You will be able to size a spending buffer that lets you avoid selling investments after a fall.
Imagine the second year after you stop work. Markets have fallen by a third, the headlines are grim, and the funds you planned to sell for this year's spending are worth far less than they were. You have two options. You can sell anyway, at the bottom, or you can pay the bills from money that never went into the market at all. The second option exists only if you set it up years earlier.
Lesson 2.3, Sequence risk: why the first years matter most, showed that losses early in a drawdown do the most damage, because selling after a fall locks in the loss. This lesson sizes the main defence against that risk.
A cash buffer is a reserve of one to a few years of spending held outside the share market, in places where its value does not fall when markets do. Savings accounts, fixed deposits, Singapore Savings Bonds and Treasury bills are common places to hold it. Each has its own access rules and returns, which Bonds, T-bills, SSBs and fixed deposits covers, and none of them is a recommendation here.
The buffer is different from your emergency fund. The emergency fund is for surprises while you are working. The buffer is a planned part of your drawdown, there to pay your regular spending in years when selling investments would be a bad idea.
In a bad year, you spend from the buffer and leave your investments alone. They have time to recover without you selling at low prices.
In a good year, you do the opposite. You spend from your investments, and you also sell a little extra to top the buffer back up to its full size. Selling after markets have risen means you are moving money out of shares at better prices.
Over a full cycle, the buffer shrinks in the bad stretches and refills in the good ones. Its job is to give the portfolio time.
There is no single right size. A buffer of one year protects you against a short fall. Two to three years give you more room in a longer downturn, though markets have at times taken longer than that to recover. Beyond that, the extra protection comes at a growing cost.
That cost is real. Money in the buffer earns less, over the long run, than money in shares is expected to earn. With made-up figures, if a buffer of S$88,000 earns a real return of 1% while the rest of the portfolio is assumed to earn 4%, the difference is 3 percentage points a year on S$88,000, about S$2,640 a year of expected return given up. That is the price of the protection. It is not wasted. It is what you pay so that a bad start does not derail the plan.
A few things push the size up: a long bridge, a high share of essential spending, and a withdrawal rate at the top of your range. A few push it down: flexible spending you are willing to cut, part-time income, or CPF LIFE already covering most of your essentials.
Priya, from the earlier modules, chose two years. Her made-up spending base is S$44,000, so her buffer is S$88,000. She reasoned that her bridge is long, but that a third of her spending is flexible, and her spending rule from lesson 2.4 already cuts travel in a bad year. Two years with those cuts would stretch further.
The buffer only works if it is managed by rule. Without one, you will refill it when you feel nervous and empty it when you feel confident, which is the reverse of what helps.
A refill rule needs two parts. The first says when you spend from the buffer instead of investments. The simplest version reuses your definition of a bad year from lesson 2.4: if the portfolio has fallen by your trigger amount over the past twelve months, spend from the buffer. The second says when and how you refill. A common version: in any year when the portfolio is at or above where it started that year, sell enough to bring the buffer back to full.
Priya's reads: "If my portfolio has fallen 15% or more over the last twelve months, I spend from the buffer. In any year when the portfolio ends at or above where it started, I sell enough to refill the buffer to two years of spending. I review the size of the buffer at each yearly review."
The buffer matters most in the early years after you stop, when sequence risk is highest, and through the bridge years, when nothing else is paying in. Once CPF LIFE begins and covers most of your essentials, the portfolio carries a smaller share of your spending, and you may decide a smaller buffer is enough.
Before the activity, look at where your own spending sits between essential and flexible, and how long your bridge is. Those two facts will do most of the work in choosing your buffer size.
Choose a buffer size in years of spending, the place you would hold it and the rule for refilling it.
Junxiong-WFG Organisation is an authorised representative of AIA Financial Advisers Private Limited (Reg. No. 201715016G).