Retirement

Moving from a regular paycheck to living off of your nest egg is not an easy transition. At least it hasn’t been for me. One of the many decisions retirees must make is how much cash should they have in the bank.

For some it’s a question of budgeting. They keep enough to pay the bills over the next several months, but that’s it. For others cash acts as a buffer in the even the stock market drops 10%, 20% or more. For those who see cash as a buffer, several more questions need to be considered:

• How much cash should you keep in the bank?
• How do you decide when to replenish your spending account?
• Do you factor the amount of cash you have into your overall asset allocation?

In this article I’ll explore these questions. We’ll look at some research papers that address these questions. We’ll also talk about how you can get the psychological benefits of holding lots of cash without actually holding lots of cash.

The starting for all of this is the 4% Rule. First, however, we need to cover the basics.

What is Cash?

For our purposes, I define cash as money in an FDIC-insured account (checking, savings, money market account or possibly a certificate of deposit) or a money market fund. The later is not FDIC-insured, but it’s extremely safe.

What I don’t include in cash are bonds. That’s true even for short-term U.S. government bonds. T-bills as they are called are extremely safe. But they aren’t cash. And even a short-term bond fund can lose money when interest rates rise.

What about Social Security, Pensions, Annuities, and Part-Time Work?

Retirees fund retirement from many sources. Most receive social security. Many have pensions or annuities. And some, myself included, still do part-time work to generate some income. All of these sources generate cash for us, typically on a monthly basis.

The question we are addressing is how much cash, over and above any cash these other sources generate, do we need to pull from our investments. In other words, how much do we need to pull from 401k, IRA and taxable accounts each month or year for living expenses.

These other sources will of course reduce how much we have to pull from our investments. But most of us have to pull something out, and that’s what this article addresses.

The Budget-Dividend Strategy (My Preferred Approach)

My preferred approach to cash in retirement is what I call the Budget-Dividend Strategy. The nice thing about this approach is that it addresses three liquidity concerns at the same time:

1. It guarantees that I’ll always have cash on hand
2. It helps with budgeting
3. And it coincides with quarterly dividend payments, which can be used as a source of funds

Here’s how the Budget-Dividend Strategy works.

At the start of the year I pull six months worth of living expenses from our investment accounts. In our case the money gets deposited into our checking account.

When the balance declines to three months of living expenses, we add cash to bring the balance back to the six months of expenses level. If we are generally on track with our budget, this should happen after three months.

The timing is convenient because ETFs and mutual funds typically pay dividends at the end of each quarter. In our taxable account, we do not automatically reinvest dividends. So once the dividends hit our money market fund in our brokerage account, I can move some or all of them over to our bank account.

If we need more than the dividends give us, I withdrawal additional funds from investment accounts. Here I make the decision on a number of factors, such as taxes and which asset classes have performed best.

Once we start taking Required Minimum Distributions (still two decades away), we’ll use the RMD to fund living expenses as well.

Benefits of the Budget-Dividend Strategy

The are several benefits to this approach.

First, we keep the vast majority of our capital fully invested. Even assuming an initial 4% distribution per year, we never have more than 2% in cash (6 months of living expenses). And this number drops to 1% (3 months of living expenses) before we replenish the cash account.

Second, the timing of when we replenish the account coincides with distributions from ETFs and mutual funds. This isn’t necessary, and may be irrelevant for those without significant taxable investments. But it’s convenient for us.

Third, the approach also makes budgeting easier. We track our spending in Personal Capital and Tiller Money. This approach to cash, however, makes it easy to know at a glance if we are on track, over spending or under spending.

The No Cash Strategy

One approach to cash in retirement is virtually no cash at all. One could sell investments monthly to cover just one month of expenses. If most spending is put on a credit card, the no cash strategy could work.

Personally, I find the idea of tapping my investments monthly to be too much of nuisance. Still, it’s worth pointing out that one could take this approach. For those who do, finding a broker that offers check writing, online bill pay, and perhaps even a debit card would be useful. Even here, however, you’d be transferring funds from stock and bond funds to a money market fund every 30 days, which many would find tiresome.

