This article originally appeared in our monthly newsletter, Fiscal Therapy.
Please subscribe if you'd like to receive similar articles on a monthly basis.
WHAT I’M THINKING ABOUT:
If cash is king, cash management is queen
Cash is like the unloved stepchild of the personal finance industry. Turn on Mad Money and you’ll hear all about hot stocks. Read John Bogle’s legendary The Little Book of Common Sense Investing, and you’ll learn all about index funds. But when a crisis hits, it’s cash that turns out to be the Cinderella that everyone chases. In the first quarter of 2020, U.S. money market funds (which invest in cash) saw record inflows of almost $700 billion, while stock funds and bond funds each saw net outflows of around $30 billion.
What’s so good about cash? It’s liquid and doesn’t lose its value (apart from inflation). So it’s kind of like your boring, trusty mule — dependable and there when you need it.
Businesses and families alike have suffered from a cash crunch as the world and American economies have ground to a halt. And without sufficient cash, you either rack up debt or you go without. Obviously, it’s a whole lot better to develop a cash allocation plan before a crisis hits rather than during one. But, better late than never. (And if the current crisis has left you strapped for cash, see the section down below for some recommendations.)
How to Allocate Your Cash
So how much cash should you keep on hand? As a rule of thumb, any financial needs and goals within the next two years should be in cash. Here’s how this breaks down.
Checking
This is your operating account for short-term spending. Most people do well with somewhere between 3-8 weeks of upcoming expenses and debt payments in cash — in other words, enough to pay the bills plus a little cushion so you’re not worried about your checking running dry before your next paycheck.
All extra cash should be moved out to savings or investment accounts so you’re earning more on your money (more on that below). Be sure to set up automatic transfers from checking to savings accounts (and potentially investment accounts) so you’re immediately sweeping out excess cash once your paycheck hits and directing it toward your financial goals.
Savings Accounts for the Current Year’s Needs
Any financial needs coming due in the current year should also be kept in cash — in high-yield savings, though, so you’re earning more. I’m a big believer in using separate savings accounts for each category of financial need or goal, as this has a way of endowing each bucket of money with purpose (along with keeping you organized). Here are a couple of common categories to set up as savings accounts:
Large Annual Spending: This account holds funds for the year’s larger, irregular expenses, like vacations, medical expenses, annual insurance premiums, home maintenance and repairs, large gifts, tuition, and summer camps. At the beginning of each year, plan out approximately how much you’ll need, and then fund the account with monthly transfers from checking to savings. If you’ve planned properly, the account will last through the year and avoid any cash flow crunches.
Estimated Tax Payments: If you make estimated tax payments, it’s good practice to set aside funds in a separate savings account in advance. So, for example, if you exercise a bunch of stock options, be sure to set aside enough of the resulting cash in a separate savings account to cover the estimated tax payment. That way you don’t find yourself having to sell off investments to make a payment a few months later.
Emergency Savings
Maintain a separate high-yield savings account to hold enough cash to cover 3 to 6 months of expenses and debt payments. This rainy day fund is the financial buffer that stands between you and credit card debt (and financial stress) when unfortunate and out-of-the-ordinary life events happen, like income loss due to the current pandemic.
Other Financial Needs and Goals within Two Years
Additionally, any financial goals with a time horizon within the next two years should be in cash. Why? So that you’re not depending on the market’s short-term performance to meet your financial goal. If your down payment fund was in the stock market at the beginning of this year, by mid-March your dreams of homeownership were going up in smoke. So keep those near-term goals in high-yield savings. Here are a couple of examples:
Down Payment: If you’re planning on buying a home in the next two years, keep the down payment savings in cash. You don’t want your down payment fund to be subject to short-term market downturns, and you also don’t want to be drawing from emergency savings or retirement savings to make the down payment.
Baby Fund: Having kids is expensive, whether it’s one partner downshifting, taking unpaid leave, or leaving their job, or even just the cost of baby gear and maybe a doula. If you’re planning on starting a family in the next couple years, it’s smart to set aside savings in a separate account for large one-time expenses related to having a baby.
Any goals more than two years out, however, should be invested to earn higher returns, and the longer time frame will insulate you from short-term market gyrations. The closer to the goal, the smaller the allocation should be to equities. For example, savings for a down payment in 4 years should have much less exposure to equities as compared to a retirement account that won’t be touched for 20+ years.
Where to keep your cash
Keep your cash at an FDIC-insured institution that pays a competitive interest rate and carries no maintenance fees. Currently, great options include Capital One, Barclays, Marcus and Ally. These banks have strong reputations, great client reviews, no fees, user-friendly convenience, and around 1.5% APY (annual percentage yield) on cash savings. I tend to favor banks like Capital One 360 and Barclays that allow you to open multiple accounts so you can keep your cash organized according to goal and purpose.
