Pre-Retirement Cash Buffer Prep Simulation Study

Authors

Lucas Young

Van Godbold

Published

11 December 2023

Modified

23 February 2024

Disclaimer

  • This analysis is for informational and educational purposes only.

  • There could be bugs in our programmatic analysis. We are not liable for any actions you take as a result of anything you read below. Please conduct your own due diligence before making investment decisions.

  • Any decisions influenced by the information in this analysis are made at your own risk.

Overview

This analysis is an extension of the Retirement Cash Buffer Simulation Studies linked below:

Retirement Cash Buffer Simulation Study

In the Retirement Cash Buffer Simulation Study, we quantified the benefits of keeping a portion of retirement assets in cash and taking withdrawals from that cash during poor investment return years. We found that the optimal way to manage the cash buffer (with non-cash assets invested in 100% stock index funds / 0% bond index funds) was to target 4 years of spending in cash, spend cash in years with total investment returns below 20%, replenish any depleted cash in years with total investment returns above 20%, and cap single year cash liquidations to 2 years of spending.

This analysis attempts a data driven optimization for getting to retirement with 4 years of spending in cash.

Note: Cash is assumed to be held inside a tax advantaged account (401k, 403b, IRA, etc.) to avoid tax implications. All references to “stocks” and “bonds” should be interpreted to mean index funds of stocks and bonds rather than individual stocks (e.g. Google (GOOGL), Amazon (AMZN), Apple (AAPL), Deere and Co. (DE)) or bonds.

Data

Two data sources were used in this analysis:

  • S&P 500 Total Return (price changes plus dividends, used to represent the stock portion of asset allocations)

    • https://www.slickcharts.com/sp500/returns

  • Consumer Price Index (CPI) (used to make inflation adjustments to dollar values)

    • https://data.bls.gov/timeseries/CUUR0000SA0?years_option=all_years

Below are annualized summary plots of the three data sources.




Cash Savings Results

The following assumptions were used for the cash savings simulation:

  • Working career of 40 years

  • Starting retirement savings of $0

  • Starting salary of $80,000 per year

  • Annual raises during the first 15 years are 4%

  • Annual raises during the final 25 years are 2.5%

  • Retirement savings rate of 15% of annual salary

  • Pre-retirement cash target of $400,000 (4 years of $100,000 / year spending)

  • All retirement savings from the final 11 working years will be held in cash (inside a tax advantaged account; this works out to $411k)

  • All investment returns are reinvested

  • All invested dollars will have a 100% stock / 0% bond asset allocation

  • One 40-year simulation will be run starting each year from 1926 to 1983

  • All plot and table values will be inflation adjusted to 2023 dollars

In the plot below, each gray line represents the simulation for a single start year. The red line is the mean value across all the simulated start years; the blue line is the median value across all the simulated start years. These plots can be confusing at first glance. If this type of plot is unfamiliar to you, it might help to just look at the best case at the end, the worst-case at the end, and the average.



Investment Liqudation Results

The following assumptions were used for the investment liqudation simulation:

  • Working career of 40 years

  • Starting retirement savings of $0

  • Starting salary of $80,000 per year

  • Annual raises during the first 15 years are 4%

  • Annual raises during the final 25 years are 2.5%

  • Retirement savings rate of 15% of annual salary

  • Pre-retirement cash target of $400,000 (4 years of $100,000 / year spending)

  • Cash will be liquidated by selling investments over the final 1, 5, and 10 working years

  • All investment returns are reinvested

  • All invested dollars will have a 100% stock / 0% bond asset allocation

  • One 40-year simulation will be run starting each year from 1926 to 1983

  • All plot and table values will be inflation adjusted to 2023 dollars

In the plots below, each gray line represents the simulation for a single start year. The red line is the mean value across all the simulated start years; the blue line is the median value across all the simulated start years. These plots can be confusing at first glance. If this type of plot is unfamiliar to you, it might help to just look at the best case at the end, the worst-case at the end, and the average; be sure to pay close attention to the vertical axis scale which changes from one plot to the next.





Final Values



Cash Contributions


Investment Liquidation: 1 Year


Investment Liquidation: 5 Years


Investment Liquidation: 10 Years


Comparison Plots

Next, we will compare the mean and median performance between the different methods.




Conclusions

The following conclusions should be interpreted within the confines of the simulation assumptions described in the cash savings and investment liquidation sections above.

  • On average, there is relatively little difference between the methods we compared for preparing a cash buffer before retirement.

    • Cash contributions during the final 11 working years resulted in the lowest average inflation adjusted retirement savings at $2.48M.

    • Investment liquidation during the final working year resulted in the highest average inflation adjusted retirement savings at $2.56M.