The Buffer Strategy

Our approach to cash keeps the vast majority of our assets fully invested. Some advocate a different approach called the Buffer Strategy. The idea is to keep as much as five years worth of living expenses in cash. The strategy has some initial appeal.

Over the past 100 years, the worst stock market performance saw a decline four years in a row (from 1929 to 1932). The market has never been down five years in a row.

Here’s a chart of the S&P 500’s yearly performance dating back to 1928:

Of course the market could be down 5 years in a row sometime in the future. But the idea of a cash cushion is to avoid selling stocks when the market is down. It has some intuitive appeal.

And it’s a bad strategy.

First, if we rebalance our portfolio at least once a year, we won’t sell stocks in a bear market. When the market is down significantly, the simple act of rebalancing will cause us to sell bonds and buy stocks. This is true even if bonds decline a bit.

For example, in 1931 the 10-year Treasury Bond was down 2.56%. The S&P 500 (or equivalent) was down more than 43%! In that scenario, we still be selling bonds to buy stocks as part of rebalancing.

Just as important, holding five years worth of cash creates a serious drag on our portfolio’s performance. Let’s make sure we understand why.

Cash and the 4% Rule

The 4% Rule comes from a 1994 paper written by financial planner Bill Bengen. Using historical returns and inflation data, Bengen tried to answer how much a retiree could spend each year without going broke.

His conclusion was that a retiree could spend 4% of his or her nest egg in the first year of retirement. Thereafter, they could increase this amount by the rate of inflation (he used CPI). Following this approach, he concluded, a retiree’s nest egg would last at least 30 years, and in some cases 50 years or longer.

There were, however, some important underlying assumptions in his work. For example, he assumed retirees invested in an S&P 500 index fund for stocks and an intermediate U.S. government bond fund for bonds. He also concluded that stocks should represent 50 to 75% of a retiree’s asset allocation. Any more and a big stock market decline (e.g., 1929 to 1932) would shorten the longevity of a portfolio. Any less and a return to double-digit inflation could do irreparable harm.

So what does this have to do with how much cash we should hold?

For his analysis, Bengen assumed that retiree withdrew funds from the portfolio once a year and then rebalanced. The rebalancing did not factor in the cash that was just taken from the portfolio. His focus was not on how much cash to hold. That’s just the approach he chose for his analysis.

Nevertheless, it’s important to keep his approach in mind. For those choosing to deviate from a once-a-year distribution strategy (at most) to hold significantly more cash, keep in mind that the conclusions from his research may not hold. And indeed, subsequent research confirms this outcome.

Research on the Buffer Strategy

Arguably the most comprehensive study comes from Professor Walter Woerheide, Ph.D., ChFC, CFP®. At the time of publication, he was the Frank M. Engle Distinguished Chair in Economic Security Research, at The American College in Bryn Mawr, Pennsylvania.

In 2012 Professor Woerheide published a paper entitled, Sustainable Withdrawal rates: The Historical Evidence on Buffer Zone Strategies. He evaluated cash buffers of one to four years, using a replenishing strategy based on whether the investment portfolio was up or down the previous years.

If the investments were up, the cash buffer was replenished along with any required withdrawals. If the portfolio was down, withdrawals came from the cash buffer. The only time cash came from the investment portfolio following a down market was if the cash buffer were exhausted.

Looking at several different asset allocations, the results were clear. A cash buffer strategy underperforms a standard rebalancing approach. It reduces the likelihood that a portfolio will last 30 years. It also reduces the portfolio’s balance at death.

