Buying anything close to the top of the market is risky. For stocks purchased in 2000, it took 10 years for investors to get back to even. In 2018, we’re finally seeing signs of volatility as the market sold off almost 12% from peak to trough.
Who knows the future. All I know is that at this point in time I’m happy to be earning a guaranteed 4.25% return (e.g. paying down a mortgage, buying a municipal bond) than potentially losing 10% on all the new money I’m saving. For your existing investments, make sure to review your asset allocation.
Be wary of people who scoff at those who hoard cash. These scoffers probably weren’t investing during the 1997 Asian Financial Crisis, the 2000 internet bubble, or the 2008 housing market implosion. If they were, they probably didn’t have very much exposure and therefore think they are geniuses for investing in a bull market.
What I’d like everybody to do right now is take stock of all their cash sources. Hopefully, we’re not talking about just one bank account either. The stock market is at a record high post Trump’s election and we’re up ~200% from our February 2009 lows.
Keeping Track Of ALL Your Cash
1) Cash in pre-tax retirement accounts. Check your 401k, IRA, or Roth investment portfolios to see their latest compositions. Are you happy with your cash holding percentages? Are your investment portfolios aligned with your investment objectives and risk tolerance? I”m holding roughly 30% in cash for all my portfolios since early 2017 because I’m concerned about sky-high global stock market valuations. I’m waiting for better opportunities and have been buying bonds to be more defensive.
2) Cash in post-tax investment accounts. Check your cash weightings in all your after-tax investment accounts. Overtime, your cash holdings may increase due to dividend payouts. Post-tax investment account objectives are often different from pre-tax retirement account objectives due to time horizon and liquidity needs e.g. you might be investing to buy a house. I’m also fully invested in my Citibank Wealth Management account with mostly structured notes that offer downside protection.
3) Cash in your bank account. Cash in your money market account is the most precious cash of them all. I would not deploy any money market account cash until after you deploy cash in your pre-tax retirement accounts and then your post-tax investment accounts. Cash in your 401k and IRA isn’t liquid, which nullifies one of the great benefits of cash. It would be foolish to squander your liquidity when you already have illiquid cash available for investing. Remember the FDIC insures up to $250,000 per individual and $500,000 per joint account. If you have more cash than that, spread it around to different institutions.
4) Cash in your business. During a recession, many businesses will have reduced revenue. Some may even go out of business. Thus, It’s important to have enough cash to cover operating expenses. If you can’t cover existing operating expenses, then obviously cut costs and find new revenue streams. Many startups will fail over the next couple of years because they are cash flow negative. I’m strengthening my Entrepreneurship category to offset waning interest in my Investments category due to uncertainty in the global markets. Consider taking excess cash beyond operating costs out of your business and parking it elsewhere. Depending on what your business does, your business may face a higher level of liability exposure than you as an individual.
5) Hidden physical cash. Take stock of all the physical cash you have hidden around the house, in safety deposit boxes, and buried in your back yard. There’s some comfort knowing that even if you lose everything, you’ve still got a wad of cash to get you through tough times.
6) Kidnapped cash. If you are owed money, it’s time to start asking for your money back. You want to minimize exposure to other people’s financial problems before their problems get really bad. During the last financial crisis, millions of people lost their jobs and thousands welched on their mortgage. The domino effect was terrible for those who kept on paying their mortgages.
Calculate Your Pro Forma Cash Holdings
After you’ve taken stock of all your cash, consider doing this little exercise where you figure out how much cash you plan to save each month and extrapolate it into the future.
Below is an example of a personal finance client who derives income from real estate, dividends, a day job, and an online business. He’s committed to saving $20,000 a month from June 2016 thru December 2017 and currently has $149,000 in cash, equivalent to roughly 10% of his net worth. $20,000 a month equals 67% of his monthly after tax total income of $30,000.
Along the way, my client will receive estimated $50,000 year end cash bonuses and have large liquidity events when his CDs come due in April 2017 and November 2017. His goal is to build his cash hoard to around $1M so he can buy a $2.5M home in the Bay Area by 2018.
Some of you will think it is unwise to hold so much cash, but if real estate and stocks are going down over the next two years, and you’re unwilling to short, then building liquid cash is just fine.
The purpose of creating your own cash savings chart is to make you think about how much you could save if you committed to a certain monthly savings amount. It’s important to challenge yourself to save more because too many of us just wing it. Once you write out all the numbers, you’ll be surprised by how much you can actually save if you can stay disciplined.
Here’s another example of a client who’s been all over the place, saving anywhere from $1,000 – $5,000 a month and who has challenged herself to save $5,000 a month to build up a two year living expense runway by January 2018 so she can leave her job and become a rockstar freelancer and travel the world.
Downturns Take Time To Play Out
Please resist the urge to invest all your cash during big sell-offs. Leg in with a better dollar cost averaging strategy. Sell-offs happen because the future has changed. Stocks are only cheap if the future has not changed. It may take 2-3 years for the markets to figure things out. Therefore, spread your investments out over time in multiple tranches.
During a downturn, cash is beautiful. It feels liberating to be free from requiring a loan to buy a car, a house, or anything. When you’ve got a lot of cash, you don’t worry as much about losing your job or finding new freelance clients to pay the bills. It also feels amazing to take advantage of financial opportunity. Don’t ever forget how bad things can get.
Even if things turn out just peachy over the next several years, at least you’ve come up with a cash savings plan that will make you save more than if you didn’t make any projections. I’ve run my numbers in order to build a 10% position in risk-free assets for my entire net worth from a 7% position currently. I hope you run your own numbers too.
Open A High Yield Online Savings Account: Take a look at CIT Bank for one of the highest yielding savings account online. Their rates are regularly much higher than comparable banks. They also offer an 11-month penalty-free CD at a very competitive rate as well. I haven’t seen another online bank that has matched their rates in a long while.
Track Your Net Worth Easily For Free: In order to optimize your finances, you’ve first got to track your finances. I recommend signing up for Personal Capital’s free financial tools so you can track your net worth, analyze your investment portfolios for excessive fees, and run your financials through their amazing Retirement Planning Calculator. Those who come up with a financial plan build much greater wealth over the longer term than those who don’t.
About the Author: Sam began investing his own money ever since he opened a Charles Schwab brokerage account online in 1995. Sam loved investing so much that he decided to make a career out of investing by spending the next 13 years after college working at two of the largest financial firms in the world. During this time, Sam received his MBA from UC Berkeley with a focus on finance and real estate. He also became Series 7 and Series 63 registered. In 2012, Sam was able to retire at the age of 34 largely due to his investments that now generate roughly $200,000 a year in passive income. He spends time playing tennis, hanging out with family, consulting for leading fintech companies, and writing online to help others achieve financial freedom.
Updated for 2018. The Dow Jones Industrial Average plunged over 1,600 points in two weeks as the 10-year bond yield finally shot up closer to 3%. Do you know where your money is?