Cash Wedge and Opening the Investment Taps
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/sequence of returns risk.
This is where the cash wedge can really help.
What is a cash wedge?
How can any cash wedge approach help you?
What do I intend to do?
Read on!
Cash Wedge Concepts
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.
This is where any potential cash wedge approach comes in.
Daryl Diamond, a financial planner and leader in Canada on retirement income planning, has a Cash Wedge Strategy©
Daryl on his form of a cash wedge:
“When markets are volatile, it makes a big difference whether you are adding assets or withdrawing assets from your portfolio. When left intact to grow for the long term, the order of the returns on your investments will not affect your portfolio’s long-term average growth rate. This is ‘accumulation math.’ But ‘withdrawal math’ works very differently. 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 may be eroded and that makes it very hard for the portfolio to recover when markets turn back up again.
Making withdrawals from investments that are volatile can significantly impact your portfolio. Instead, consider adding The Cash Wedge© to your portfolio composition so that retirement income is drawn from a more stable source.”
I like the concept.
Traditional Cash Wedge Construction
The cash wedge is typically constructed like this:
- Year 1 – a small portion of your retirement portfolio is used for income withdrawals; money is allocated to a conservative but highly accessible mix of cash or money market funds.
- Years 2 and 3 – another 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 when using GICs, these investments are used to replenish the Year 1 income bucket you’ll withdraw from (i.e., 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. Maybe by then, the equity markets have rebounded a bit.
Source/Reference: Diamond Retirement Income Planning.
http://www.diamondretirement.com/strategies
How to implement your cash wedge?
Consider your portfolio in buckets.
“Bucketing” your portfolio means essentially dividing it into three main investment time horizons above:
- A short-term bucket (say 1-year)
- A medium-term bucket (say 2 or 3 years)
- A long-term bucket (say 4 or 5+ years)
The bucket approach helps the shorter-term bucket insulate your portfolio (think mostly equities/stocks) to remain invested through market ups-and-downs and grow more with time.
Because annual retirement income is drawn from the short-term bucket or Year 1, it holds accessible assets or just plain ol’ cash in reserve.
As annual retirement income is drawn from the short-term bucket or Year 1, it is periodically topped up from the medium bucket, with finally money strategically withdrawn from the long-term bucket to funnel down.
Based on Daryl’s approach:
“On maturity, the short-term investments are used to replenish The Cash Wedge© and provide guaranteed income for years two and three respectively. The rest of your savings is left to grow with time in a diversified portfolio that meets your personal financial needs. Over time, any profits are moved from the invested portfolio into a cash position to create income for year four and subsequent years.”
How to implement your cash wedge using a GIC-Ladder
You can implement your cash wedge using GICs although that’s not a must.
To do so, divide your savings into two (2) or more separate GICs. Terms can range from 1-5 years. Every year, one of your GICs will mature. Take that money and put it into another GIC term.
Here is an example of a 5-year ladder courtesy of Tangerine:
Source/Reference: Tangerine.
By doing this, you spread your savings across different terms WHILE minimizing your exposure to interest rate changes. With some GICs maturing every year, you can spend this if you need to and keep investing in equities instead.
Other cash wedge approaches?
I believe the cash wedge process is sound overall but I will probably implement a derivative of this approach, for less maintenance. I am likely to implement something like the following:
1. Treat any income from our pensions like it is: fixed-income. I will try to ensure this fixed-income allocation is about 20% or so of our total portfolio. If we cannot meet this criterion I may use whatever portion of our personal investments to get this fixed-income allocation including some cash. I hope to enter semi-retirement with some sort of bias to equities but I might need some fixed-income just in case to avoid any sequence of returns risk.
Also called sequence risk, recall sequence of returns risk is the risk that comes from the order in which your investment returns occur. To put it another way, there is a major risk that the stock market declines in the early years of your retirement. If you couple that with ongoing portfolio withdrawals and/or major spikes in inflation, that could significantly reduce the longevity of a portfolio and destroy your retirement dreams.
