Withdrawal Strategies: The Importance of a Cash ReserveSubmitted by Mission Financial Planning on October 19th, 2014
Keeping a portion of your investments allocated to cash can be very practical in the day to day management of an income-producing portfolio and will increase your portfolio’s survival rate long term. Most retirees are familiar with the withdrawal benchmark of 4% per year; the same benchmark makes sense for a percentage of cash reserve held in a “fully invested” portfolio. Ideally, the majority of the income needed from a portfolio will come from stock dividends and bond income; withdrawals above and beyond dividends and bond income will require the liquidation of securities. These transactions may create tax consequences and trading costs.
In a declining market, the need for income from a portfolio without a cash reserve would force the sale of securities that would be better held long-term. For tax planning it is sometimes helpful to accelerate or delay a capital gain into a different tax year. Having a year’s equivalent of cash eliminates the need to sell securities every month to create monthly income and so reduces transaction costs. Whether for tax reasons, market timing or reducing transaction costs, cash on hand provides flexibility in the timing of when securities need to be sold.