Here’s a summary of his findings:

Several other studies have confirmed these results:

• Cash reserve buffers, withdrawal rates and old wives’ fables for retirement portfolios
• Research Reveals Cash Reserve Strategies Don’t Work… Unless You’re A Good Market Timer?
• Cash Buffers, Sustainable Withdrawal and Bear Markets

Harold Evensky

Harold Evensky is the father of the bucket strategy. He’s also a proponent of the Buffer Strategy for cash. In 2021 he co-authored a paper (The Benefits of a Cash Reserve Strategy in Retirement Distribution Planning) that concluded a cash buffer equal to one year of expenses actually improved the likelihood that a portfolio could be sustained for at least 30 years. His study is the outlier and deserves a brief comment.

He found the a 1-year buffer strategy (he called it the Cash Flow Reserve or CFR) out performed a standard rebalancing approach (RDCA–Reverse Dollar Cost Averaging), particularly with taxes and transaction costs were factored in. Here’s a summary of his findings:

There are several serious flaws in the study.

First, it used a 1-year cash buffer that was allowed to fall to just two months. As a practical matter, that’s no cash buffer at all.

Second, he used a Monte Carlo simulations instead of historical data. In and of itself this isn’t a problem, but the inputs he used heavily favored cash. He assumed an average stock return of 8.75%, well below the historical average. He also assumed a 3.5% return on cash with a 3.0% rate of inflation. This gave cash a 0.50% real return.

In other words, the study was designed to reach a certain conclusion, in my opinion. The fact is that a significant cash cushion represents a significant drag on performance that hurts retirees in the long run.

How to Sleep at Night with Little Cash in the Bank

While it’s clear that the Buffer Strategy underperforms, we need to address the psychology factors. As someone who is semi-retired, I understand firsthand the fear of spending investments. That fear grows when the stock market drops as it did at the start of the Covid pandemic.

To address this real concern, here are a few approaches retirees can take that won’t do as much harm as holding too much cash.

First, calculate how long you can live on just your bonds. If you have a 60/40 stock/bonds allocation, for example, you can live on just the bonds for about 10 years, assuming an initial 4% withdrawal.

This approach assumes your bonds are primarily U.S. government short and intermediate-term bonds. Riskier bonds, such as high-yield or emerging market debt might not provide as much comfort. The point is that recolonizing just how long your bond portfolio can get you may help you weather a stock market decline.

Second, and related to the first, is to allocate some of your bonds to cash. For most this would mean a money market fund. For example, a 60/40 portfolio would become a 60/30/10 portfolio (stocks/bonds/cash). Studies have found that converting some of the bonds to cash doesn’t have a major effect on the longevity of the portfolio.

Bill Bengen actually reached this conclusion in a 1997 paper. He found that a 10% allocation to short-term U.S. Treasury Bills did not significantly reduce the starting safe withdrawal rate of about 4%. Others have reached similar conclusions (see here and here).

Final Thoughts

Investing during retirement can be stressful. Still, we need to resist the urge to play it “safe” by holding too much cash. What may feel safe could over time do far more harm than good. A simple approach of three to six months in cash keeps are capital invested while still giving us ample room to do with unexpected expenses.

Opening an IRA account is an important step towards saving for retirement. The best IRA accounts have low fees, a wide array of investment options and tools that make investing easy. 

Summary of Best IRA Accounts

M1 Finance

Best all around IRA Account

M1 Finance earns our top award for the best all around IRA account. It earns this honor for several reasons. 

First, it charges no account fees or transaction fees. Second, it enables you to build what it calls pies. You can think of a pie as a portfolio that you can include just about any ETF or stock that you want.

You can use pre-constructed pies that are excellent for retirement investing. In fact, I’ve created a 3-fund retirement portfolio in M1 Finance that anyone can use. I’ve also created several more complex portfolios to consider. 

• 3-Fund Portfolio
• 4-Fund Portfolio
• 5-Fund Portfolio
• 6-Fund Portfolio

With M1 Finance, managing an IRA is easy. You can rebalance a portfolio with the click of a button. And for those that want to invest in individual stocks, you can easily create a pie that contains the stocks of your choice or add individual stocks to a pie that is invested also in index ETFs like the portfolios above.

