How Much Cash Should You Have In Hand?
When my stocks dropped like a rock in the dot com bubble crash of 2000, it was obvious to me that I had made some mistakes.
The obvious ones were chasing past returns and hyper-focusing all of my investable cash into a risky, speculative asset. The not so obvious mistake, but as it turns out, the far bigger one: Lack of cash management.
There will be plenty of times over your wealth building career that you’ll buy into an asset and then watch that asset plummet. I’m sorry to break it to you, but it’d be just like saying you can golf your whole life and not ever end up in the bunker, behind a tree, or in the bottom of a pond. You are going to get a first glimpse of hazards. One of those hazards is running out of cash, and then having to sell your assets in a down market.
I don’t like to have cash sitting in the bank. Not only is the purchasing power eroded by inflation, but there’s plenty of lost opportunity cost - what I’m giving up by taking a certain course of action. In the case of uninvested cash when you see tech stocks cranking up 40% a year, your opportunity cost looks a lot like 40%.
What I failed to recognize is that in a few short months, my life was about to change more drastically than any previous point of my life, and beyond having kids, greater than any point in the next two decades. I was moving from being a college student with little to no personal financial responsibility, to becoming a fully functional adult in the real world where I’d be responsible for all of my own expenses. I’d be making my own house payment, buying my own car, paying for insurance, managing food and groceries, clearing my medical bills, and making financial decisions that I previously ignored as too minor . The days of being able to bank almost all of my cash were soon to be over, and I had not factored in that transition. At all.
So when the stocks did crash and my business dropped, and I now had monthly bills, I was in a budget deficit, and I just couldn’t go and turn on the printing press to solve my problems. I had to sell my stocks to raise cash to live, otherwise, I’d be moving back in with my parents, which as much as I love them, was not going to happen.
I am aware that there are certain things that I do on a daily basis that make my life much better than what it would be otherwise. One of those is reading the Holy Scripture to get my mind right to start my day. Admittedly, I’m consistently inconsistent and struggle with staying focused. The best way for me to soak up the wisdom is to read books that have pieces of the Scripture and modern day teaching principles wrapped together. One of the books I’m reading, mostly for just 10-15 minutes when I wake up, is called, “And then God created Golf”. It’s a short book to guide the Christian golfer not only through the mind numbing challenges of an insanely hard game, but through the tough seasons of life. Here’s a quote I read this morning:
“You are a fortunate person indeed, if you can begin each day accepting the fact that during the day there will be ups and downs, good breaks and bad ones, disappointments, surprises, unexpected turn of events. At the same time wise golfers have learned to accept those adverse conditions on the golf course as representative of real life challenges.”
Just change a couple words around and we have the perfect summation of investing life: “At the same time wise investors have learned to accept those adverse conditions in their portfolios as representative of real life challenges”.
Life As An Investor
There are many fundamental traits that go into being a wise investor. There’s a host of traits that we can consider when analyzing whether an investor is wise or foolish. Professional development (consistently focusing on increasing skills to increase income), asset allocation, patience, buying things you understand, holding great assets for long periods of time - these are all extremely important characteristics.
At the top of this list? Cash management.
Several years back I read a Sports Illustrated article of the widespread financial issues that professional athletes deal with after retirement. I couldn’t believe the numbers: 78% of professional, highly paid people go broke after just 3 short years of retirement! Clearly, going from not making much money, to suddenly getting paid millions, to then going back to not making much money is rather tough to deal with. Lottery winners aren’t in any better shape either. Whether they win $500 or $1 million, about 70% of lotto winners lose or spend all that money in 5 years or less.
Standard financial mainstream advice says to have six months worth of living expenses socked away in cash as your “emergency fund”. I fully support this advice. But is it enough? Is it too much? And what do they mean by “cash?”
There are different forms of cash. After all, we want to maximize our return on invested cash, and minimize the damage that inflation does to cash sitting on the sidelines. So what’s the best answer?
Like all things in personal finance, there are certain core principles that are unwavering, and the much longer list of “it depends”. So, let’s unpack what it looks like to have the right mix of cash management.
The question most people ask when it comes to cash management and establishing emergency funds is, “How much cash should I have on hand?”
