How many times have you seen, heard or read market commentators, popular financial writers and stock pickers nebulously talk about “your money?” They act as if all of your money is sitting in one big, undefined pool that either instantly heats up or cools down based on the ever-changing conditions of unpredictable markets.
But this really isn’t true—or if it is, it shouldn’t be. A better analogy is to think of yourself as CEO of a monetary workforce which has a variety of different jobs. These jobs determine how aggressively or conservatively your capital should be invested.
If you’re like most people, you tend to pay the most attention to money you spend on food, your home, clothes, entertainment and other everyday expenses and bills. Since the main source of this money is income from your job or Social Security or pension payments, it usually doesn’t stick around long enough for you to worry about investing it.
But, hopefully, your income exceeds your regular expenses, allowing you to assign the surplus to two monetary teams:
- Short-term funds reserved for anticipated or emergency expenses you may have over the next few years;
- Long-term funds invested to grow over time to pay for your toddler’s college education or build your retirement nest egg or legacy.
As CEO, it's your job to make sure each dollar knows its job and has the right tools to succeed. Let’s take a look a closer look at these monetary teams.
The short-term reserves: You need it when?
It’s a sound management practice to assign a certain amount of your surplus income or savings as reserves you may use anytime from now to the next five years to pay for:
- anticipated expenses such as a second home you plan to purchase in the next few years or the first year of your high school freshman’s college education; or
- unanticipated expenses, such as the sudden loss of a job or healthcare benefits.
If you’re retired, you may want to build a similar short-term “retirement reserves” team to cover 1-3 years of expenses or entertainment or travel expenditures that exceed the income provided by Social Security or pensions. For example, if you spend $100,000 per year and have $40,000 in Social Security income, consider keeping $60,000 to $180,000 ($100,000 minus $40,000 = $60,000) in short-term reserves. Having these reserves at your disposal may eliminate the need to make non-required withdrawals from your 401(k) or IRA accounts, which will give them more time to grow.
Since you may need this money within a short timeframe, you’ll want to shield it from potential investment losses by keeping it in cash-like vehicles. These include FDIC- (or credit union-) insured interest-bearing savings accounts, money market funds, CDs or even Treasury bills.
The long-term team: Hands off for now
The most hard-working members of your monetary workforce are tasked with the objective of achieving long-term financial goals ranging anywhere from 10 to 50 years or more.
You probably have several different long-term teams: 401(k) plan accounts and IRAs to build your retirement nest egg. 529 college savings plans for your children. Wealth set aside to establish a legacy for your loved ones and favorite chartities.
Long-term teams use stock and bond investments to maximize growth over time, and you generally want to trust them to do their job with minimal interference. This may prove difficult, since you’re more likely to pay more attention to their poor performance when markets are down, while forgetting that over time the long-term team tends to deliver better returns than the short-term team.
For example, those who remember the Great Recession of 2008-2009 often don’t realize that in spite of it being the worst market environment since the Great Depression, it only took about four and a half years for the S&P 500 to recover the ground it lost. And since its 2008 trough it’s finished in negative territory only once (in 2018) and has delivered double-digit returns in seven out of the last ten calendar years.
Shifting team resources
In many cases, short- and long-term monetary teams work side by side in the same location, such as in a mix of stock, bond and cash investments in a taxable portfolio, IRA or 529 plan. And sometimes situations call for transferring assets from one team to the other.
For example, when you set up a 529 plan for your newborn daughter, most of the money will initially work for the long-term team, investing in stocks and bonds to maximize growth potential. But when she enters high school, you might start shifting more of these assets—say a year’s worth of tuition—to the 529 plan’s money market option to help make sure this money doesn’t lose value before that first tuition bill arrives.
Another example: You’re retired and want to build your 1-3 year “retirement reserves” workforce. You may want to fund this cash cushion with required minimum distributions from your 401(k) plan or traditional IRA accounts or with cash in your taxable accounts. That way you may have enough spending money for the next few years so you won’t need to shift additional assets from your long-term retirement team at a bad time, such as during a market downturn.
Allocating your workforce
How effectively you can build and effectively manage your short- and long-term monetary teams depends on a number of factors, including:
- How well you’ve defined your financial goals and monetary needs;
- How much of your current income or savings you can assign to each of these teams; and
- Your willingness to let your long-term team do its job unimpeded, even during periods of market instability.
You don’t have to go it alone
Just because you’re the CEO doesn’t mean you have to make decisions in a vacuum. A financial advisor or financial planner can help you evaluate all of your financial goals and resources and help develop strategies to equip your monetary workforce with the tools and direction it needs to do its many jobs effectively.
This article was written by Chris Gullotti, a financial advisor located at Canby Financial Advisors, 161 Worcester Road, Framingham, MA 01701. He offers securities and advisory services as an Investment Adviser Representative of Commonwealth Financial Network®, Member FINRA/SIPC, a Registered Investment Adviser. He can be reached at 508.598.1082 or [email protected]
This article has been provided for general informational purposes only and should not be interpreted as personalized financial advice. We recommend that you consult with a financial advisor or financial planner before you implement any major changes to your financial plan or investment accounts. Certain sections of this article contain forward-looking statements based on our reasonable expectations, estimates, projections, and assumptions. Forward-looking statements are not guarantees of future performance and involve certain risks and uncertainties, which are difficult to predict. Past performance is not indicative of future results. Diversification does not assure a profit or protect against loss in declining markets. The S&P 500 Index is a broad-based measurement of changes in stock market conditions based on the average performance of 500 widely held common stocks.
©2018 Canby Financial Advisors