Account Types: Traditional IRA, Roth IRA and SEP IRA

Account Fees: $0

Transaction Costs: $0

Minimum Deposit: $100

Investing Tools: Easily create customized portfolios or use portfolios created by M1 Finance, auto-invest settings, auto-rebalance portfolio

Promotions: $30 bonus when you fund your account with $1,000+

Betterment

Best for hands-off investors

I met the founder of Betterment, Jon Stein, about 10 years ago. Since then, I’ve followed Betterment closely. It is one of two robo advisors I recommend for IRA accounts. 

With Betterment, the only decision you have to make is how much you want invested in stocks and how much in bonds. Betterment even helps you make that decision through a series of questions. Once you set your stock and bond allocation, Betterment does the rest. It automatically allocates your portfolio across about a dozen stock and bond ETFs.

One downside of Betterment is that, like all robo advisors, there is a fee. Betterment’s fee is 25 basis points (0.25%) for what it calls Digital Investing. The cost goes up to 40 basis points (0.40%) with Premium Investing, which gives you unlimited calls and emails to Betterment’s team of Certified Financial Planners. These fees are in addition to the costs of the underlying ETFs. 

Pros:

• Well established robo advisor
• Reasonable costs 
• Excellent portfolio construction 
• Very easy to use
• Human advisors for an extra fee

Cons:

• Fees over and above the cost of ETS
• Limited choices in portfolio construction

Account Types: Traditional IRA, Roth IRA, SEP IRA, Inherited IRA

Account Fees: 0.25% to 0.40%

Transaction Costs: None

Required Minimum: None

Investing Tools: Automatic portfolio construction, diversification, rebalancing, and dividend reinvestment

Promotions: Up to 1 year of waived account fees

Wealthfront

Best for hands-off investors

Wealthfront is the second robo advisor to make our list of the top IRA account options. It’s very similar to Betterment. You simply select your stock and bond allocation and Wealthfront takes care of the rest. 

It has a similar cost structure at 25 basis points plus the cost of the underlying ETFs. It does have a few differences in terms of portfolio construction. Most notably it includes a REIT index fund in retirement accounts, whereas Betterment does not. Wealthfront automates investing. It helps you create a personalized portfolio, and then rebalances it automatically as markets fluctuate. 

Pros:

• Easy to use
• Low cost
• Excellent portfolio construction
• Automatically rebalances portfolio
• Automatically harvests tax losses in taxable account

Cons: 

• It does charge a fee over and above the ETFs
• Limited portfolio construction options

Account Types: Traditional IRA, Roth IRA, SEP IRA and IRA Rollover

Account Fees: 0.25%

Transaction Costs: None

Required Minimum: $500

Investing Tools: Personalized portfolio construction, automatic rebalancing, automatic tax loss harvesting

Promotions: Get the first $5,000 managed for free (See details here)

Vanguard

Best for hands-on or hands-off investors

I’ve been a Vanguard client for decades. I’m a huge fan of their mutual funds and ETFs. Of course, you don’t need to open a Vanguard account to invest in their funds. In fact, you can invest in Vanguard funds through any of the IRA brokers listed here.

For those who know they want to invest in only Vanguard funds, however, it is a good option for opening an IRA. It’s also a good option if you want to use its advisory services. It offers both a digital advisory service for 25 basis points ($3,000 minimum) and a human based advisory service for 30 basis points (minimum $50,000). Otherwise you can invest on your own for just the cost of the Vanguard mutual funds and ETFs.

Pros:

• Excellent mutual funds and ETFs
• Digital and human powered advisory services

Cons:

• Website could be better
• Advisory services have minimum investments
• Vanguard mutual funds have minimum investments (typically $1,000 or $3,000)

Account Types: Traditional IRA, Roth IRA, SEP IRA, IRA Rollover, Inherited IRA

Account Fees: None unless an advisory service is used

Transaction Costs: $0

Required Minimum: $1,000 to $3,000 for many of Vanguard’s mutual funds, no minimum for ETFs, $3,000 for its Digital Advisory Services, $50,000 for its Personal Advisory Services.