I hope to avoid that.
Unless I take my commuted pension value, it is my expectation that (eventually) most of our fixed-income via workplace pensions will pay for many basic retirement expenses.
Before any pension years, we’ll rely on our portfolio, particularly dividend income to cover many day-to-day expenses.
2. I intend to keep about one-years’ worth of retirement living expenses (about $50,000) in cash savings – that’s my cash wedge. This portion is really not up for debate. I believe such cash savings will be good enabler to help ride out any short-term market storm and/or cover any cash emergency situation without doing into debt.
At any time, if I don’t chose to “live off dividends or distributions” I could withdraw cash from my cash savings – for market safety.
Worse case, while in semi-retirement, I could spend this cash without ever touching my portfolio value for a year or so. I figure with part-time work in semi-retirement, that gives me about 1-2 years of spending cushion without ever having to touch my/our portfolio.
After our cash wedge/cash savings is tucked away my key retirement income streams will be:
- Income from Canadian and U.S. stocks.
- Income from low-cost, diversified, equity or dividend ETFs that invest in hundreds (or thousands) of stocks from around the world.
Once all debt is gone and the income generated from our portfolio is consistently higher than our expenses then we’ll probably stop working full time.
We will have reached our Crossover Point.
Essentially, a cash wedge can be any combination of the following in my book:
- A cash wedge of cash savings and little bonds or no other fixed income.
- A cash wedge of cash savings, some fixed income in the form of bonds or Guaranteed Investment Certificates (GICs), and/or
- A cash wedge of cash savings, GICs, bond ETFs or simply bonds as part of a balanced portfolio (of stocks and bonds).
Either way, you can see a common denominator of the cash wedge approach is simply to have some cash savings in retirement for any “what ifs” in life.
What about Canada Pension Plan (CPP) and Old Age Security (OAS) benefits?
We will consider taking CPP and OAS money at or after age 65 to be used as a fixed-income hedge against major spikes in inflation. There are a number of retirement withdrawal strategies to consider and I’m sure my approach to prepare for retirement will change over time.
For now, using a modified cash wedge approach is my starting point.
What are your thoughts on the cash wedge? Will you use a similar strategy? Retirees – how are you managing your cash flow?
I am not sure How well the cash wedge works with a RRIF, much of the above talk has been about FIRE _ RRSP. and or non Reg investments.
With a RRIF the yearly increases eat into retained dividends and cash wedges quite fast. Even with a Dividend growth Portfolio that returns a stable 4.5 %, when the minimum RRIF payments get over 5 % the boat slowly sinks. ( as the Gov. intends it to do so ). You also forget that almost 60% of canadians have no Defined Benefit Pension Plan . Not everyone will have a 700 thou or 1 Million RRIF. The current averages run from 100 to 500 thou, And the basic withdrawal is a percentage of The RRIF total INCLUDING cash wedge .I have Darryl Diamonds book and it is a great resource, But it misses the point a bit with those that won’t be spending more than 50 thou with CPP & OAS thrown in. Perhaps a strategy for those of us in the middle and not at the top tax echelons would be an interesting read and resource. I do read your blog regularly.
Thanks Andrew.
I guess where I am coming from is a cash wedge is usually in a taxable account, very liquid, readily accessible and not inside the RRSP/RRIF whereby you want equities compounding away tax-deferred for as long as possible.
No, I am well aware that most Canadians don’t have any pension. Which is why they need to have a 60/40 or 70/30 bias of stocks/bonds in their RRSP/RRIF for mostly growth – for the reasons you stated.
I have also enjoyed Daryl’s book – excellent – but I don’t agree with everything for me 🙂
Thoughts on this:
https://www.myownadvisor.ca/they-have-1-2-million-and-no-pensions-can-they-retire/
No pensions.
Thanks for your readership and comments. I always enjoy hearing from readers and trying to respond to every one.
