Financial advisor Harold Evensky pioneered the cash-deposit strategy in 1985 so clients would stay calm during market downturns and not be forced to sell depleted stock to fund withdrawals. He originally told clients to keep two years’ worth of supplemental living expenses in the cash deposit, but later he reduced it to a single year’s worth.
Evensky, now 79 and retired from planning, disagrees with how the cube approach is often used today. Some advisers keep up to 10 years of living expenses in short- and medium-term categories, and long-term investments in a third category. Evensky prefers his simpler two-bucket approach: one for cash and the other for long-term investments. He says a year’s worth of cash is enough to protect investors from market volatility, and holding more than that reduces returns.
Evensky, who has a bachelor’s degree in civil engineering and taught personal finance for years at Texas Tech University in Lubbock, Texas, also rejects some of the conventional wisdom on personal finance. For starters, Evensky disagrees with the belief that people naturally spend less after they retire; he says they spend less mainly because they have less. If they saved more while working, they would spend more in retirement, he says.
We located him at his home in Lubbock. His answers have been edited.
Barron’s Retreat: Why did you come up with the bucket approach?
Evensky: Two reasons: withdrawing money at the wrong time was problematic; and when investors see their portfolios crash, they tend to panic and sell. By having a cash reserve that lets them know where the money for their purchase is coming from, they can hang on while everyone else jumps off the cliff.
Why is it problematic to withdraw money at the wrong time?
If you are withdrawing money in a bear market, you are probably selling stocks, which is probably not the right time to sell stocks. That’s when you want to be shopping. You want to buy low and sell high, which is the opposite of what most people do.
How does that prevent the cash deposit?
With the cash bucket, you are not required to sell any of your long-term investments. You have control over when to sell them because you are drawing the funds for living expenses from the cash bucket.
When do you refill the bucket?
As you monitor your investment portfolio over different periods, you need to rebalance. That is the moment when you refill the bucket with cash. Or if the market has had a big rally and you are going to sell some stocks to buy bonds, take some of those profits and refill the cash bucket.
What happens during a prolonged poor quality market?
Then you should be selling bonds to buy stocks, so take the opportunity while you rebalance to take some of the bond sales and refill the cash deposit.
How often does this happen?
It has never happened since we started using it in the 1980s. There has always been an opportunity to refill the cash bucket from rebalancing. But if it did happen, then you would dip into your investment portfolio and sell the short end of your bond duration portfolio where there would be little or no loss.
Some market insiders don’t like the cash deposit.
There have certainly been many papers on the inefficiency of the cash bucket. And I can’t disagree with pure mathematics. If you set up a bucket of cash, there is an opportunity cost because that cash is not in long-term investments. And that’s where I think the behavioral aspects far outweigh any potential drawbacks.
Did you realize that the cash deposit would have a calming effect on investors when you started using it in 1985?
I guess I didn’t realize how powerful the effect would be. Go back to the accident in 1987. It seemed that the world had come to an end. That was really scary.
One thing I did was pick up the phone and start calling customers. Nobody was happy. But no one panicked, and no one called and said, ‘Harold, I can’t take this. Take me to cash.
How does your system work?
My goal was simplicity and something that would make sense to customers and something they could easily live with and manage. The only change over time was that the cash deposit originally had two years’ worth of supplemental cash flow. Several years later we did an academic analysis and concluded that one year was optimal. That lowered that opportunity cost of having more cash.
What do you mean by supplemental cash flow?
You do not need to set aside 100% of what your annual expenses are. Only those expenses that would not be covered by a pension, Social Security, etc. It is a much smaller number than your annual expenses.
Some people cube up to 10 years’ worth of cash and bonds. Is that a mistake?
I am prejudiced, but the answer is yes. It can feel good in the short term because people feel, ‘Wow. I am super protected. But unless someone is very rich, they can’t afford that magnitude of opportunity cost.
Not only that, but the simple approach has worked remarkably well. It worked during the ’87 crash. It worked during the tech stock crash, it worked during the great recession. The proof is in the pudding.
Do you use a bucket approach yourself when investing your money?
Not that you probably need it. It is the idea of eating your own kitchen. This is what we tell customers to do, and I think it’s what we should do.
How is your money invested?
My wife and I are probably 70% fixed income and 30% equities. It has changed significantly because I am retired and have been fortunate over the years to accumulate significant assets. Asset allocation is a function of what I need to achieve my goals.
Do you think the stock market is about to crash?
The answer is yes, but they have been telling me that for years and that does not influence our investment philosophy. I’m not a big believer in market timing.
You were trained as an engineer. How did you become a financial advisor?
Kind of a peculiar route. After the military I joined my family’s construction business in Florida and after a couple of years I started my own home building business. I loved what I was doing, but it had no future because of high inflation and skyrocketing mortgage rates when home buyers could even get financing. I got a job as a stockbroker.
I wasn’t really unhappy with the brokerage, but they never understood what I wanted to do.
You want to do?
He wanted to do financial planning, not just sell investments. Every morning the manager would come in with a list of clients and how much they had in the money markets and say, ‘This client has a lot of money. There are some really good bond buys out there. Why don’t you call them?
And I was like, ‘I know what they need. They don’t need any of this.
Studies have found that retirees spend less as they get older. You do not agree.
The problem is that those studies don’t indicate whether they are spending less because they want to spend less or because they have to spend less. That is a big difference.
Clearly, for those with limited resources, they are probably spending less because they have to spend less. But for those investors who have resources, when someone retires, the main change is that they now have free time. Time costs money. Join the country club. Go take those cruises with your kids around the world.
I think the general conclusion that they spend less is nonsense.
So, as a wealth advisor, did you plan for clients to have the same expense in retirement?
Yes. When we are doing the planning, it is based on year-by-year objectives. Some years it may be many more because they want to go on the world cruise they’ve always dreamed of, and the next year, they may not go. But I think it’s wrong to arbitrarily assume that they’re going to spend less.
You have quite a conservative approach. It means that many people would have to save more while working.
I agree with all of that, except for the word conservative. I think it’s smart.
There is nothing anticonservative about living in a world of dreams.
Anything else I should have asked you?
There have been hundreds of documents about someone’s risk tolerance. And I finally came to the conclusion that the only rational definition of risk tolerance is what that pain threshold is right before a customer calls me and says, ‘Harold, I can’t take this. Take me to cash.
If you’re making decisions about your stock and bond balance, you’d better be reasonably sure that when all hell breaks loose, you can live with it. And what’s worse, when all hell breaks loose, you better be prepared to do the opposite of what everyone normally wants to do. You need to sell what works well and buy what works poorly.
When have you had to do that?
The most painful period I went through was the great recession. We are big believers in rebalancing. Well, the market went down and we said, ‘Okay, we need to sell bonds and buy stocks.’ And they all said, ‘Okay, sure.’
And then he went back down. And we said, ‘You know we have to do it again.’
And they said, ‘Well, are you sure about that? It seems that the market is in free fall. And we said, ‘Yeah, that’s just what we have to do.’
And then it went back down, so we rebalanced three times. That was difficult.
Did everyone accept it?
Everyone agreed, not happily. But in retrospect, it certainly worked.
As we tell people, ‘Look. If the market keeps going down forever, all bets are off and it won’t matter what you’ve done. We will all go to hell together. We do not plan for Armageddon. We have a basic belief that, over time, the national and world economies will grow, along with the investment markets.
Thank you, Harold.
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