Investing Tools: Asset allocation tool, investment comparison, screen & analyze investments, retirement planning tools, education savings tools.

Promotions: None

Fidelity

Best for hands-on and hands-off investors

Fidelity is a full service broker that powers many of the 401k plans and other retirement accounts. As an IRA provider, it gives investors access to virtually every mutual fund and ETF or stock available in the market. It does so without account fees, and its minimums, if any, are low. It offers excellent tools although frankly, in my experience, the website is not always the easiest to use.

Fidelity also offers its own version of a robo advisor, called Fidelity Go. Unlike Vanguard’s Digital Advisory Service, it requires no account minimum and is free for accounts up to $10,000. For accounts between $10,000 and $49,999, it costs $3 a month. For accounts $50,000 and up it costs 0.35% per year.

Pros:

• Wide range of investment options 
• Robust investing tools
• Low costs 
• Fidelity Go

Cons:

• Website can be difficult to use

Account Types: Traditional IRA, Roth IRA, SEP IRA, IRA Rollover, Inherited IRA

Account Fees: None

Transaction Costs: None

Required Minimum: None

Investing Tools: Stock ETF or mutual fund research and market analysis tools

Promotions: None

Merrill Edge

Best for hands-on investors and Bank of America clients

I recently opened a rollover IRA at Merrill Edge. It’s part of Bank of America, making it ideal if you bank at BofA. Merrill Edge can be a great way to have all of your accounts under one umbrella. Similar to a Fidelity or Vanguard, you can invest in just about anything through Merrill Edge. 

It also offers a robust set of tools for research and analyzing investments, including tracking your progress towards retirement. It does offer its version of a robo advisor, called Merrill Guided Investing. The downside is that it’s more expensive than Betterment or Wealthfront.

Pros:

• Low Cost 
• Excellent investment tools
• Integrated with Bank of America accounts 

Cons:

• No automated rebalancing
• Merrill Guided Investing more expensive that other robo advisors

Account Types: Traditional IRA, Roth IRA, SEP IRA, IRA Rollover, Inherited IRA

Account Fees: None for self-directed IRA accounts. Merrill Guided Investing costs 0.45% for online only and 0.85% for online with an advisor

Transaction Costs: None

Required Minimum: None for self-directed IRA; $1,000 for Merrill Guided Investing; $20,000 for Merrill Guided Investing with an advisor

Investing Tools: Research and retirement planning tools

Promotions: Up to $2,500 for new accounts depending on value. This promotion occurs annually for a limited time.

Ally Invest

Best for hands-off investors

Ally, the financial institution best known for online banking, brings the same excellent website and mobile app to an investment platform. It offers both self-directed IRAs and its own version of a robo advisor called Managed Portfolios. It also comes with a host of tools to analyze your investments and your portfolio. 

For self-directed IRAs, there are no commissions or account fees. The Managed Portfolios option requires just a $100 minimum. Unlike other robo advisors, Ally doesn’t charge a fee. However, it does require you to keep 30% of your portfolio in cash, which is a non-starter for retirement investing. As such, I don’t recommend Ally Invest’s Managed Portfolios unless you have a specific reason for keeping so much in cash.

Pros:

• Virtually free 
• Easy website to navigate 
• Excellent tools
• Excellent mobile app

Cons: 

• Managed Portfolios keep 30% in cash 

Account Types: Traditional, Roth IRA and Rollover IRA

Account Fees: None

Transaction Costs: None

Required Minimum: None to open a self-directed account, $2,000 for margin accounts, and $100 for a Managed Portfolio account.

Investing Tools: Streaming charts, profit/loss calculator, market and company snapshots, probability calculator, watchlists, market data and option chains.

Promotions: $50 to $3,500, requiring a deposit of transfer of $10,000 to $2 million or more. Ally Invest also credits transfer fees, up to $150, when moving accounts from another broker.

How to Choose the Best IRA Account

Don’t focus on what you will invest in

One of the big misconceptions about opening an IRA account is that you should focus on what you want to invest in. When I started investing 30 years ago, this was an important consideration. I couldn’t go to Fidelity and buy Vanguard funds. Over time, you could but there were fees.