I believe the more important question is, “How much liquidity should I have”
Having cash on hand in an emergency fund is typically either one of two things, or both: Either actual cash in a safe or under a mattress, or cash in a bank account. I’d like you to start thinking in terms of liquidity. Liquidity indicates a person or company’s ability to pay debt obligations, or current liabilities, without having to raise external capital or take out loans. High liquidity means a person can easily meet their short term expenses and debts, while low liquidity implies the opposite and that a person or company could imminently face bankruptcy.
Here are 4 ways to consider boosting your liquidity, so you can confidently navigate the hazards of modern American financial life:
- Tangible Cash: Have cash, as in, cold hard physical cash that you can touch. Cash in my safe gives me that warm fuzzy feeling of knowing at a moment’s notice I can easily access cash. I don’t like to keep a lot of cash on hand, but typically a month’s worth of expenses is sufficient.
- Banked-up Cash: I keep enough cash in my checking accounts for about two months of expenses. Since bank accounts pay out a measly .01% interest, and then they take my hard earned cash and loan it out for many multiples of what they pay me, they are the clear winners in this arrangement. So I prefer to give them the least possible amount. I want to be the shittiest high net worth customer the bank can have.
- HELOC (Home Equity Line of Credit): Most people treat their home equity like an ATM machine. When they really want to buy something, they borrow out their equity (after all it’s their money right?) and tap it for their next luxury vacation, or the kitchen remodel. Prior to the 2008 housing crash, Americans were maxing out their home equity to the point they had no margin for error should housing prices actually drop. We know how this story ends, with millions of people underwater (owing more on the home than the home was worth) and having to come to the closing table with cash to release their mortgages, or worse yet, getting foreclosed and losing their home and credit.
The way I use a HELOC is more of a cash management tool. I open the HELOC so when I do need the cash, which I’ll never use for a liability, I don’t have to go through the month-long process of applying, appraisals, financial documents, signing over the rights to my first born son, etc. I can drive to the bank and have a check in my hand that day. What I love about these types of loans is that unless I use them, I don’t pay any interest.
- High cash value whole life insurance: To me, this is not so much of an investment as it is an incredible cash management system. This is where the bulk of my “emergency funds” reside. Why? Because a properly structured whole life policy allows my money to grow at much higher rate (mine is growing at around 5.5% after tax rate), it protects my family should something happen to me, which would certainly disrupt our household earning power, and it protects my cash from a lawsuit.
Whole life policies are not allowed by law to be named as an asset in a judgment. Most importantly though, is the liquidity factor - I can call my broker and within a week have funds wired to my bank account, with no loan application, no credit check, and without worrying about being in debt. I simply borrow against the collateral in my policy, which is my cash value. It’s a non-taxable event. Consider the difference between borrowing against your policy and having to sell your stocks. You’re either selling for a loss in a down market, which is about as bad of a financial choice as the predatory fees on credit cards, check cashing businesses, and higher risk car loans. Or, you’re selling at a gain, which is then taxed at your ordinary income rate if you’re selling with less than a year of ownership.
Now, I’d love to add a #5 to the list: cryptocurrency. And eventually, I’ll be able to. But it’s not ready yet because it’s extremely volatile. But at some point in the future, when we have mass adoption, then and only then will we have the stability in this asset. Then it will make sense to be able to consider it a form of liquidity. But that day is coming, and potentially faster than we think.
Let’s Wrap It Up
The idea for this blog came about because I had to come up with $52,000 in cash to pay the remainder balance on the Bitcoin mining container we need to get our mining operation plugged in and generate income. The final amount due is $32,000 higher than what we were originally told 8 months ago when we ordered it, but due to supply chain issues for the parts we needed it came in substantially higher. I was just about to pull from my whole life policy, which I don’t want to tap too much of since I don’t know when I may need it for a real emergency. Luckily I had a house under contract that closed without enough proceeds to cover the final balance, but if I hadn’t, I would have taken out the loan and then paid it back when I got my next influx of cash.
So then, wise Yoda, what is the right amount of liquidity to have in hand?
I have a full year of liquidity in all four of these forms, along with guns and bullets, precious metals, and a full year food supply with a shelf life of 25 years. I want to be prepared for any hazards life throws at me. I want to have, you guessed it, indestructible wealth. Do you?
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