@MJG,
Is the 3-5 year cash on hand related to the average Max DD of funds? This would be my guess.

Hi BobC,
Thank you so much for responding to MFOer Davidrmoran’s questions with regard to the whys of your near-term cash portfolio asset allocation policy. Your explanations are clearly and understandably presented.
But you did not address the question of why you decided that a 3 to 5-year war-kiddy reserve is the favored approach for most of your customers. How was that reserve time-span determined?
Is it close to the historical average time length of a Bear market? Is it tied to the psychological behavior or biases of your clientele? I appreciate that it is a conservative approach that over the stated 30-year period of your business has been attractive to your customers. Congratulations on preserving their loyalty. It demonstrates that you are doing something right for them.
But that conservative approach is leaving much end wealth on the table. How happy would your clients be if they recognized that their end wealth could have been substantially higher without compromising their portfolio survival odds?
Let’s do a simple illustration over the lifetime of your advisory organization. I’ll use the Portfolio Vizualizer website option titled “Backtest Portfolio”. Since your firm has counseled investors for 30 years, I’ll imagine two starting portfolios in 1984 with one thousand dollars each and not touched through 2014. Portfolio Visualizer will effortlessly calculate the end wealth of each portfolio.
Like in the earlier Monte Carlo simulations, let’s assume a 40/10/30/20 mix of US Equities, International Equities, Bonds, and Cash, respectively as a baseline. That could be representative of a portfolio that your clients might find acceptable based on a 4-year cash reserve recommendation from you.
By way of comparison, let’s switch some of that cash into a Bond holding to reflect a 2-year reserve allocation. In that instance, the mix is 40/10/40/10. Both portfolios are a 50/50 equity/fixed income asset allocation.
What is the end value after 30 years of these two portfolio options?
The end value for the 4-year protective cash option is $12,793. The end value for the 2-year protective cash option is $14,120. That’s for every one thousand dollars invested in 1984. That’s roughly a 14 percent penalty.
The 2-year reserve cash portfolio does marginally increase portfolio volatility from 9.51% to 9.68%. However, during that period, the Worst year was a negative 17.39% and it was registered by the 4-year cash reserve portfolio. Go figure!
That’s a lot of money that you are asking your clients to sacrifice for “perceived” safety. I say “perceived” because the Monte Carlo analyses hint that the 4-year reserves portfolio is slightly more likely for bankruptcy. From an end wealth perspective, the 4-year option is an opportunity cost.
I like Short Term Corporate Bonds as a near-term alternative to cash. Using those to substitute for the 10% cash case generates an end wealth of $15,016 for every one thousands dollars invested in 1984. It does introduce a little more risk.
Let’s test the results for timeframes shorter than 30 years. The number magnitudes and percentages change, but the relative rankings of the three options examined do not change if the investment period is shortened to the recent 20 years nor for the current 10 year period. The 4-year reserve cash option comes at an opportunity cost.
There is a reduced end wealth price to be paid for keeping excess reserves in cash. That’s one reason why active mutual funds maintain a low cash allocation unless some downturn is projected.
I’m sure you access a back-testing tool similar to the one I used at Portfolio Visualizer. I’m equally sure that you generate these type of tradeoff studies for your customers to allow them to make an allocation decision. One size does not fit all clients well, especially given the many factors that influence a final asset allocation decision.
By the way, it took me ten times the effort to report these results than to actually do the calculations.
Best Wishes.

The 3-5 years of expected PORTFOLIO withdrawals protected. The 3-5 year number does not include SS benefits, any pension, annuity income, etc. - just what you would need to take from your investment portfolio. This might include required IRA distributions, cash from taxable accounts, or a combination of these two...whatever you expect to need from your investments to meet your total cash flow needs. So, if you have a $500,000 portfolio, and you expect to need $20,000 per year from this to meet your total needed annual cash flow, we would recommend having at least $60,000 to $100,000 of the portfolio in cash, CDs, or short-term bonds. The strategy helps to reduce the possibility that you would need to sell equities in a down market to generate cash flow. And it still leaves 80% of the portfolio to be diversified. Some clients choose to make the 20% held aside a part of the total (replenish the cash flow bucket as withdrawals are made - maybe semi-annually, but at least annually in up markets. Others prefer to keep the 3-5 year bucket as a separate entity. It has worked for our clients for 30 years. Hope this explains the strategy.

Correct.
A couple of years' cash in addition to SS, maybe a bit more, is what I have been doing in all my calcs.
I was just querying OP about that 3-5y and its source. A good way to stay out of the market unduly.

Perhaps it might be useful to consider the details of the suggestion "to have 3-5 years of portfolio cash flow needs in cash, CDs, or short-term bonds."
I would think that the "3-5 years" figure does not mean that you would need a reserve capable of funding your entire living requirements for that period of time, but merely the "marginal" extra amount over and above predictable income sources such as SS, pension or annuity necessary to fund that period.
1) First, this scenario assumes that there is some annual portfolio drawdown required to maintain the living standard required.
2) That drawdown would be in addition to any income from predictable sources such as SS, pension or annuity.
3) That drawdown may also be reducible if it exceeds the minimum living standard required.
4) So only the amount of cash reserve required to supplement other income sources to maintain the minimum required income level, for "x" number of years without portfolio drawdown, needs be considered, not the entire annual income amount.