Today, you can invest in virtually anything  at just about any broker with few if any transaction costs. As a result, when opening an IRA account, the focus shouldn’t be on what you want to invest in. Instead, focus on how you want to invest.

Focus on how you will invest

There are basically three types of investors. There’s the hands off investors, who simply wants to set it and forget it. There’s the hands-on investor who wants to control every detail of the portfolio. And then there are those who want to be able to control their investments to some degree, but at the same time automate things like rebalancing the portfolio.

Understanding the type of investor you are will help you pick the best IRA account.

3 Types of Investors

1. Hands-Off Investors

The best IRA account options for hands-off investors are M1 Finance, Betterment and Wealthfront. Strictly speaking, Betterment and Wealthfront are the most hands off types of IRA accounts in our list. As noted above, you simply set the stock and bond allocation and they do the rest. The downside is that they both charge fees for the service of 25 to 40 basis points. While that may not seem like much, over a lifetime of investing it can easily add up to hundreds of thousands of dollars.

With M1 Finance, you do have to decide on the pie you want to use. They’re easy to create and there are pre-built pies that are ideal for long term retirement investors. Once you select one, it functions very similar to a robo advisor. 

Each contribution you make is divided among the individual investments in your pie according to the allocation you set. In addition, you can rebalance the portfolio with the click of a button. At the same time, however, you get great control over your investments. For example, if you wanted to add the stock of a single company to a three fund portfolio, you could do so in a matter of seconds. You could then allocate whatever percentage of that portfolio you want.

Either way, M1 Finance, Betterment and Wealthfront are all good options for hands-off investing.

2. Hands-On Investors

A traditional broker is certainly a strong option in our list that includes, Vanguard, Fidelity, Merrill Edge and Ally Invest. While they each have their own pros and cons, for most IRA investors it frankly doesn’t matter. You can buy any investment you want at any of these brokers and they all function in a relatively similar ways.

Alternatively, hands-on investors could use M1 Finance. As noted above, you can construct the pie or multiple pies as you see fit. You control the rebalancing and at the same time M1 Finance tools make rebalancing very easy.

3. Control with Automation

As you’ve probably guessed by now, there’s only one that fits into this category, and that’s M1 Finance. If I were starting as an investor today, I’d probably use M1 Finance. I use it today to invest all of the cashback credit card rewards that we receive.

Understanding the Impact of IRA Account Fees

Investment fees are critical to the long term performance of any portfolio. Most IRA account brokers charge no account fees or transaction fees. The one exception are robo advisors, including automated investing platforms at traditional brokers. Fees for these services range from about 0.25% to 0.45%.

It would be a mistake to dismiss these fees. While robo advisors are a good choice for those wanting totally hands-off investing, it’s important to understand how these fees can effect your wealth over time.  

Let’s assume you invest $500 a month over a 45 year period (we’ll ignore inflation). The account would grow to approximately $2.6 million with an 8% return (thank you, compounding!). If we reduce that return assumption by 25 basis points to account for the robo advisor fees, the account balance drops by more than $200,000 after 45 years.

While it’s certainly true that $200,000 45 years from now will be worth a lot less than it is today, it’s still a lot of money. This doesn’t rule out Betterment, Wealthfront or other managed portfolios. But it should be a consideration as you make your choice.

Mythodology

My analysis stems from holding accounts at each of the brokers on the list, with the exception of Ally Invest. I’ve had a Rollover IRA, Roth IRA, Traditional IRA, SEP IRA or an Inherited IRA at Wealthfront, Vanguard, Fidelity and Merrill Edge. I’ve held taxable accounts at Betterment and M1 Finance.

Beyond my own experience, I focus on fees and functionality. Fees are always critical, and how each broker works is important. You want to match your own personal approach to investing with the right IRA account. I also considered each broker’s website and mobile app, as well as their investing tools.

FAQs