Howdy, Stranger!

It looks like you're new here. If you want to get involved, click one of these buttons!

In this Discussion

Here's a statement of the obvious: The opinions expressed here are those of the participants, not those of the Mutual Fund Observer. We cannot vouch for the accuracy or appropriateness of any of it, though we do encourage civility and good humor.

    Support MFO

  • Donate through PayPal

Cash Flow Strategy

edited July 2021 in Other Investing
An excerpt from a longer writing. Both seemed worth sharing.
E&K Cash Flow Strategy. Sometime in the early 1980s, at Evensky and Katz we developed the E&K cash flow strategy that we continue to use today. It allows us to break the paycheck syndrome -The traditional withdrawal strategy for retirement is the income portfolio. It is a deeply flawed strategy, and any financial adviser who recommends income portfolios should cease and desist. Clients think that because they are retired, the way to get income is through dividends and interest. Such thinking arises from what my partner Deena calls the “paycheck syndrome,” by providing clients with a regular cash flow that they can depend on. Typically, it also includes an inflation adjustment because pay typically goes up with inflation.

To implement the cash flow strategy, we bifurcate the portfolio into two components—the cash flow reserve and the investment portfolio. The cash flow reserve portfolio is made up of two parts: two years’ worth of cash flow and any amounts needed for lump-sum expenses—a wedding, a new car, for instance—over the next five years. We base this amount on our five-year planning model. We do not believe in investing in stocks or bonds unless we have a five-year window in which to decide when to sell. We thereby mitigate the timing risk because we have control over the timing.



  • Nice piece. Evensky is a common sense kind of guy. I'm not sure where that excerpt came from, because it looks somewhat like a mashup of three consecutive paragraphs on p. 71 (pdf p. 9) of the cited paper. It's worth reading what's in the paper for emphasis. I've highlighted some additonal text:
    Clients think that because they are retired, the way to get income is through dividends and interest. Such thinking arises from what my partner Deena calls the “paycheck syndrome,” and it is nonsense. ...

    ... if clients depend on income largely from their bond portfolios, then when interest rates go up, they feel rich. But what is actually happening to the value of their portfolio? It is going down. When interest rates go down, they feel poor, but the portfolio value is going up. The strategy runs counter to financial reality. ...

    People need real income. They need real cash flow, not nominal cash flow, and they do not get that real cash flow from an income portfolio.
    In a nutshell, this is why I (and some other posters here) focus on total return, not yield.
    See also M*, Income vs. Total Return: Who Says You Need to Take Sides?

    Needless to say, I also like what he has to say about Monte Carlo analysis:
    [T]here is nothing new about it. ... I think it has been misused and overused. ...

    I see several problems ... First, the increased number of guesses that Monte Carlo allows does not mean more accuracy. Second, Monte Carlo devalues the goal-setting process. Third, Monte Carlo probabilities are all or nothing. If Monte Carlo says I have a 70 percent chance of success, what does the remaining 30 percent mean? Starvation? Finally, Monte Carlo offers no insight into the unexpected, such as a Katrina event or the subprime crisis.
    He goes on for several paragraphs with examples and ways to address his concerns.

    The cash flow strategy described may be better known as the two bucket strategy:
    The first bucket strategy was developed by financial planning pioneer Harold Evensky in 1985. This was a two-bucket approach with a cash bucket holding five years of retirement spending, and a longer-term investment bucket consisting mostly of stocks. When the stock market performed poorly, withdrawals were taken from the cash account to avoid selling stocks in a down market, and when the stock market did well withdrawals were taken from the investment bucket, and investments from this bucket were also sold to replenish cash.

    As a complement to the final section of the paper, Other Strategies, here's Wade Pfau's Fortune piece on managing sequence of return risk.
  • edited July 2021
    Do we suppose anything in the last 13y, since 2008, the date of the article, has caused modulation of any of its core thoughts?
  • msf
    edited July 2021
    From cited paper:
    One of the primary questions clients want answered is: What is the safe maximum withdrawal rate? Once again, Bengen has done some of the seminal work on this topic and has currently settled on a withdrawal figure of 4.15 percent for a portfolio with 63 percent in stocks.
    This was outdated in 2008, let alone today. Bengen had raised the figure to 4.5% in 2005 by incorporating small cap stocks, and today his figure is even higher:
    Bill [Bengen]: [I]n 2005, while I was working on my book, I introduced small cap stocks, U.S. small cap stocks, which really juiced everything. The return – they didn't have a perfect correlation with large cap, so that juiced it from 4.15% to almost 4.5%. ... And that's when I came up with that number.


