Cash Wedge and Opening the Investment Taps

A “cash wedge” is what Daryl Diamond, financial planner, author, educator and respected financial professional on all-things retirement money management calls the income delivery process.  Daryl Diamond should know a thing or two about the “cash wedge”, Daryl is largely responsible for the concept, a process dedicated to helping retirees reconcile their income needs to fund their lifestyle objectives securely.

The way I see it, most retirees will need to withdraw capital from their investment portfolios and take advantage of government programs like the Canada Pension Plan (CPP) and Old Age Security (OAS) for retirement expenses to survive.  For many retirees withdrawing from their capital should be a major concern for them:  due to longevity risk, inflation risk and financial risk.

This is where the “cash wedge” process can really help.  You already know that investing in the stock and bond market can grow your portfolio during your asset accumulation years.  In your withdrawal years however you need to be careful.  When equities are up and down it makes a HUGE difference when you draw-down the investments in your portfolio. Because you’re always drawing income from the “cash wedge”, you’ve bought yourself time to weather stock market volatility.  Daryl calls this “withdrawal math” and I like his concept.

Daryl on the “cash wedge”:

“When you begin to take income from your investments, the order of the annual returns on your investments makes a big difference. If returns are low in the initial years, the capital base is eroded and that makes it very hard for the portfolio to recover when markets turn back up again.  The Cash Wedge Strategy© can assist in minimizing the impact of withdrawing income during volatile markets. Making withdrawals from investments that are volatile can significantly impact your portfolio. Instead, consider adding a Cash Wedge to your portfolio composition so that retirement income is drawn from a more stable source.”

The wedge is largely constructed like this:

  • Year 1 – a small portion of your retirement portfolio is used for income withdrawals; money is allocated to a conservative, highly accessible investment such as a money market fund or savings account. This is the bucket where you draw your retirement income from.
  • Years 2-3 – a portion of your retirement portfolio is allocated into a guaranteed short-term investment, such as a 1-2 year Guaranteed Investment Certificate (GIC), some bonds or some fixed-income funds. On maturity, these investments are used to replenish the retirement income bucket you’ll withdraw from (Year 1).
  • Years 4+ – the rest of your portfolio is left to grow, as a diversified equity portfolio, providing growth for future years and to fund the early-year buckets.

Cash Wedge

 

Opening the investment taps

The “cash wedge” process is very sound and I will probably implement a derivative of this at some point.  However, I think this strategy requires regular maintenance.  So, for less maintenance I will likely do something like the following:

  • Treat any income from our pensions like it is: fixed-income.  I will try to ensure this fixed-income allocation is about 30-40% of our portfolio.  If we cannot meet this criterion I will use whatever portion of our investments to get this fixed-income allocation.  It is my expectation that most of our fixed-income will pay for basic retirement expenses (all food, all shelter and all clothing).  If not, we will have to a) work longer (to build our portfolio) or b) spend less in retirement or both.
  • I intend to keep about one-year worth of retirement living expenses cash savings.
  • After the one-year cash fund is tucked away I will create a 50/50 split of the remaining portfolio funds this way:
    • 50% invested in dividend-paying stocks from Canada and the U.S. and use the dividend income generated from these investments for living expenses, and
    • 50% invested in a couple of low-cost, diversified, equity or dividend ETFs that invest in hundreds (or thousands) of stocks from around the world. We will spend the distributions from these investments and keep the capital intact for a period of time, for long-term growth.

The equity portions in our portfolio should provide a mixture of steady dividend income and distributions and some capital appreciation while the fixed-income portion should provide all basic retirement needs.  You might be wondering about CPP and OAS?  I figure any income from government programs is a bonus for us in our 60s.  CPP and OAS money will be used as a hedge against major spikes in inflation.

There are a number of retirement strategies to consider and I’m sure my approach to prepare for retirement will change.  For now, using the “cash wedge” process as my starting point, my hope is to layer our income delivery process to cover basic living expenses and structure the rest of our portfolio for steady income and growth.

What are your thoughts on the cash wedge?  Will you use a similar strategy?  Retirees – how are you managing your cash flow?

Image courtesy of  http://www.diamondretirement.com/strategies

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15 Responses to "Cash Wedge and Opening the Investment Taps"

  1. I must be missing something with this idea. If you can have 25% or so of your portfolio in money markets and CDs earning a couple % and live off that then you have more then enough money to worry about needing income.
    e.g. To need $50,000 of income at 2% would be $2.5m. If that is 25% of your portfolio you have $10 million to live off of in retirement.

    Dont get me wrong I am a huge fan of income assets and strongly believe that a person should have income in the portfolio vs selling assets to live off of.
    However I don’t think living off interest of that low a category of yield would work out.

    Reply
    1. Well, yes and no. Use the equity investments that are more long-term to fund the short-term investments, whereby the first year is in cash and very liquid and investments are less liquid as the duration gets longer

      Your idea is what I’m trying to achieve; live off investment income and not necessarily draw-down capital to generate income .

      Reply
  2. Interesting strategy. The tax consequences of investment withdrawals in retirement years can be huge. I think most people should aim to achieve a balance between pension income, drawing down their RRSP and of course a TFSA. For people retiring now (or already retired) a TFSA likely isn’t a huge factor since the balances are likely small relative to their overall retirement income. However for someone like myself who has 20 years until retirement, a TFSA can be a huge factor. I view the TFSA as a gift from the government because the income is completely free of tax and can help anyone with expenses as they retire. As you know RRSP withdrawals get taxed at the marginal rate and eligible pension income can affect things like the OAS clawback. I think it’s important for people to consider the tax consequences of any withdrawals as they can be huge depending on their own individual circumstances

    Reply
    1. RRSP withdrawals are a huge barrier some investors must overcome. With over a dozen years into a DB pension and DC pension for my wife and I respectively, some RRSPs and maxed out TFSAs – if my wife and I can maintain our savings rate – we’re on a decent track. More work to do on the debt stuff though 🙂

      Reply
  3. I used a similar plan of action for my mother in law. I made sure she had enough cash in high interest saving account 1.05% for 1.5 years and the rest I have in a monthly dividend paying portfolio about 4% to supplement her income until her full pension and old age security kick in. I hope she can retain her capital without drawing it down before she dies but it is gonna be tight. All depends on her expenses in the future.

    Reply
  4. I sort of did this with my kids RESPs, in that I withdrew the money in Bonds and Money Markets and then wait to withdraw from equity based funds (but this was 2008 and the market had gone in the tank).

    Reply
  5. Seems pretty much like using a cushion of cash for your monthly needs, having liquid interest paying assets that can easily be drawn on/come due regularly/deposit income into the cash pool + equities to keep topping up the cash cushion monthly. For me ideally, i’d like to have fewer bonds/gic’s due to lower returns(least for now) but also as previously mentioned that interest is taxed as income unlike dividends which are generally at a lower rate. And definitely prefer to have investment income be higher than expenses of course 🙂

    Reply

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