Coronavirus may change how investors look at cash

(Originally published in Bond Buyer September 22, 2020)

The conventional wisdom has been that clients should keep six to 12 months of living expenses in cash in case of job loss or another unexpected event. While that is sound advice, in the age of COVID-19, this may no longer be enough.

Some people think of cash narrowly — as a form of personal working capital necessary to cover day-to-day living expenses. But it’s worth revisiting this viewpoint, particularly in a midst of a pandemic of uncertain duration.

“For many clients, a much larger cash cushion may be advisable.”

Cash plays a much larger role in our portfolios, and in our psyches, than we might care to admit. As a result, for many clients, a much larger cash cushion may be advisable, to serve as an important source of stability and optionality. Beyond the necessity of keeping cash on hand to meet ongoing obligations, having a larger cash cushion enables clients to mentally-withstand a much broader range of events, from personal dislocation to market volatility.

Staying the course

As the COVID-19 pandemic unfolded, it became apparent that many aspects of our daily lives would soon be in flux. While many clients became concerned by a correction that drove down market indices by more than 35% in a matter of weeks, astute advisors were able to hold clients’ hands and help them stay the course. But for some clients, the volatility was too much to bear, and they strayed from their long-term plan and sold securities. Within weeks, the broad market indices had recovered, and in some cases, surpassed their pre-pandemic highs. Unfortunately, those investors who sold in a panic lost out.

Having a larger cash cushion can help clients stay true to their long-term strategies and avoid selling at precisely the wrong time. Holding cash can thus help clients boost portfolio returns simply by providing the psychological insurance necessary to remain invested.

Many months into a pandemic that still shows few signs of abating, and with an unemployment rate hovering around 20%, a six-month cash cushion may also be insufficient to bridge the gap for those who experience job loss, or for business owners who may not be collecting the monthly distributions to which they had become accustomed in a pre-COVID world.

Those fortunate enough to already have several years of operating cash on hand are able to think longer-term. In addition to being able to support their families and businesses, they can make new investments at a time when others might shy away from providing capital.

The ability to make investments during downturns offers investors the opportunity to earn outsized returns. Cash isn’t just a hedge; it’s the ultimate in option value, providing the ability to invest when capital is otherwise scarce.

Personal flexibility and optionality

In cities across the country, many people are re-thinking their desire to live in close proximity to their neighbors. With parents working from home and children attending school remotely, many families are placing a premium on having more space — both indoors and out. As a result, suburbs are experiencing a renaissance as city-dwellers are relocating to ride out the pandemic.

Those with extra cash on hand have the privilege of being able to deploy it in an instant to rent or purchase another home without having to sell their existing residence in a panic. Advisors who can help clients through these emotionally challenging times can earn clients for life.

In summary, cash is much more than working capital; it should be considered a strategic asset class. It can protect clients against the unexpected, help them earn higher returns by staying the course, achieve greater personal flexibility, and make new opportunistic investments at a time when others are fearful and capital constrained. It’s no wonder why clients are increasingly asking their advisors about cash.

How to Start an Emergency Fund (and Why You Need One)

Image by Gino Crescoli from Pixabay

If you have a financial emergency — an unexpectedly high medical bill, a sudden move across the country, or a job loss — how will you pay for it? Most financial advisors recommend keeping a separate emergency fund that you wall off from your retirement and other lifecycle-related savings accounts. This will allow you to meet urgent funding needs without having to take money from your retirement or educational accounts, which can lead to penalties and tax bills.

It can be difficult to get started with an emergency fund, especially if you’re focused on specific savings goals like buying a house or paying tuition. The best way to make saving a habit is to use behavioral-finance techniques to your advantage. Open an online-savings account at a bank that pays high interest rates, and set up automatic monthly transfers from the main checking or brokerage account where your paycheck gets deposited. That way, you won’t have to think about making a manual deposit. It’s okay if you start with a small amount; the important thing is to be consistent.

While you’re setting up your emergency fund, make sure that you’re earning the highest interest rate possible. This will harness the power of compound interest, which means that the money in your account will earn interest as it sits there, and, if you don’t take it out, will accumulate as the interest goes back into the account to earn even more interest.

Why does this matter? Your emergency fund, by design, is money that you are going to keep on the sidelines and — hopefully — never have to use. Because you are not going to invest it in securities, which are risky, you want to make sure that you can earn as much as possible in interest on your cash in this account. Earning higher interest can help your emergency fund keep pace with inflation.

It’s also important that your emergency fund be kept in an account that’s fully liquid. If you have to access this money, you may need it immediately; you won’t have time to wait the three days that a money market fund will take to get the money back to you. An online savings account solves this problem. You can have the money wired back to your checking account same-day.

Are these accounts safe? Any bank account that is FDIC-insured is backed by the federal government up to $250,000 per depositor, per account type, per institution. If the bank goes under — unlikely, but still possible — the FDIC will return your money up to this limit.

One good way to make sure your emergency fund is FDIC-insured and kept in the highest-rate online-savings accounts possible is to use technology solutions, like MaxMyInterest, to manage it. Max isn’t a bank; it’s software that automatically allocates your funds among high-yielding accounts at online banks, to make sure your money always earns as much as it can safely. You can learn more at MaxMyInterest.com.