Preparing For The Unexpected
OCEAN CITY -- When we think about an unexpected change in our cash flow, we usually assume it's due to a problem: repairing a flooded house, making ends meet after a layoff, an elderly parent's injury that requires around-the-clock nursing care. Sometimes, though, what puts you on the spot is an opportunity. If your dream vacation home goes on the market for a song, for example, do you grab the great deal even if it means compromising your long-term investment strategy?
Whatever the nature of the event, you'll be in a much better position to deal with it if you have ready access to the funds you need. That's why it makes sense to prepare for the unexpected by having an emergency cash strategy in place.
"By taking a proactive rather than reactive approach to managing your cash, you can try to cushion future blows, funding unexpected liquidity needs on favorable terms and without potential adverse tax implications," says Nevenka Vrdoljak, director, Investment Analytics, Investment Management & Guidance at Merrill Lynch.Vrdoljak breaks down the process of putting together a liquidity strategy into three clear steps.
1. Identify and prioritize your expenses. Consider organizing your cash into three categories: basic, to meet everyday expenses and maintain your standard of living; precautionary, to help protect your standard of living in the face of unexpected events, such as a health crisis or a job loss; and discretionary, for "nice-to-have" purchases.
How these categories break down in a cash strategy will vary according to individual circumstances. For example, wealthier investors may have a smaller proportion allocated to basic liquidity needs. Risk tolerance is also an important consideration: Conservative investors typically view liquidity management primarily in terms of preserving capital and meeting anticipated cash flow needs.
Age is also a major factor. "Younger investors are typically concerned with meeting basic rather than discretionary needs, while older investors are usually more concerned about precautionary and discretionary needs," says Vrdoljak. Younger investors may have more basic living expenses (child care, education) and be focused on the demands of daily life, making them less prone to consider discretionary purchases. Older investors may have more leisure time.
2. Pre-fund your cash priorities. Work with your financial advisor to set aside a reasonable amount of cash to meet basic needs — generally 6 to 12 months' worth of living expenses. You might consider putting this cash in short-term CDs and interest-bearing checking and money market accounts. By laddering the CDs with staggered maturity dates, you can see to it that cash becomes available to you at predictable intervals. If it's not needed, you can roll it over into a new CD or interest-bearing account.
Precautionary needs should be funded with cash and, when appropriate, credit solutions. The latter can be considered when the need is short term and thus less likely to adversely affect debt burden and overall financial health. You might consider a credit card with a competitive interest rate, a home equity line of credit or a securities-based lending solution, such as a Loan Management Account® (LMA®), which allows you to pledge a broad range of personal assets as collateral for quick access to a low-interest line of credit. (See sidebar.) One sensible idea can be a pre-established credit line. "That way, you won't find yourself in the position of seeking cash when you desperately need it — which is usually when it's hardest to get," says David Laster, director, Investment Analytics, Investment Management & Guidance.
In addition, structured lending solutions available through Bank of America can help you leverage a broad range of nontraditional assets — including fine art, aircraft, commercial real estate and other nonfinancial assets — as collateral to borrow anywhere from $2 million to $200 million, so that you can finance a purchase quickly. You can also get help from financing experts in areas such as fine art, marine investments and aviation. If you're considering buying a yacht, for example, your financial advisor can connect you with both a credit specialist and a marine financing specialist.3. Review your cash strategy regularly.
As your life circumstances change, so will your cash plan and the ways you've made use of credit. Even changes to your portfolio due to market swings can necessitate adjustments. "You may need to rebalance your portfolio to align it with your cash flow needs," says Vrdoljak. "It's not a one-and-done approach."
Of course, your financial life — like everyone's — will remain in an ongoing state of course correction. But once you've established a workable system for having both the cash you need and the cash you may need, life's little surprises — and opportunities — will be far less likely to catch you off guard.(The writer is a senior financial advisor and can be reached at 410-213-8521.)