Cash management has a role in financial planning, even in an era of low interest rates. With stock markets continuously reaching new heights over the last decade, cash has been an unpopular holding in most investor’s portfolios. However, there are circumstances whereby effective cash management can plug the gap in unpredictable times, particularly when markets are volatile.
Cash management strategies for retirement
Volatile markets create uncertainty globally and locally. This applies equally to individual financial planning just as much as at the macro level. If you are still in the wealth accumulation stage of your retirement planning, the old maxim of staying in the markets is as true today as it ever was. There is no point selling at a loss if you don’t need to use the money immediately or within a short timeframe.
The situation is very different for those in the decumulation stage and have based their retirement strategy on Defined Contribution pensions and/or investment income.
If you are fully invested and taking an income from a portfolio or pension, and the markets correct or even crash, you will be forced to sell losses until markets recover. This is where cash management strategies can help. It may be wise to increase your cash position to a level where, perhaps, you reserve two years of income to pay your pension. This way, you can leave your invested assets undisturbed until such a time as the markets recover.
Alternatively, those with savings in bank deposits might consider turning that tap on and closing the pension or investment portfolio tap for a while. The cash pot can be refilled when markets stabilise by selling gains rather than having to sell losses.
Most Defined Contribution pensions allow ‘Flexible Access Drawdown’ (FAD). This means it is easy to stop income payments at any time and withdraw funds from other sources. Annuity-based and Defined Benefit pensions aren’t subject to market fluctuations, so nothing to be concerned about there. However, anyone who holds a pension plan which can only be withdrawn under ‘Capped Drawdown’ rules should check their options and see if it’s possible to change this to FAD.
Capped Drawdown works on the 70/30 principle whereby up to 30% can be taken as a lump sum, and the other 70% is used to provide an actuarially calculated ‘income for life’. In most cases, this assumes steady growth in stock market returns and an income level of a maximum of 150% of Government Actuarial Department annuity rates. This strategy works, provided the markets don’t crash! Should this happen, income would have to be revised lower at the next actuarial review. Again, making sure you have a cash holding which can be drawn on when markets are uncertain is vitally important.
Risk tolerance
There are online risk profiling tools available that help construct an investment portfolio. The ‘level of risk’ is defined as ‘the degree to which you are prepared to accept fluctuations in your investment value to improve your chances of achieving higher long-term returns’. Although many investors have enjoyed healthy returns over the last decade, it should be noted that past performance may not be indicative of future results. Investors should also consider their capacity for absorbing losses. When your portfolio shows healthy gains, it’s easy to think that you have a high capacity for loss as your original capital may remain intact if markets correct. I would argue that it’s important to revisit your risk profile and capacity for loss at this point. It may be time to consolidate gains and reduce exposure to markets, at least temporarily.
In any case, it’s good practice to regularly review your risk tolerance alongside your overall financial planning strategy. In turbulent times, it might turn out that cash management becomes an essential element of your plan. Your planning can benefit from increased flexibility regarding income generation and help reduce overall investment risk without exposing your portfolios to enforced consolidation of losses.
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