Mark
Hi MOA,
Just recently stopped working and would be interested in your advice for direction of some New Money expected in the new year. My wife and I both have healthy six figure amounts in RRSPs totaling in the seven figures. After helping our two sons with a total seven years of university the RESPs now depleted and their ongoing studies we are finding it hard to put funds aside for those TFSAs to grow. Starting the drawdown of my RRSP in January but expecting a windfall of approximately 100k that can be split between my wife and I in the new year. I have actively been asking friends with more financial knowledge than myself but I am coming to the conclusion that it may be personal preference on best place to apply funds. I would like to eliminate my kids OSAP debt when they graduate this spring. Any ideas would be greatly appreciated!
Kevin, congrats on the “healthy six figure amounts in RRSPs totaling in the seven figures.”
Great stuff and incredible savings.
I can’t offer direct advice of course but you can certainly gift any money for TFSA contributions to your kids. You might be smart in doing so since that has no attribution rules tied to it. So, while you can’t contribute directly to someone else’s TFSA, and that includes your spouse or children, you can provide another person with money so they can contribute to their own TFSA. 🙂
It really does come down to personal preferences, tax decisions and more. We’ve seen this over at Cashflows & Portfolios looking at many drawdown plans.
https://www.cashflowsandportfolios.com/
Honestly, the next generation has a financial challenge on their hands. I think well-off parents that are not jeopardizing their own financial journey, should they be able to and want to help their kids out, by all means should as they please.
Just some personal thoughts!
An approach could be to help them fill up their TFSAs slowly as they work to kill debt. There is tremendous value in time and money invested. If the debt burden is high, it might make sense to kill that first before investing.
Thanks for your readership!!
Mark : Always love reading these articles, although I am not quite in the same boat. The work pension plans really tip the scales from an income point of view. My partner has or will have a modest DC income , but I don’t and will only have from what I saved or invested. The RRSP / RRIF factor is also a huge hurdle for planning purposes due to the increasing withdrawal rate. I have no fixed income, all solid Div paying stocks. All my stocks must have a annual div. and increasing div. yearly and solid earnings, not a fan of Bonds, but I see the benefit of a GIC or high interest saving for short term cash stash. I have followed Can. Tom Connolly for a number of years, and am a fan of his approach to investing. Keep publishing your articles, always great to get another prospective, on what can be a challenging ( at times) endeavour.
Interesting call on the dividend paying stocks; my plan as well re: cash + dividend paying stocks only for my personal portfolio. I will rely on DB and DC pensions to count as fixed income in my 60s+.
I too, see the benefits of cash or GICs as I get older but I really think investors need to learn to live with stocks with bonds basically yielding nothing.
Huge fan of that retired teacher in Kingston too 🙂
All the best and thanks for the kind words.
Mark
Your cash wedge should be a secured line of credit on your home. Make sure you set it up before you retire so you can have access to the equity in your home. You can use this to weather any dips in the market and replenish it when the market comes back. If you have a Manulife One account from Manulife Bank you can access up to 80% of the value of your home. This could provide you with more than two years of yearly expenses and can be an emergency back up for health care, travel surprises, or a market drop. The last thing you do before you retire is to secure this line of credit so you can qualify using your employment income. A reverse mortgage is usually 50% and is harder to qualify for when you are retired. Put your cash in products that provide better returns as you can access this line of credit at any time. The question is how big of a cheque can you write tomorrow if a need arises.
Really happy to have found a Canadian based financial blog.
I’ve read a few of your posts and you talk about holding US Stocks. A few question:
1. You talk about not having all our eggs in one countries basket (my words not yours but I hope you get the idea) and while I’ve heard about that before, I’ve also read a lot of people saying that Canada is stable (more so than the USA) so I’m wondering why you’re going to invest south of the border.
2. I’ve held Vanguard shares (VGK) since 2009. While they’re up, the tax “hassles” of paying tax (in the USA) and claiming again in Canada at the highest tax bracket just isn’t worth it to me. Have you thought about this?
