I have two issues with today’s typical “financial planning” advice:
First, is that it often de-prioritizes, or outright ignores, the full funding of a Buffer, Contingency, and Emergency fund.
When the protection side of our plan is ignored, it simply does not matter what rate of return we get on our opportunities. Because if something happens, those opportunities will often end up being liquidated to cover current costs, at the expense of future growth on those investments.
Second, the typical financial planning advice is focused almost solely on market-based investments. With these investments, the investor takes 100% of the risk, has no control over the investment, exposes themselves to withdrawal penalties, and offers no collateral to protect their principal.
We are taught to de-prioritize cash because of the current abysmally-low interest rate environment. So we give up our protection strategies in order to get a higher rate of return on our money. But as we have seen in 2020, this has caused serious problems for a lot of people who did not prioritize the funding of their Contingency/Emergency funds.
But there is more available to us than banks and brokerage houses.
A macro timeline strategy:
- Cash Flow Buffer fund ->
- Contingency/Emergency fund ->
- Opportunity fund
- All wrapped in a Will and Trust
These different funds, kind of like a series of buckets, get filled in sequence.
30-Day Buffer for W2 employees:
This is the YNAB principle of using last month’s income to pay this month’s bills. The purpose of this is so that we can stop worrying about timing our expenses with when we receive our paychecks. This is very basic-level budgeting stuff here, but consciously implementing this can make a huge impact on our personal economy.
180-Day Buffer for business owners:
Same as above. But since business owners can experience longer periods of time with no inflows, it helps to have this buffer readily available. This number is not a hard-and-fast rule and will be different for different types of businesses.
If I could wave a magic wand, all of my clients would have a contingency fund equal to one year’s worth of income. If COVID has taught us anything, it’s that having a significant, liquid source of cash available would have been of great value to many families. Our contingency fund needs to reside somewhere *liquid*.
Liquid = accessible within 30 days, guaranteed. Examples are non-qualified cash accounts, 30-Day (or less) treasuries, and life insurance. Home equity does *not* count towards this fund as home equity is not guaranteed as the house must either be sold or we need approval from a bank or other lender to get it.
A true emergency is the permanent loss of income from family income earners due to death or disability. For a family to fulfill their plans, uninterrupted, the full “Human Economic Value” (sometimes called “Human Life Value”) of the primary income earner(s) must be replaced.
Make no mistake: anything less than the full Human Economic Value will result in something less than what the family could have had. The family will either have to adjust their standard of living now to accommodate a lower income, or they will give up the future value of assets they use to live on in the present.
Buffer and Contingency/Emergency funds are separate. One is for cash flow management and the other is to provide cash flow if our normal source(s) of income is interrupted.
In my opinion, Buffer, Contingency, and Emergency funds *must* be fully funded before allocating resources to the Opportunity fund.
Everything over and above our Buffer and Contingency/Emergency funds can now be allocated to our Opportunity fund. The Opportunity fund can be used for whatever opportunities we see that best fit our desired results.
Opportunities should include things that offer one or more of the following: guarantees/collateral to protect our principal, control, and liquidity. Examples
- Real estate to live in
- Real estate to invest in
- Businesses you own
- Businesses you want to invest in
- Life settlements
A note about Contingency/Emergency funds:
I put these two funds together because they can often be handled together, at the same time, using certain types of life insurance, specifically dividend-paying, cash value life insurance, also known as whole life insurance. With whole life insurance, we can protect our “Human Economic Value” and earn very respectable, tax-free growth on our Contingency/Emergency cash at the same time.
The guarantees of a whole life policy can be 15-20 times higher than most big banks.
Another note about Contingency/Emergency funds for business owners:
Business owners can experience some additional benefits by creating a strong Contingency/Emergency fund.
Rather than only spending money to get a tax deduction, through the use of specialized enterprise-risk insurance, business owners can get significant tax deductions for saving money. This specialized insurance can pay claims on cash flow interruptions, providing actuarial leverage toward their Contingency fund. Something that I think would have helped a great many businesses in 2020.
A final word – wrapping everything in a will and trust.
There is one other thing that can cause major problems with our financial future and the legacy we want to leave behind – and that is not providing clear directives about what should happen should you no longer be alive to direct our financial plan.
If you don’t have a plan, be aware — the government does.
Setting up a living will and trust with financial and medical powers of attorney will ensure your plans live on, even when you don’t.
To determine how these strategies might benefit you,