(PUB) Investing 2016

17

May 2016

Morningstar FundInvestor

leave the long-term portfolio components undisturbed and in place to recover. 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 bucket one 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 insuffi- cient to meet living expenses in a given year. But holding too much cash in bucket one can drag on a portfolio. Thus, I’ve typically recommended that investors hold anywhere from six months’ to two years’ worth of living expenses in cash instruments; in my recent discussion with financial planner Harold Evensky, the architect of the “bucket” approach to portfolio planning, he suggests that holding one year’s worth of living expenses in cash is a good rule of thumb. Step 3 | Identify Next-Line Reserves In addition to lining up cash to serve as your emer- gency fund and supply living expenses in case of a downturn in your long-term portfolio, it’s also valuable to identify “next-line reserves” in case your cash runs dry. In my model bucket portfolios, for example, I’ve stairstepped the portfolios by risk level: In addi- tion to cash, I’ve maintained exposure to a high-quality short-term bond fund. If, in a catastrophic market environment the cash in the portfolio runs dry, the short-term bond fund could be tapped in a pinch; even in a terrible market environment, such a fund is unlikely to incur steep losses. For retired investors who forgo cash/bucket 1 as part of their investment portfolios, identifying next-line reserves is essential. Retirees might also consider home equity as a source of liquidity in a pinch. This article discusses the idea of maintaining a “standby reverse mortgage” to help a retiree limit the opportunity cost of cash while also maintaining access to liquidity during a downturn in the investment portfolio.

Step 4 | Maximize Yield—to a Point True, it’s hard to get excited about earning 1% on anything, and that’s about as high a yield as you’re apt to get on cash accounts today. But look at it this way— 1% of $100 , 000 is $1 , 000 , whereas 0 . 25% (the yield on some lesser-yielding cash accounts) is just $250 . That $750 differential could be a month’s worth of groceries, or a two-night stay in a luxury hotel. Depending on the amount of cash you’ve set aside, it’s worth your while to shop around for the best yield you can find. Today, online savings banks will tend to offer the best combination of decent yields and FDIC protections. And the more you invest, the more attractive your yield is apt to be. Thus, it can be a good idea to consolidate your cash hold- ings into a single receptacle, if practical. Stable-value funds, discussed here, are another way to earn a higher yield than true cash instruments and may prove especially valuable when there’s a more meaningful yield differential between cash and intermediate-term bonds. While stable-value funds court more risks than true cash instruments, they’ve historically been quite safe. You can only find stable- value funds within company retirement plans, though, so to maintain access to them, you’d need to leave assets behind in your plan rather than rolling them over to an IRA . Retirees will want to be careful about reaching too far for yield, however. While some cash alternatives do promise a higher yield than does true cash, they might give up something in exchange—liquidity, stability, or both. K Contact Christine Benz at christine.benz@morningstar.com