Near Retirement? You’re headed for trouble if you don’t have a retirement cash cushion!
Why does it make sense for you to have a cash cushion when you retire? It helps smooth some of the inevitable rough spots. It offers peace of mind. In the end, it can mean the difference between a comfortable retirement or an anxious one.
Who doesn’t need a retirement cash cushion? No one!
What is this “cash cushion”? We think of it as a cross between the ever-popular “emergency bucket” and the increasingly ubiquitous “retirement bucket strategy.”
All ages should have an “emergency bucket” which can be used to handle emergency unplanned unexpected expenses. Most Independent Financial Advisors (IFA) in RSA used to suggest you have 3 to 6 months of living expenses saved away in a liquid account. This has just been increased to 12 to 18 months based on post Covid-19. This increase now includes unexpected events of a magnitude such as losing your job. This bucket, with up to a year-and-a-half of your living expenses is safely into an easily accessible account while you’re working. When you retire, the numbers changes. You no longer have to worry about getting a job. But there always is the possibility of surprise expenses popping up every now and then in life.
Remember though, a retirement cash cushion heading into retirement is not part of the “post retirement emergency bucket”
The retirement cash cushion is actually part of the retirement plan itself. Cash in the retirement plan is for risk mitigation and not for emergency funding. Do not use retirement portfolio cash for emergency bucket!
Guess where you get the money to pay for a medical emergency? Why, the emergency bucket, of course. It is important to have an emergency fund during retirement. Emergency costs still occur during retirement (home, car and other things). You don’t want to draw retirement funds and be forced into market timing. This makes you face “sequence of returns risk” which has a devastating impact on your retirement plan.
You should build a retirement cash cushion that’s large enough to cover recurring monthly expenses that have nothing to do with ‘emergency’ spending! It also helps clarify the difference between the role of the retirement cash cushion and the emergency bucket.
We trust you may recall reading about this “sequence of returns risk” previously. It represents the biggest reason why you need a retirement cash cushion heading into retirement. One issue you need to be concerned about is the so-called “sequence of returns risk”. The sequence of returns is the order of how your portfolio returns happens over time. If you are in your accumulation phase, the sequence of return doesn’t really impact your final outcome. However, if you are in the withdrawal phase (retirement), the sequence of returns can have a dramatic impact on your retirement income.
After retirement, turbulence happens when the market drops dramatically (Covid-19)!
A retirement cash cushion will protect you from having to sell investments to cover expenses. The reason this is so important is if the market drops when you retire and you are forced to sell, you’ll have to absorb those losses. With an adequate retirement cash cushion, you can simply spend the cash and wait for the market to bounce back. It is there for only one thing: safety = cash. Don’t go worrying about investing it to maximise income.
A retirement cash cushion is needed to ‘smooth out’ spending. It is hard to spend the exact same amount every month and often there are large ‘spikes’ month to month such as going on a holiday or an emergency home repair. The cash cushion allows you to spend the money that is needed (without running a credit card balance) and then rebuilding the reserve back up.
Also keep in mind that there are many uncertainties in those first few years. The uncertainty is not related to what you’ll be doing, but to what it will really cost.
A larger retirement cash cushion can give you a sense of confidence as you head into one of the largest transitions of your life. Having a retirement cash cushion not only protects you through market down-turns or an emergency, it also allows you to spend on hobbies, traveling and important lifestyle changes. The primary reason it makes sense for you to have a retirement cash cushion is because there will be an adjustment period in the first several months of retirement.
Yes, you have a plan for how much you’ll spend, but that doesn’t always line up with reality.
Retirement, like any other change, brings with it worries and unease. This is natural. That’s what the retirement cash cushion does. A retirement cash cushion provides certainty in uncertain times. Having that ready supply of cash can buffer you against investment volatility, disruptions in cash flow or other financial events outside of your control.
Cash on hand is peace of mind.
The best time to start building your retirement cash cushion is in the few years before retirement. It requires the same discipline it took you to build up and maintain your emergency bucket throughout your working career. It’s not too late to begin saving for your retirement cash cushion.
After all, who doesn’t want a more comfortable retirement?
Brian Price brian@biglife.co.za