That is certainly a much smaller number than the total amount required to maintain the entire required income level, for "x" number of years.
Thanks very much to all who've responded to my request for comments on this particular thread. Quite a nice array of thoughts to consider.
OJ

Hi Davidrmoran,
You raise important questions with regard to a retirement cash cushion requirement. How much is needed? How was that level determined? What fraction of a retirement portfolio should be protection money in the form of near-term cash equivalents?
I retired twenty years ago, and at that time I was exposed to several professional retirement expert estimates. Yesteryears typical number hovered around two years worth of the planned withdrawal rate. Does four years near-term cash provide additional protection benefits?
This is another example of the benefits of Monte Carlo simulations to scope the issues. There is little need to rely on rules-of-thumb or instincts or opinion.
Since the retirement decision is so far in my rearview mirror, I really don’t want to spend too much time doing real work. Therefore, I only did 4 simulations to illustrate the tradeoffs. These took about 5 minutes to complete using the Portfolio Vizualizer Monte Carlo tool. If the subject is of paramount significance for you, a more comprehensive set of calculations is likely warranted.
I assumed a 30 year retirement time horizon with drawdowns at the 4.5% and 5.5% portfolio levels. I used the programs Historical Returns and Historical Inflation options. I postulated a simple portfolio mix with an asset allocation of 40% US equities, 10% International Equities, 30% or 40% Bond, and either 20% or 10% cash. That’s a 4 calculation matrix with a 50/50 split between equities and fixed income sources.
Obviously, end wealth was always higher (like a factor of 2) for the lower 4.5% withdrawal schedule. End wealth was higher for the 2 year cash reserve portfolio. Portfolio survival was marginally higher for the 2 year cash reserve portfolio. At the 2 year cash asset allocation, portfolio survival was 88% for the 4.5% drawdown rate, and dropped to 70% at the higher 5.5% withdrawal rate.
The 2 year cash cushion wins by both end wealth and survival measures.
These sample simulations suggest that you need not concern yourself with a 4 year cash reserve. Although it certainly would increase the comfort zone for any retiree, it is likely an unnecessary luxury. It seems like an arbitrary number. Portfolio asset allocation is always a top-tier investment decision, especially so during retirement.
I suggest you try a few Monte Carlo cases yourself to confirm and expand my brief findings.
Best Wishes.
EDIT: For completeness, here is the Link to the Monte Carlo code that I used in the reported calculations:
https://www.portfoliovisualizer.com/monte-carlo-simulation

Frank, at least for me I was never fond of hedging because you have two decisions instead of one, i.e. when to lift the hedge. The junk funds have been flat but on a total return basis made all time highs as recently as Friday. After the close today I will be anywhere from 40% to 50% in cash (15% now) Will be watching how OSTIX handles the selloff because would like to go there. Since 12/08, there has always been a place to hide in bondland. My fear has been what happens when there is no place to hide. Bank loans may shine someday but haven't seen much from them yet. Friday's employment report should prove interesting, especially for Treasuries. I need a little under a 1.50% annual return to not have to touch my principal so may just kick back and watch for awhile. This in and out get tiring for this old trader. Then again, doubt I could ever just sit back and watch if something is moving in Bondville.
Edit: While the junk ETFs ala JNK and HYG are seeing higher than normal % declines today, noticed the SJNK is unchanged and on extremely heavy volume. SJNK is the short term junk ETF. Looks like many on moving to the shorter dated junk.

I would agree that Treasuries could be in a bear market. TLT, as a proxy for long-term Treasuries, is down about 15% from its high about February 1. Meanwhile, the high-yield market seems to have hit a high about March 1 and since then has gone nowhere to down, depending on which fund or ETF I'm looking at.
As a bond investor, I don't see anything that looks very good right now. Lately I've considered shorting Treasuries via RRPIX, although a correction in the stock market would likely cause treasuries to reverse upward. I own high-yield funds, which I'll hesitate to sell if junk starts to tank and instead could hedge these with RYIHX.
Junkster: What do you think of hedging as a strategy for high-yield? My thinking is that if the NAVs of my junk funds fall, hedging with RYIHX should mitigate those NAV losses while I continue to collect the dividends from the long funds.

3-5y cash? Where does that range come from? Bounceback plus a cushion? That would be half the nut for many, if not more.

Its not a very good article because it fails to site the key fact that might make them attractive though probably not to most people on this site.
If you hold for 20 years you get a 3.5% annual return http://savings-bond-advisor.com/series-ee-interest-rate-rules/

@JoJo26, Artisan funds tend to be higher than that of the average mutual funds. Perhaps in the future retail investors MAY gain access to the lower expense Advisor shares with lower minimum for IRA accounts. For now the minimum is $250K.

