In our previous posts, we’ve discussed the value of giving your dollars a job description, thinking about timing and first use, and the difference between risk and volatility. Currently, we’re witnessing extreme volatility and price movements in equity investments. Some days are up, while others are down. The markets here, in the U.S. and abroad, do not like uncertainty. Uncertainty is present, not only in our financial lives, but also in our day-to-day living as we work, play, and make various choices with our time.
So how do you plan for uncertainty? At Flowerstone Financial, we believe it begins by creating a written plan that outlines your short and long term priorities. This positions you proactively, from the start, to focus on inputs instead of outcomes. A review of safety net planning is also addressed as part of your plan to ensure or limit reacting as much as possible. Often the families we speak with have a lot they want to accomplish. It often remains unclear to them as to where they might start and how to get it all done. A written plan provides clarity and direction as you put your goals down on paper. It gets you thinking, “How might this impact the selection of investments in support of my plan?”
Each plan that we create needs to have a certain aspect of cash reserves in place before we may address investments. We’ve discussed how easy it is to second guess your decisions or question your choices when you use the wrong account or dollars for a purchase or expense. Investing for tomorrow begins with an honest assessment of your cash reserves today and how much you should hold. What upcoming expenses are you preparing for? New auto purchase, summer vacation, income taxes in April? All of these examples are short term cash needs that are best addressed with available cash today. Only after you have addressed your short term cash needs should you move on to selecting investments for the long term. In our experience, most investors are too busy and successful to think about short term cash needs until they find themselves really wanting more cash.
The problems created by using the wrong dollars, or mentally accounting for multiple roles from a single cash account, are often due to our brain. Our brain likes short cuts (less is more) and it will often take the path of least resistance. Our brains can play tricks on us and create difficulties in our financial lives. That’s the value in reviewing your balance sheet annually and checking the job description of each of your accounts. Putting pen to paper allows you to reset your expectations or make changes if necessary in what you are holding and why.
So how much cash reserves should your plan account for? That answer depends on your short term spending needs. Long term cash has a role in planning too. Retired individuals and families tend to hold 24 months of expenses in cash to plan for the current volatility we’re experiencing today. Some hold more and some hold less, it’s a personal choice which should be determined by your written plan. When you’ve repurposed your time, you will need dollars to spend and live on, regardless of where “the market” stands at any given time. Cash reserves allow you to suspend equity distributions in times like these so you may continue to make essential and discretionary purchases.
Cash provides security in many forms but we cannot delude ourselves into thinking cash is an asset class or an investment. Cash is not a strategy or investment policy, it best represents liquidity. Cash just sits there and provides a return of your money when called upon. Attempting to treat your cash as an investment or expecting a higher return will most certainly cause problems. Cash has a specific role to play in your plan. It can’t, and won’t, keep pace with the rising cost of life, therefore investing in equities is necessary. Life is fun and can be expensive, we’ll cover how equities addresses both next time…