At some point, I am going to retire, so I wanted to calculate how much of my portfolio I should put into cash in order to protect myself against sequence-of-returns risk. If you’re withdrawing monthly from a portfolio that’s partially invested in equities and a bear market comes along, you’ll run out of money a lot sooner than if you’re in a bull market, and it only makes sense that putting part of your portfolio in cash would provide some protection. So I looked at various scenarios over the last 47 years, and I’ve come to a rather surprising conclusion.

Let’s assume you have $1,000,000 and you withdraw $5,000 a month. If you keep it all in cash, you run out of money after 200 months, or less than 17 years.

Now let’s assume that you put a portion of that money in an index fund (for the sake of convenience I’ve used the Wilshire 5000 index in this article, with dividends reinvested; you can read about it here). How much of it would you need to put in equities in order to eliminate the chance that you’d run out of money in less than 30 years? I’m assuming you keep the percentage constant and rebalance every month. In other words, if you decide to put 40% in the index fund, you’d look at your total balance at the end of every month and make sure that exactly 40% was invested in the index fund.

Well, let’s take starting points on January of every year from 1971 to 2003, giving us 33 different trajectories (after 2003 doesn’t give us enough years to evaluate). If you put all your money in cash, your chance of running out of money is 100%. If you put 40% of your money in an index fund and 60% in cash, you’d still run out of money at some point in four out of those 33 possibilities, and moreover, 12 of them have a less-than-30-year track record, so it’s possible that you’d run out of money in some of those scenarios too. So 40% simply isn’t enough to put into equities to provide protection.

Now what if your withdrawal rate is higher, say $10,000 per month, or an initial withdrawal rate of 1% (12% annually)? In all cash, you run out of money in 100 months, or a little over eight years. That’s bad.

We can now add five more starting points, extending our list of beginning years to 38, including the possibly dire scenario of beginning in 2007 or 2008. With a 50/50 allocation to equities, you run out of money in 143 months, on average, or close to 12 years (the range of possibilities is 99 to 199 months). There’s a 1 out of 38 chance that your money will run out sooner than if you had kept your money in cash, but that’s only one month sooner.

With a 75/25 allocation to equities/cash, you run out of money in 189 months, on average, or close to 16 years (the range of possibilities is 96 to 385 months). Now the chance of running out of money sooner than if you were in 100% cash is 2 out of 38, but again, “sooner” means a difference of less than six months. Clearly, a 75/25 allocation to equities is better than a 50/50 allocation, no matter what your withdrawal rate is.

And what if you put the whole sum into equities? Well, in a number of cases - 15 out of 38 - you never run out of money. You can just keep withdrawing $10,000 per month until today, which means between 16 and 44 years (remember we’re comparing to an eight-year period for the all-cash scenario). In 2 out of the 38 cases (if you’d started in 2000 or 2001), you’d have run out of money sooner than you would if you had been in all cash, but again, “sooner” means less than a year sooner (the range of possibilities is 91 months to forever).

A lot of RIAs advise keeping some portion of your funds in cash. There are certainly very good reasons to do so. It’s convenient to have cash if you want to pounce on an undervalued asset, take fast advantage of an opportunity, use as a liquidity reserve in case you’re unable to sell your holdings, or simply pay your bills. But to keep cash on hand because of sequence-of-returns risk simply makes no sense.

Is sequence-of-returns risk a myth? Absolutely not. Starting returns make a huge difference to the longevity of your retirement account. But is the solution to this risk to hold a portion of your portfolio in cash? Absolutely not. Cash is a terrible hedge. It offers no long-term advantages whatsoever over equity holdings.

Of course, even if cash has had no advantage in the past 47 years, it’s possible that we’ll see a bear market that is far worse - deeper and longer lasting - than any since 1971. There are certainly countries where this has happened. But not in the US. Compared to a domestic equity index fund, cash is truly trash.

CAGR since 1/1/16: 47%.

My top ten holdings right now: NTWK, PCOM, OSIR, PDEX, PERI, RLGT, LFVN, ELMD, BDL, AVNW.

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