How Much Of Your Portfolio Should You Keep In Cash?

At some point, I am going to retire, so I wanted to calculate how much of my portfolio I should put into cash in order to protect myself against sequence-of-returns risk. If you’re withdrawing monthly from a portfolio that’s partially invested in equities and a bear market comes along, you’ll run out of money a lot sooner than if you’re in a bull market, and it only makes sense that putting part of your portfolio in cash would provide some protection. So I looked at various scenarios over the last 47 years, and I’ve come to a rather surprising conclusion.

Let’s assume you have $1,000,000 and you withdraw $5,000 a month. If you keep it all in cash, you run out of money after 200 months, or less than 17 years.

Now let’s assume that you put a portion of that money in an index fund (for the sake of convenience I’ve used the Wilshire 5000 index in this article, with dividends reinvested; you can read about it here). How much of it would you need to put in equities in order to eliminate the chance that you’d run out of money in less than 30 years? I’m assuming you keep the percentage constant and rebalance every month. In other words, if you decide to put 40% in the index fund, you’d look at your total balance at the end of every month and make sure that exactly 40% was invested in the index fund.

Well, let’s take starting points on January of every year from 1971 to 2003, giving us 33 different trajectories (after 2003 doesn’t give us enough years to evaluate). If you put all your money in cash, your chance of running out of money is 100%. If you put 40% of your money in an index fund and 60% in cash, you’d still run out of money at some point in four out of those 33 possibilities, and moreover, 12 of them have a less-than-30-year track record, so it’s possible that you’d run out of money in some of those scenarios too. So 40% simply isn’t enough to put into equities to provide protection.