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Cash: It’s the asset class investors love to hate. Even as low inflation and a declining interest-rate environment has helped both stocks and bonds deliver decent positive returns over the past decade, poor cash investors have had to settle for ever-lower yields.
Today, cash savings rates are barely positive, and cash yields likely to get better any time soon, as the Bank of England’s Monetary Policy Committee voted yet again to keep base rate at 0.25% last month.
But even though cash unattractive today, it remains an essential ingredient in all financial plans, especially those in retirement. Not only can it help meet unplanned expenses, which occur in retirement just as at other life stages, but it can also help on the peace-of-mind front. A cash component is the linchpin of “the bucket strategy” for retirement portfolios, enabling retirees to tolerate the fluctuations that will accompany the stock and bond components of their portfolios.
Given that market valuations are not especially cheap today, opportunistic investors may also like the idea of maintaining some “dry powder” that they can put to work when markets fall, whether stocks or bonds.
Do You Still Need an Emergency Fund in Retirement?
Given that one of the key reasons to hold an emergency fund is to tide you over in case of unexpected job loss, it may not seem necessary to maintain an emergency fund once you stop working. But at least some type of an emergency fund remains essential in retirement, too. It can allow you to cover large, unexpected expenses without having to raid your long-term assets. Think a repairs to your car, a new roof, big vet or dental bills, or emergency calls to aid family members.
Just how large your in-retirement emergency fund should be depends on your personal circumstances. What big expenses have tended to catch you off guard in the past? What new ones could crop up in retirement? If you own a home, especially an ageing one, and responsible for ongoing maintenance costs, that argues for a larger emergency fund than if you rent.
It’s also a fact of life that financially healthy family members are sometimes asked to help adult children or siblings who are less financially well-off; if you’ve been a financial saviour for your relatives in the past, you could find yourself in that spot in the future, too.
Consider the Portfolio Construction Bucket System
In addition to setting aside an emergency fund, retirees may also want to consider a cash component as part of their long-term portfolios. The virtue of that cash “bucket” is that in difficult market environments, either for stocks or bonds, the retiree can leave the long-term portfolio components in place to recover their value and use the cash holding to fund other investments or alternative expenditure.
That makes sense from an investment standpoint, and can also provide valuable peace of mind in turbulent market environments like 2008. The retiree can spend from the cash bucket on an ongoing basis, periodically refilling it with income distributions or rebalancing proceeds. Alternatively, the retiree can leave the cash undisturbed, to be spent only in catastrophic situations when income distributions and/or rebalancing proceeds are insufficient to meet living expenses in a given year.
But be warned – holding too much cash can drag on a portfolio. Harold Evensky, the architect of the “bucket” approach to portfolio planning, suggests that holding one year’s worth of living expenses in cash is a good rule of thumb.
A version of this article originally appeared on Morningstar.com. It has been edited for a UK audience.
