4. Buffer Assets—Avoid Selling At Losses
The final category of approaches to managing sequence risk is to have other assets available outside the financial portfolio to draw from after a market downturn. Returns on these assets should not be correlated with the financial portfolio, since the purpose of these buffer assets is to support spending when the portfolio is otherwise down. An old strategy in this category is to maintain a separate cash reserve, perhaps with two or three years of retirement expenses, separate from the rest of the investment portfolio.
While this is a safe approach, one disadvantage is that the cash reserve could have otherwise been invested to seek higher returns than cash provides. Cash can be a drag on the portfolio, and in recent years more attention has focused on other alternatives. In a sense, though, cash reserve strategies are just another type of a time segmentation strategy. The two main alternatives discussed are to use the cash value of permanent life insurance policies as a reserve, and to open a line of credit with a reverse mortgage to serve as a reserve.
Editor’s Note: This article is excerpted from Wade Pfau’s forthcoming book, How Much Can I Spend In Retirement.
Wade D. Pfau, Ph.D., CFA, is professor of retirement income at The American College and director of retirement research at McLean Asset Management.