I have a need for ~$5,000USD cash every year so instead of buying it (and paying the exchange rate), I’m going to open a USD Bank Account (in Canada) and spend that money. Any interest earned will be minimal and my money won’t (potentially) grow but the hassle factor x 2 (buying cash and taxes) will outweigh any potential money earned.
Besos, Sarah.
Always great to hear from readers Sarah.
Hope this helps…
1. You talk about not having all our eggs in one countries basket (my words not yours but I hope you get the idea) and while I’ve heard about that before, I’ve also read a lot of people saying that Canada is stable (more so than the USA) so I’m wondering why you’re going to invest south of the border.
Answer: I do so because while I’d like to think I could predict the future I believe holding U.S. stocks and U.S. ETFs is far better diversification than just investing in Canada. My long-term goal is to own about 30% of my personal portfolio in the U.S. Another 30% in international markets and/or a combination of U.S. multinationals that earn a good portion of their profits from around the world (e.g., KO), and another 40% invested in Canada.
I will be 100% equities for the foreseeable future.
2. I’ve held Vanguard shares (VGK) since 2009. While they’re up, the tax “hassles” of paying tax (in the USA) and claiming again in Canada at the highest tax bracket just isn’t worth it to me. Have you thought about this?
VGK is an all-Europe fund from what I know. Do you have the opportunity to invest in VGK in a tax-deferred or tax-free account? Based on my own experiences such U.S.-listed funds are best served/held in U.S. $$ RRSP. You’ll avoid withholding taxes there.
3. I have a need for ~$5,000USD cash every year so instead of buying it (and paying the exchange rate), I’m going to open a USD Bank Account (in Canada) and spend that money. Any interest earned will be minimal and my money won’t (potentially) grow but the hassle factor x 2 (buying cash and taxes) will outweigh any potential money earned.
I would argue if you’re willing to give up some capital gains, holding U.S. dividend ETFs like VYM and HDV will churn out more income than some other U.S. ETFs. Let the U.S. ETFs you own pay distributions every quarter and spend the distributions as you wish in US $$.
Many investors I know have opened a USD $$ bank account in Canada and keep a “float” in there of about $5,000-$10,000 for international trips. They get the U.S. money into that account by withdrawing RRSP funds each year and winding that account down over time.
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 🙂
I also prefer to have investment income higher than expenses! This is where I want to be, it’s a long journey and I need to be patient Wisp.
Yup same, luckily I’v still got plenty of time being only 25 🙂 Or maybe enough div income to retire + pay for a trip every quarter, now thats a dividend!
Geez, so young! 🙂
I love your articles
I am retired and have a cash wedge of 100k in savings paying 1.90%
My annual expenses before tax are 100k
Can I do better than this?
Should I purchase a GIC for the 100k for 1 yr paying3.50%
Or what do you advise?
Thanks
Thanks very much Bill.
🙂
Well, not advice, but I know for us my cash wedge (about $50k) for semi-retirement will largely be just cash vs. GICs. Potentially as I get older, I might expand that cash wedge into a mix of cash and 1-year or 2-year GICs. I know some retirees and folks we help at Cashflows & Portfolios are doing that now since I see their asset mix.
So, some clients keep $40-$50k in cash, then 1-year GIC (say $50k) that now pays 3.5%+, and then some have 2-year GIC beyond that with another $25k or whatever they wish renewing then. They then keep all other assets invested, mix of stocks, bonds, just equity ETFs based on their financial plan intact.
It really “depends” on your risk tolerance and goals and how long you might need to ride out any short-term (bad) market volatility. I am definitely preparing and will have very soon 1-years’ worth in cash to spend, just in case the markets have to shut down for an entire year – I hope that doesn’t happen of course 🙂
Hope that provides some insights.
Mark
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).
Good to hear how this approach might work for RESPs as well, given those accounts have a shelf-life.
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.
Great to hear from you and understand how this approach might be employed for others.
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
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 🙂
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.
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 .