovered and I hopefully will have plenty of time to allow equity to recover. I may not be maximising returns like Big Ern, but I am content not to be making big losses.
I like your idea of monthly automatic deposits, I’m currently on the other side of the fence “a) Watch your bank account slowly deplete every month”. I’m doing this on a quarterly basis so I only have to think about it 4 times a year.
gradragstoriches
Love the breakdown. Are you reinvesting dividends or moving them into the cash bucket as they come in?
Great article – simple but effective process of automation to keep the monthly budgeting process alive during the transition from work to retirement. I really like this approach and plan to spend a few hours this weekend setting up something similar for myself. We are already familiar with measuring our spending against a budget so why not keep the same habit now I have crossed over from paycheck to withdrawal?
It is completely psychological, but in the end it works!