Have The Rules of Financial Planning Changed Forever?

Week 849,763 and I swear I’m not losing my mind. So what if my desk is talking to me a little bit? He is a jolly little chap and offers me some real friendship these days. What furniture is talking to you?

For the more thought-provoking topic I’ve been thinking about these days: have the fundamental rules of financial planning changed? I’m specifically referring to how we approach emergency savings. What do I mean? Well, glad you asked.

First, a question. If I asked you how many months reserve should you have in cash, what would your answer be? Go ahead I’ll wait…

That’s right, 3-6 months of expenses should be sitting in a cash reserve account for most people. This was the first lesson when I started in this business. It was on the CFP exam and has been almost every financial planner’s knee-jerk answer any time someone would ask. Being I’m one to challenge the status quo, I’ve been doing a lot of thinking lately. Does this age-old foundation of financial planning need to be updated to the current times?

What am I thinking?

The rule of 3-6 months cash reserves is based off the notion that if one loses their job, or has an emergency spend, they can tap into this reserve to easily access cash. In the wake of a worldwide pandemic, a lot of people are having expenses they didn’t anticipate and job security issues that may last longer than 3-6 months. People are being laid off, taking pay cuts, and being furloughed. Basically, there’s a lot of uncertainty these days (which isn’t necessarily a new thing). The question is though, does preparing for a longer uncertain period (over 3-6 months) make sense?

The conundrum.

To some degree this is a double-edged sword. (By the way has anyone actually ever seen a double-edged sword? Just saying.) On one hand, having 9 or 12 months in cash sounds great, so what’s the real harm? On the other hand, are you robbing Peter to pay Paul (man this has a lot of analogies)? What I mean is, are you hoarding a bunch of money in virtually a zero-growth cash account at the detriment to your retirement savings? Very possibly. Therefore, you could be more prepared, but doing so may come at the cost of some of your future goals. It’s a tough one, right?

The considerations.

So, how does one properly weigh what is right for them? The short answer is give me a call. The long answer, however, is there are things to think through first.

  1. First, what is your actual job security? This should help you determine if you should consider padding the cash a little more.
  2. Are there dual income earners in your household? This will allow you to think through if you can live on one person’s salary. Naturally, this will decrease your risk.
  3. Can you cut expenses easily? Maybe your 3-6 months covers you under normal circumstances. But in really unsettling times, could you make it last 12 months?
  4. Do you have other means of cash? Do you have a parent or grandparent who can possibly offer a stopgap? Maybe you have a home equity line of credit where you can access cheap cash against your home? Think creatively about the means of which you can access cash.
  5. Finally, what other assets do you currently have? Do you have non retirement brokerage accounts or other easily liquidated assets? Do you have rental homes or things of that nature which you can tap into for additional cash?

Creative solutions.

All this is thought provoking stuff, I know, but where has the rule changed? I think being in this business for twenty years and living through four major earth-shattering catastrophes, I have a few thoughts. In some instances, I do think it makes sense to beef-up cash reserves greater than 6 months. However, I also like to think creatively. Is there a way to have your cake and eat it too (there I go again).

If you asked me a year ago what financial steps one should be taking to secure their future, I would start by saying 3-6 months savings and max out your 401k. If you do that and nothing else, you’ll be in a better position than most. But today, and moving forward, the rules may be changing. The big question I’ve been asking is how can we look at this differently?

What if we still kept that 3-6 months of cash reserve, but reordered our retirement savings? Contributing to your retirement plan up to the company match is a stone-cold no brainer. From there and instead of constantly increasing your contributions, you shift your savings to other places—like a Roth IRA (if you’re able) and a liquid investment account.

On one hand, you’ll lose tax deferred savings, but on the other, you’ll gain flexibility and options. The Roth IRA allows you to pull out principal prior to retirement age for any reason without penalty. This is a great option for most, as it’s a fabulous retirement tool with great tax benefits, and gives flexibility and accessibility. The non-retirement investment account has ultimate flexibility, just no tax savings. Now I know the tax savings are nice to have, but moving forward it may not be the most important factor to consider.

By reorganizing the savings, you’ve accomplished a few things. You’ve given yourself a handful of different options to access funds, kept your retirement savings intact, and thus positioned yourself to increase your cash holdings if needed. All this at the small cost of some tax savings.

Final thoughts.

Now if you can afford to max out your 401k and still save elsewhere, that might be the best answer of them all. The exercise is to crash-test your financial picture. Run through it with yourself and/or your spouse. If income stopped immediately, how long can you survive? How long until you needed to access additional funds and where would that come from? Would there be a cost or penalty? Balance that against your likelihood of falling into that situation and I think you’ll have a good starting strategy.

As always, we’re here to help guide you through these difficult discussions. I hope you enjoyed these thoughts and ask yourself how prepared are you?

Related: Important Life Lessons from a Covid-19 Victim: My Grandmother