    Michael [Kitces]: And so, what do you think about as the number in the environment today?

    Bill: I think somewhere in 4.75%, 5% is probably going to be okay. We won't know for 30 years, so I can safely say that in an interview.
    Kitces, Financial Advisor Success Podcast!, Oct 13, 2020
  • When I needed some revision surgery 12y after the first op, I asked the doc if the need had to do w subpar work prior. He said 'Nope; life happens; wear and tear'. I said 'What about 12y from now? Will I need it yet again? Will your work last longer?' He said, 'Dunno; I'll be retired.'
  • 4% is the new 3.5%.
  • It all depends on how long you think the next bear market will last. You need to have enough cash to avoid selling stocks at the bottom to live on. If portfolio ( or SP500 or whatever index you like) value is within 5% of top sell some equities for replacement of that year's expenses. If less than that use the remaining cash/bond portion.

    In 1929 it took 32 months to recover but got hit again in 1937 and it took five years.
  • It all depends on how long you think the next bear market will last. You need to have enough cash to avoid selling stocks at the bottom to live on.
    Good point. Having enough cash would lessen the pain throughout the drawdown. Today environment with the Fed may have change the situation comparing to the depression era in the 30's.
  • Another Tool that looks useful slanted towards rich looks good for all.

    I would rather use this than borrowing against a house !!

    — 5:30 AM ET 07/10/2021
    By Rachel Louise Ensign and Richard Rubin

    Rising stocks and rock-bottom interest rates have delivered a big perk to rich

    Americans: cheap loans that they can use to fund their lifestyles while minimizing their tax bills.

    Banks say their wealthy clients are borrowing more than ever before, often using loans backed by their portfolios of stocks and bonds. Morgan Stanley (MS) wealth-management clients have $68.1 billion worth of securities-based and other nonmortgage loans outstanding, more than double five years earlier. Bank of America Corp. (BAC) said it has $62.4 billion in securities-based loans, dwarfing its book of home-equity lines of credit.

    The loans have special benefits beyond the flexible repayment terms and low interest rates on offer. They allow borrowers who need cash to avoid selling in a hot market. Startup founders can monetize their stakes without losing control of their companies. The super rich often use these loans as part of a "buy, borrow, die" strategy to avoid capital-gains taxes.

    The merely rich are also borrowing against their portfolios. When Tom Anderson started at Merrill Lynch & Co. in Cedar Rapids, Iowa, in 2002, many of his fellow advisers had just one or two securities-based loans in their book of business. Over the years, he encouraged more clients to borrow and noticed peers doing the same. Now it is common for advisers at big firms to have dozens of these loans outstanding, he said. Merrill Lynch is now a part of Bank of America (BAC).

    "You could buy a boat, you could go to Disney World, you could buy a company," said Mr. Anderson, who now consults with banks on how to manage the risks associated with these loans. "The tax benefits are stunning."

    For borrowers, the calculation is clear: If an asset appreciates faster than the interest rate on the loan, they come out ahead. And under current law, investors and their heirs don't pay income taxes unless their shares are sold. The assets may be subject to estate taxes, but heirs pay capital-gains taxes only when they sell and only on gains since the prior owner's death. The more they can borrow, the longer they can hold appreciating assets. And the longer they hold, the bigger the tax savings.

    "Ordinary people don't think about debt the way billionaires think about debt," said Edward McCaffery, a University of Southern California law professor who says he coined the buy-borrow-die phrase. "Once you're already rich, it's simple, it's easy. It's just buy, borrow, die. These are planks of the law that have been in place for 100 years."

  • beebee
    edited July 2021
    @Sven I found this on the topic of Buy, Borrow, Die. thanks.

  • edited July 2021
    @bee, thank you for the links. Very informative indeed.
  • edited July 2021
    Concerning SWR....when presented with problems in life it usually is prudent to allow for a margin of safety. One business cycle normally contains several painful surprises.
  • From the first piece:

    You’ll want to put this money into the stock market, real estate, or another asset class that appreciates. ...

