Understanding money matters and managing your cash flow are an integral part of any sound financial management strategy. Effectively managing your cash flow can free up capital to save and invest—assets you can put to work—helping you pursue your financial goals.
It’s made of simple linen and cotton paper, it doesn’t weigh much or take up much space, but printed money is a major part of our lives.
In 2019, the Bureau of Engraving and Printing printed roughly 7 billion pieces of paper currency with a face value of $206.9 billion. How much of that money is going into your savings and investments? Money is one of the things we think about every day, even many times a day. But while we may think about it, talk about it, and worry about it, we sometimes fail to take the time to manage our cash effectively.
Every successful investor knows that management of cash assets is key to a sound strategy. To begin with, you’ll want to understand how time may influence your ability to reach your goals. Next, you’ll also want to take a look at your financial profile and examine your credit standing, your cash holdings, and whether it is time to rebalance your cash portfolio.
How do my credit score and time affect my investment outlook?
Once you understand the role time plays in your long-term investment outlook, you can be better prepared to make wise decisions when it comes to cash management.
Having a good handle on how your credit score can affect your purchasing power could also help. There can be a correlation between your credit score and the rates you may be charged for any type of installment debt. And a higher credit score has the potential to add up to real savings over time.
In one example, let’s consider a $400,000 loan with a 30-year fixed-rate mortgage. An individual with a credit score of 620 would qualify for a mortgage interest rate of 5.83%. At that rate, the mortgage may carry a monthly payment of $2,354.
Let’s see what may happen if the person’s credit score is above 760. With that credit score, the individual would qualify for a 30-year fixed-rate mortgage with an interest rate of 4.24%. The monthly payment would be $1,966. That’s a difference of nearly $388 per month, or over $4,600 per year.
Over the life of that mortgage, that difference adds up to nearly $140,000—more than a third of the cost of the home. Just because of a credit score.
What is the right mix of investments for me?
One of the goals of a sound financial strategy is to find the appropriate mix of investments. Cash alternatives have lower risk but also offer the lowest potential return. Stocks on the other hand tend to be more risky, but typically offer a higher return.
The reason why cash alternatives are at the foundation of a well-balanced portfolio is that cash alternatives allow you to meet short-term and unpredictable expenses. Having cash and cash alternatives also may allow you to manage other investments—rather than selling at what could be an inopportune time.
Keep in mind that allocating your assets among different investments is an approach to help manage investment risk. It does not eliminate the risk of loss if security prices decline.
For that portion of a portfolio that must be liquid, most investors consider one or more of four places. Each has drawbacks and advantages.
Traditional bank savings accounts (savings, checking) are both guaranteed, up to certain limits, by the FDIC. However, traditional bank account returns are modest at best.
Certificates of deposit, on the other hand, are time deposits offered by banks, thrift institutions, and credit unions. They may offer a slightly higher return than a traditional bank savings account, but they also may require a higher amount of deposit. If you sell before the CD reaches maturity, you may be subject to penalties.
Bank savings accounts and CDs are FDIC insured up to $250,000 per depositor, per institution and generally provide a fixed return, whereas the value of money market funds can fluctuate.
Money market funds are investment funds that seek to preserve the value of your investment at $1.00 a share. Money held in money market funds is not insured or guaranteed by the FDIC or any other government agency. It’s possible to lose money by investing in a money market fund. Mutual funds are sold by prospectus.
Treasury bills are actually debt-based instruments—investors lend money to the U.S. government and are paid a specific rate of return. Treasury bills are backed by the full faith and credit of the federal government as to the timely payment of principal and interest. If a Treasury bill is sold prior to maturity, there is the opportunity for a capital loss or gain, depending on the interest rate environment.
How do taxes and inflation affect my cash?
Cash alternatives offer low risk, low potential returns; each of these investments may be vulnerable to taxes and inflation.
It works like this.
Let’s assume you invested $10,000 in a CD earning 1%. After one year, your account would be worth $10,100. After taxes on the interest are paid, the account would be worth $10,078.
Then you need to account for the effects of inflation. Assuming a 3% rate of inflation, the account value would actually be the equivalent of $9,776.
If you aren’t careful, you can actually lose purchasing power with your low-risk, low-potential-return investments. This is a hypothetical example used for illustrative purposes only. It is not representative of any specific investment or combination of investments.
Cash & Expenses
At any stage in life, it is wise to reserve enough cash on hand to cover your expenses in three areas:
First, you should be able to replace your income for a short period of time in the event of job loss or a loss of investment income. A good rule of thumb is to have enough on hand to replace your income for three to six months. Or consider setting aside a fixed dollar amount, based on your individual situation.
Second, you should make allowance for emergencies that may occur, such as a catastrophic illness or an accident.
And third, you should have some cash on hand for upcoming large expenses, such as a wedding or an extended vacation.
Everyone’s situation is unique. This information is not intended to be a substitute for specific individualized legal advice, and we suggest you discuss your specific situation with a qualified legal advisor. As always, feel free to contact us with any questions as to how these issues may fit into your overall financial plan!