Cash runway: An effective strategy for income-dependent portfolios
At Waugh McDonald, we've long advocated for the concept of a "cash runway" in portfolio management, particularly for those who rely on their investments for income, such as business owners transitioning out of their companies and retirees. This approach involves maintaining a specific number of years of living expenses in cash and fixed deposits, providing a buffer against market volatility. A recent review of a Client Family Trust portfolio illustrates the effectiveness of this strategy.
The cash runway in action
The Client Family Trust initially established a substantial cash runway, allocating approximately $1 million (about 16% of their current portfolio) to cash and fixed deposits under our management. This provided a 5-year cushion for living expenses.
This real-world scenario demonstrates both the utility and the need for ongoing management of the cash runway.
Balancing growth and security
While the cash runway is crucial, it's just one part of a comprehensive strategy. The Client Family Trust's portfolio also includes:
84% in equities (approximately $5.2 million): Aimed at long-term growth
Current total portfolio value: $6.2 million (grown from an initial $4 million over 4.5 years)
This balance has allowed us to pursue growth while maintaining short-term financial security. Our approach aligns with Warren Buffett's wisdom on the power of equity investing. As Buffett once said, "The stock market is a device for transferring money from the impatient to the patient." By allocating a significant portion of the portfolio to equities, we're positioning for long-term growth while the cash runway provides immediate security.
We view the biggest risk to our clients' financial well-being as running out of money, not short-term market volatility. Our cash runway strategy is designed to address this fundamental concern, allowing us to focus on long-term growth while managing short-term needs.
This strategy differs from the classic 60/40 equity/bond split. Instead of relying on bonds for stability, we've created a more polarised approach: a substantial cash runway for immediate needs, with the remainder invested in equities for growth. This allows us to potentially capture higher returns in the equity markets while still ensuring predictable cash availability when required.
Key benefits of the cash runway
Market downturn protection: The runway allows income-dependent investors to avoid selling equities during market lows to meet living expenses.
Psychological comfort: Knowing short-term needs are covered reduces anxiety during market volatility.
Strategic flexibility: It provides time to make thoughtful decisions about portfolio rebalancing or asset sales.
Adapting the strategy over time
As the cash position is to be drawn down over the years, it's crucial to reassess and potentially replenish the runway. This might involve:
Reallocating a portion of equity gains to cash
Adjusting withdrawal rates
Exploring other income-generating investments
The importance of regular review
The future erosion of the cash position highlights the need for regular portfolio reviews. At Waugh McDonald, we recommend:
Annual reassessment of the cash runway
Adjusting the strategy based on market conditions and personal circumstances
Considering tax implications of any portfolio rebalancing
Conclusion
The cash runway strategy, as exemplified by the Client Family Trust, offers income-dependent investors a powerful tool for managing market volatility and ensuring financial stability. While the Trust's cash position will decrease over time as planned, the runway provides crucial protection and flexibility.
This approach allows for a more aggressive growth strategy in the equity portion of the portfolio, as demonstrated by the overall portfolio's impressive growth from $4 million to $6.2 million over just 4.5 years.
At Waugh McDonald, we tailor a strategy to each client's unique situation, recognising that the ideal balance between cash reserves, and defensive and growth investments can vary. Regular reviews and adjustments ensure that the cash runway continues to serve its vital role in portfolio management for those relying on their investments for income.
Our cash runway approach offers a unique alternative to the traditional 60/40 portfolio typically associated with a moderate risk profile. By allocating approximately 16% to cash and fixed deposits as a cashflow runway and the remaining 84% to equities, we've achieved strong performance for this client, growing their portfolio significantly over 4.5 years. This strategy provides both the security of a substantial cash buffer and the growth potential of a larger equity allocation.
While this approach has worked well in this instance, it's important to note that all investment strategies carry risks, and past performance doesn't guarantee future results. The ideal portfolio allocation always depends on individual client circumstances, goals, and risk tolerance. We tailor our approach to each client's unique situation, ensuring that the balance between cash reserves and growth investments aligns with their specific needs and objectives.
Reach out to us today at info@waughmcdonald.co.ke to explore how a cash runway can help secure your financial future.
.png)