    Real estate is almost perfect for this because:
    • its value tends to go up,
    • it is not volatile
    • you can depreciate it, which reduces your income tax
    • it’s easily accepted as collateral.
    Given that the idea is for you to never sell and that it would be extremely painful for you to sell (with cap gains and net investment income taxes due on both the appreciation and the depreciation), volatility of a buy/hold/die asset seems irrelevant.

    Depreciation is permitted only for income producing property, so you couldn't just buy land and depreciate it. You'd have to either manage rental property yourself or pay someone else to do this. Either way, another added cost.

    IRS Pub 522, Chapter 2, Depreciation of Rental Property

    Collateral? It's at least as easy to to get a margin loan on securities as a real estate loan. Liar loans are still available for investment properties so I guess you could cash out that way. But it would probably cost you more than a margin loan. IB offers rates of 2.6% variable or lower depending on your type of account.

    What about property taxes? If this added cost was mentioned in either piece, I missed it. (There was note in the comment section on Calif. property taxes in the first piece, but not in the context of a current cost.)

    Though the resemblance is largely superficial, the cited pieces call to mind pitches for whole (or universal) life insurance - you can borrow against the investment tax free and its value passes tax free (aside from estate taxes) to heirs. From the closing paragraph of the second piece:
    The result, therefore, is a life without taxes. The principal investment provides, through appreciation, additional wealth, which the Patriotic American Citizen then matches in debt.
  • beebee
    edited July 2021

    This is all outside my pay grade, but I think you make a good point regarding the use of borrowing on margin. I just would be concerned with the risks of borrowing on margin and how one might mitigate risk.

    If one bought real estate using a margin loan how would one best manage downside market risk? If markets trend upward, the investor might enjoy the ride of both the stock market and the real estate market. But, if markets trend downward, all kinds of negative scenarios come to mind. The most devastating being a margin call on the loan. A loan that is tied up in a not so liquid asset, real estate, that may be losing value also.

    Would a protective puts help? Option contracts would add additional costs and would need to be rewritten as they expire. They might provide a layer of insurance against a margin loan being call.

    As far as IB goes:
    Is there a cost to being on the IBPro platform at IB verses their IBLite membership?
    -The Margin loan rates look to be about half with IBPro (1.3% verse the 2.6% you quoted).
    Wonder also, is the surcharge avoidable and is it a one time charge?
    Is a margin loan purely an interest only loan?
    Are these loans "all or nothing loan" or can one pay down the margin & interest over time?

    Navy Federal has 2.635% fixed for 30 years (conventional mortgage loan) refinanace comes in at 4.25%
  • I've had limited vicarious experience (POA, executor) with investment real estate property including depreciating and inheriting it, and with using a margin account to borrow against securities (drawing out cash). So I've gone through the processes, but that's about all.

    The buy/borrow/die strategy seems to be to tap (borrow) money gradually as needed (without incurring taxes). Not so much to leverage for more investing whether in stocks or real estate. When the strategy is followed in moderation over time margin calls should not be a concern. That's because as the assets appreciate, the loan to value ratio drops, enabling one to safely borrow more.

    The Navy Fed conventional mortgage rate you mentioned is almost surely for an owner-occupied home. That's different from investment property. You can't depreciate your home and you can't take a loss on it if you sell it for less than cost.

    But what one can do with owner occupied property and not with investment property is flip it to avoid cap gains taxes. One does not need to buy/borrow/die. One can exclude up to $250K (individual)/$500K (joint) of gain from income. Rinse and repeat. This is not a cash flow strategy. However the point of the buy/borrow/die strategy is not so much to generate cash flow as it is to avoid taxes on the needed cash.

    I've rarely looked at IB, because it is targeted at active traders, and because historically it was not hospitable to mutual fund investors. From what I see now, some of that has changed. In general I'm not a good source of info on IB. Perhaps the more active traders here can provide better insight.

    One thing I did find is that IB just (July 1) dropped its inactivity fees on IB Pro.

    My limited experience with borrowing cash on margin was suggesting this to a friend to use as a bridge loan between closing on the purchase of one property and on the sale of another. The payments made on the loan were pure interest. Since the entire amount was repaid once the sale closed, I can't say for certain that a partial repayment would have been okay, though I don't see why not.
Sign In or Register to comment.