The second step in my series on dealing with volatile equity markets is: Understanding Your Cash Flow Needs.
“Cash is king.” Perhaps the saying has been overused since the mortgage meltdown and economic distress of the last few years, but it is none the less true. There is power in its simplicity. Have you ever found yourself looking at a bill that you did not have the cash to pay or feel buyer’s remorse after purchasing a big ticket item on credit?
Even as I pondered how to explain the importance of understanding cash flow, my phone rang. Honestly, it did. It was my 20 year old son in a state somewhere between panic and despair. He had $80 to his name (no credit allowed) and needed to buy food for the first two weeks of college and fill the tank of his gas guzzling SUV. What to do? Call Mom of course. But that is not an option most adults have.
Let’s assume you have an investment portfolio. Should you instantly sell your stock portfolio to pay your bills if you find yourself short on cash? What if you are not short on cash but you are just short on confidence? Given the brutal equity market in July and August, you might be wishing that you made that decision in May instead. Should you sell your bond portfolio to meet your immediate cash needs? At least it has not lost value. However, if you are considering either of these options, I would ask you if you really understood your cash flow needs. Where is your cash?
I can hear the recoil to my comment – “But, what if it is an emergency?” Or “I don’t want to lose another dime in the stock market!” Unexpected financial events will happen to you and to the economy. If you are investing in a long-term portfolio, by understanding your cash flow needs, you have already considered this possibility and taken some precautions against the unexpected. But if you have not, I hope to provide you with some recommendations that I find helpful and should make it easier for you to navigate volatile times.
1. Define where your cash is coming from and the certainty upon which you can rely on it. If you are working, this is your salary. Is your job at risk? If you have a partner, are they working? Is that job at risk? If you are in retirement, do you have a pension? Social Security? Or are you spending down your savings?
2. Define where your cash is going. What expenses are fixed each month – such as a mortgage payment, utilities, or a car payment? What expenses do you have some control over – such as eating out, clothing, and vacations?
3. Create two scenarios, at a minimum: What does your cash flow look like if the income is not interrupted and you can spend normally? What does your cash flow look like if your spouse’s job was lost, for example, and how can you change your expenses to meet any cash shortfall?
4. Repeat this exercise annually and, if necessary, make changes accordingly to your savings, spending and investment strategy.
Yes, I just asked you to create a best and worst-case budget. Not many people like budgets. I don’t even like budgets. I am not saying emphatically that everyone must live on a budget, but how can you know if you need to react to an economic event without understanding your best and worst-case cash scenario? For example, if you are a two income family and one earner loses a job, you should have enough cash in a savings account to bridge the cash deficit for at least six to nine months (longer if that makes you feel more comfortable). If you are in retirement and require additional dollars monthly to fill the gap from income sources, you should have at a minimum one to two years of cash in your savings account or retirement portfolio to meet your cash needs. This, of course, leads us to Step 3: Fill Your Investment Baskets Based upon Steps 1 and 2.
When you understand your personal cash flow, you take control of your financial situation. A lost job, a flooded basement, an unexpected medical bill may make you pause, may make you angry, and may even worry you, but it should not make you panic.
In an effort for full disclosure, my son just called me again. Upon more completely understanding his cash flow situation, he found a part-time job at a sandwich shop.
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