From the Archives of TGIF 2 Minutes – with an update on cash.
One of the most critical factors of long-term personal financial success is…. guess:
- A) The markets
- B) Spending
- C) Interest rates
- D) Stock selection
- E) Income level
And the answer is… SPENDING. This fact is why a truly competent financial planner will spend the most time on discussing spending, both today and future projected. Spending can also be expressed as “lifestyle” or “the basics of food, shelter, and transportation plus lifestyle”.
However, the inevitable will happen. And YOLO (“You Only Live Once”) will creep in.
- “The inevitable” means Murphy’s Law. Murphy’s Law states that if anything can go wrong, it will. Note the word, can. Of course, anything can go wrong. Therefore, count on one or more things going badly wrong, perhaps often, along the course of life, specifically financial life.
- YOLO creeps in too. Even the best planned budget or lifestyle will give in to aspirational, impulsive purchases or vacations. It happens.
What if Murphy’s Law or YOLO strikes,
- In the first year of retirement which could possibly coincide with a market downturn?
- In the year a child starts college, with tuition due imminently?
- In conjunction with a fender bender or minor car incident?
- Amidst an urgent or ongoing health challenge?
- In the first year of marriage?
The most basic factor that can soften a huge spending blow is CASH savings. Holding an amount of cash – un-invested cash savings – is key to surviving Murphy’s Law or YOLO events. (By the way, thanks to the US Fed numerous cash and cash-like instruments currently yield over 4.5%).
The important factor worth considering is separating “emergency fund” or fallback savings from “slush fund” or vacation savings. When Murphy’s Law events happen, often it is tempting or necessary to pay on credit or use monies designated for other specific purposes – greatly upsetting a neatly planned strategy of reducing debt.
Realize that cash is part of a short-term AND a long-term asset allocation. Asset allocation refers to the amount of stocks, bonds, and cash in an overall portfolio. Cash, specifically, can be invested for various periods of time: days, several months, one year or much longer periods using instruments such as money markets, US Treasuries, CDs, and bond funds of all sorts of durations (duration = amount of time until the investor gets his or her principal back plus interest). Having the “correct” amount of cash holdings allows more risk to be taken with the remainder of a portfolio.
Being realistic about different types of spending is key. There are certain items that most people know they will need or want but can’t perfectly predict or plan for adequately.
- Necessity items like transportation and primary home need to be funded from earmarked cash savings.
- Aspirational, “bucket list” items such as fun cars, second homes, vacations, club, and family activities also need to be funded from designated savings – separately earmarked savings that may take a bit longer to accumulate.
At least the good news is that Murphy’s Law and YOLO events typically don’t happen every day and can be factored in to a short- or long-term financial plan with the guidance of a qualified financial planner who you know and trust.