What To Do If You’re Strapped for Cash
Being short on cash during this crisis is not an easy position. While each person’s circumstances are different, here are some recommendations that will generally be helpful for everyone.
1) Understand what you have. Create a net worth statement if you don’t already have one. Effective change starts first with a clear picture of your finances.
2) Slow down your drain on cash. Trying to generally reign in spending is of course a good idea, but be sure to take these more targeted steps.
Pause any automated savings or contributions you have in place, such as your 401(k). Tax-deferred savings for retirement are nice, but having sufficient cash now is better.
Pause or cancel any non-essential recurring bills such as the gym, extra streaming subscriptions, or other monthly subscriptions.
Call your creditors and negotiate. Can you negotiate a lower payment, lower interest, or penalty-free delay on your next payment? The CARES Act provides certain relief measures for qualifying student loan debt and many lenders are making allowances for COVID-19 related hardships right now.
3) Get a budget. While you’re at it, take stock of all areas of spending and create a thoughtful plan for your cash going forward.
4) Spend down cash, then investments. The reality may be that you’ll need to spend down some savings during this time. Here are some guidelines on the best way to do this.
If you have emergency savings, tap that account first.
If you have FSA and HSA accounts and have not yet taken withdrawals for eligible expenses, do so now.
If you have taxable investment accounts such as a joint brokerage account with a spouse, you can sell investments and move cash to your checking account within a few days. There may be taxes due next April if the investments you sell had capital gains, but there’s no penalty for taking money out of a taxable investment account. I often find clients have extra cash that was never invested sitting in an investment account which is an easy source of cash.
If you have a Roth IRA, consider withdrawing past contributions from it if necessary. Contributions to a Roth IRA are made with after-tax dollars. You can take out contributions (not earnings) at any time regardless of your age without taxes or penalty.
The CARES Act also made allowances for penalty-free withdrawals from qualified retirement accounts (e.g., 401k, 403b, IRA) up to $100k regardless of age for those impacted by the pandemic. You may owe taxes on the amount withdrawn but the CARES Act allows you to spread this across a three year period.
5) Wisely and thoughtfully take on debt if necessary. If the above measures are not enough and you must take on debt, go for your lowest cost options first which will vary based on your situation. Credit cards (even those with a limited time 0% interest) are always a last resort. Here are some examples of credit that may be available you:
Small business loan (for the business owners and self-employed) through your bank or the SBA.
Home equity loan or line of credit.
Personal loan. (By personal, I mean a loan from a bank, not your parents.)
401k/403b loan.
6) Federal Economic Impact Payment. I know the stimulus money isn’t coming very quickly, but if you’re entitled to a federal economic impact payment make sure the IRS has correct details on file for you here. Some of you may need to make sure your 2019 tax return is filed to maximize your payment.
Some of the above measures are extreme — tapping retirement accounts, taking on more debt — and should not be taken lightly. That being said, these are extraordinary times which may call for very out of the ordinary actions with your finances. Weigh your options, discuss with close family or friends, sleep on it, and make the best decisions you can given the facts at hand.
What I’m Reading
What Coronavirus Reveals About Wealth Among Friends
By Lisa Miller, The Cut
This essay, fantastically written and personally challenging, explores the socioeconomic rifts the Covid-19 crisis has revealed among citydwellers. As the author’s friends have fled the city for their country homes, she has remained in her Brooklyn apartment.
A whole layer of New York just up and left, including some of my friends. That is shocking, as they say, but not very surprising. The rich have always holed up in the country to wait for historic unpleasantness to pass. Yes, this virus amplifies the differences between us, but the gaps have never been wider, forcing millions to the terrifying edges of the bottom tier.
For those who do have means, the question is how we will respond to the need. We can hole up and turn inward in the name of self-preservation, or we can be proactive and sacrificial about using our resources for the sake of those most vulnerable.
Three Equations for a Happy Life, Even During a Pandemic
By Arthur C. Brooks, The Atlantic
Arthur Brooks, who wrote last year’s excellent article Your Professional Decline Is Coming (Much) Sooner Than You Think, returns with this inaugural entry in his new column on happiness. Here he offers three researched-based formulas for happiness. I recommend reading the article, but here’s the cheat sheet:
#1: SUBJECTIVE WELL-BEING = GENES + CIRCUMSTANCES + HABITS
#2: HABITS = FAITH + FAMILY + FRIENDS + WORK
#3: SATISFACTION = WHAT YOU HAVE ÷ WHAT YOU WANT
Equation #3 is most directly relevant to money. While personal finance generally focuses solely on the “What You Have” part of the equation, I’ve observed how what you have often drives what you want — the more you have, the more you often grow to want. So aim to be wise, generous, and content with what you do have, and you’ll find it serves you (and others) well in the long run.
If you’re ready for financial guidance, accountability, and an action plan, check out our one-on-one services or online courses.