Former manager from Janus. Short piece from Denver Post in 2014.

In perhaps his biggest misstep, he invested with a neighbor from Cherry Hills Village named Sean Mueller, who promoted a day-trading system offering returns of 12 percent to 20 percent a year.
In 2009, Rollins signed on as Mueller's director of research. But Mueller, like Armstrong, hid a much darker side than the charismatic persona projected in public.
In 2010, Mueller received a 40-year prison sentence for running a $71 million Ponzi scheme that defrauded 65 investors, including former Denver Broncos quarterback John Elway.

denverpost.com/business/ci_26176640/former-janus-star-blaine-rollins-attempts-mutual-fund

FYI: (This is a follow-up article)
Is active or passive better? It depends whom you ask.
Regards,
Ted
http://www.marketwatch.com/story/this-study-shows-stock-fund-managers-can-beat-an-index-2015-06-03/print

@Scott: Ben Bernanke was the best Federal Reserve Chairman in my lifetime. As showen in the above link duening his tenure the S&P 500, the market's proxy, was up 8 out of nine years for a. 888% batting average. He helped me make a lot of money !
Regards,
Ted

One thing I do agree with Bernanke on:
http://www.cnbc.com/id/102728250
US Congress pushed China towards AIIB: Bernanke

FYI: Ben Bernanke doesn’t seem to think the stock market is too frothy.
In his latest blog post for the Brookings Institution, the former Federal Reserve chair said the easy-money policies deployed during his tenure at the central bank have arguably only returned stock prices to “normal” levels.
Mr. Bernanke crunched the numbers and found that the S&P 500 rose by about 1.2% each quarter from the end of the 2001 recession through the fourth quarter of 2007–the pre-crisis business cycle peak. If the S&P had continued to climb by that same rate, Mr. Bernanke’s math tells him the S&P 500 would have sat at about 2123 in the first quarter of this year. That’s three points above its first-quarter top of 2120 in February and 55 points higher than where the index finished the first three months of the year at 2068
Regards,
Ted
http://blogs.wsj.com/moneybeat/2015/06/02/janet-who-ben-bernanke-says-stocks-arent-expensive/tab/print/
Chairman Federal Reserve Board 2006-2014:
2006: S&P 500 15.61%
2007: " " 5.38%
2008: " " -36.55%
2009: " " 25.94%
2010: " " 14.82%
2010: " " 2.10%
2012: " " 15.89%
2013: " " 32.15%
2014: " " 13.48%

The current secular bull market has been referred to as the most unloved bull market in history. Maybe so. Oh, for the days of no 24-hour 'news' being blasted at us. Very little of it is news. Most is opinion and hype of the crisis du jour. I suspect that there would be much less angst right now if we were rid of this brainwashing. Are there real worries? Of course there are, but sky-high stock prices are not one of them. That WAS the case in 2000. Sky-high real estate prices and the government's push to allow virtually anyone to have a home loan are not one of them. That WAS the case in 2007. There is very little real speculation right now, and a lot of folks who were invested in 2007 are still sitting on the sidelines, either waiting for the right moment or content to hold cash, CDs, and bonds. The Fed will likely push up the Fed Funds Rate this year, but likely only by 25 bps, then wait to see how the economy and markets handle it. We are not going to see an aggressive Fed in the near term.
A correction is always a possibility in any point in time. That is easy to prepare for, both psychologically and investment-wise. A bear market is another thing, as David pointed out so well. Investors should understand how much their portfolio could lose in a true BEAR market and ask themselves if they can handle that from a life planning, time horizon point. Perhaps the most important thing for folks in the withdrawal stage is to have 3-5 years of portfolio cash flow needs in cash, CDs, or short-term bonds. Once that is done, it is usually easier to handle the downside pressures.
A geopolitical even could change things quickly, so waiting for that to happen is a fool's game. Investors should analyze their portfolio now and make adjustments according to their cash flow needs, real risk tolerance, and investment time horizon. After all, it was Louis Rukeyser, when asked what the markets were going to do, on more than one occasion said "The markets will fluck up and fluck down". So there you go.

FYI: Recent sales underscore the perils of timing interest-rate changes--and the virtue of patience.
Regards,
Ted
http://news.morningstar.com/articlenet/article.aspx?id=699839

FYI: Government savings bonds aren’t meant to be blockbuster investments; they are intended to be safe havens for your cash. But lately, rates on savings bonds are downright anemic.
Regards,
Ted
http://www.nytimes.com/2015/05/28/your-money/appeal-of-savings-bonds-wanes-in-ultralow-interest-environment.html?ref=topics&_r=0

FYI: Four Vanguard international equity index funds will more broadly diversify with the addition of small-cap stocks, and will follow broader FTSE all-cap benchmarks as a result.
Regards,
Ted
https://pressroom.vanguard.com/content/press_release/Four_Vanguard_Funds_to_Broaden_Diversification_6.2.15.html