Join Peter and Jonathan as they explore how to determine the optimal balance between cash equivalents and other investments. While cash may be appealing to investors in the short term, learn why attempting to time the market isn’t advisable and gain valuable insights to help enhance your long-term investment strategy. Plus, explore whether a revocable living trust is the right choice for your estate planning needs.
Hosted by Creative Planning Director of Financial Education, Jonathan Clements, and President, Peter Mallouk, this podcast takes a closer look into topics that affect investors. Included are in-depth discussions on financial planning issues, the economy and the markets. Plus, you won’t want to miss each of their monthly tips!
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Transcript:
Jonathan Clements: This is Jonathan Clements, Director of Financial Education for Creative Planning. With me is Peter Mallouk, President of the firm, and we are Down the Middle. Lately there’s been much discussion about that most prosaic of investments, so-called cash equivalent. We are of course talking about things like savings accounts, treasury bills, Money Market funds and similar super-conservative investments. Today, if you hunt around, you can earn 5% or more on your cash. That’s prompted some folks to pay for cash at the expense of bonds and stocks. Meanwhile, among Wall Street’s talking heads, there’s been much chatter about the amount of cash on the sidelines and its potential to drive the stock and bond markets higher. Peter, to sort this all out, let’s start with first principles. How should folks go about calculating how much to hold in cash investments?
Peter Mallouk: The answer to that is to start by asking, “Well, what do we expect each asset class to actually earn us over time?” Over the long run, we think cash earns the least. Otherwise, no one would ever go buy a bond. Why would you go loan money to a corporation or a municipality for 2, 5, 10 years when you can leave your money in the bank or in a Money Market and do better? So we expect more from bonds. And of course we expect more from stocks than bonds, otherwise no one would deal with the ups and downs and the 30 to 50% swings if you could get the same return in bonds. And some people expect more from private investments, otherwise they would never give up liquidity. So we expect the least from cash.
If we expect the least from cash, we really want to have the least amount in cash. What’s that amount? The amount is what we need in the coming months. For some people, maybe even as much as six months. Very much depends on your job, job security, your access to liquidity. A lot of people think they need a lot of cash, but they really don’t need a lot of cash, they need access to cash. If you have an investment account, in an emergency you can borrow against the account, you have access to cash. If you have a home equity line of credit that lets you borrow up to 100,000 against the value of your home, you have access to cash in the event of an emergency. For most people, having three months to six months of cash is plenty, and that’s the amount they should be holding in cash.
Jonathan: What about if you’re a retiree? Often we talk about not having money, say, that you’re going to spend in the next five years exposed to the stock market and the risks there. Shouldn’t a retiree hold somewhat more than three to six months in cash?
Peter: Great point. I have a lot of retirees that think they should have several years in cash, and I always let them know they don’t. The portfolio itself is producing income. The bonds are giving yield. Real estate investments are giving distributions. Stocks are paying dividends. That accounts for some of the need. There are some outside income sources that are usually in play, too, whether it’s a rental property or social security or defined benefit plan or something like that. But on top of that, the portfolio should be designed to cover the next few years with bonds, as well.
We have a higher expected rate of return for bonds. They’re not always positive. They’re positive about to 80 to 90% of years, so that’s not batting 100% like cash. When we get out more than a few months in cash, bonds is the place to go to cover several years of needs.
Jonathan: And yeah, right now, you can earn higher yields with cash investments than you can with bonds. But I think we can expect the situation to look quite different come the end of the year. Right now, the federal reserve is talking about making multiple cuts in short-term interest rates, and the result is that yields on cash investments are likely to come down a lot over the year ahead. If folks are heavily weighted in cash right now, should they be moving their money elsewhere? And if they decide they should, how should they go about doing it? Should they do it right away? Should they do it slowly over time? What would be your suggestion?
Peter: I think when you make investment decisions, you should make the decision as if you’re going to make it dozens of times. So just like we tell somebody in the middle of a stock market correction, “Okay, look. If we try to time this,” well, the real question is there is going to be a correction about once every year or so for the next 30 or 50 years of your life. What are we going to do those 30 or 50 times? That we all know statistically the right thing to do is to not try to market time those corrections. Same thing here. If we’re going to make decisions on how much cash we should have, we should be looking a little less, a lot less at the yield and more on the general rules of investing, which is have as little in cash as possible.
To your point about cash and Money Market and bonds paying the same, and sometimes Money Market even a little more, that’s very tempting. And people say, “Well, I’ll just stay in Money Markets until things change,” but what the bond market is telling us is what you just said. We expect rates to come down. So if you have a Money Market account paying four-and-a-half and a bond paying four-and-a-quarter, well, when rates drop and the Money Market is paying three-and-a-half, that bond will still be paying four-and-a-quarter. If instead at that point you wait to go to the bond market, bond yields will be lower.
The bond owner is locking in this rate for a period of years and we all expect, because the Federal Reserve is telling us they will lower rates, that they will probably lower rates several times to the point where Money Market falls before bonds. This is not an opportunity where we can just walk in and do it later. It’s like people saying, “I’m going to sit on the sideline with stocks and when things calm down, I’ll come back in.” Well, when things calm down, it’s too late. The stock market looks ahead but the bond market looks ahead, too.
Jonathan: We all as investors tend to have somewhat short memories, but folks who think back to the 2010s… I’m not saying we’re going back to an era of zero short-term interest rates, but if you remember the 2010s, the yield people were pocketing after inflation and after taxes was pretty much nothing through the 2010s. While we may not be going back there, we’re likely to be a lot closer to that situation come the end of the year than we are right now. While today’s high cash yields are tempting, they’re also likely to be fleeting.
So anyway, Peter, moving on from today’s discussion, it’s time for the tip of the month. What do you have for us this month?
Peter: All right. My tip of the month is to reacquaint yourself with estate planning and I’m going to fulfill the tip right now, because I want to cover some of the basics of estate planning. We’ve never covered it on this podcast and I think it’s relevant to 100% of our listeners. Making sure your estate planning documents are current and that you have documents that meet your needs is my tip of the month. I’m going to just walk through the very basics so that people can leave this podcast knowing if they’re in good shape here or not.
I’ll start with the healthcare power of attorney. Very simple document that just says, “Hey, if I can’t make a healthcare decision for myself, here’s who’s going to make it for me.” A lot of people say, “Well, do I really need that? Won’t the hospital just listen to my spouse, my mom and dad even though I’m an adult?” The answer is no. You have to have a healthcare power of attorney that says, “Here’s who’s going to make healthcare decision for me.” If you don’t have that, what happens is people might wind up in probate court fighting over who gets to make a healthcare decision for you, and that process requires people to get conservatorship over you. It takes six months to a year often. By then, the healthcare help that you are going to provide is long gone or you can’t make the same difference. So make sure you have a healthcare power of attorney not just for you, but everyone in your family that’s over 18.
If you’re a listener in your forties or your fifties or more, you should be thinking about your kids that are over 18. Make sure they’ve got a healthcare power of attorney, and you should make sure your parents have them, too. Healthcare powers of attorney aren’t just life and death. They’re also moving somebody from a hospital to a hospital or a doctor to a doctor or a long-term care facility to another one. So very, very important document.
There’s also a financial power of attorney. “Hey, if I can’t make a financial decision for myself, who’s going to make it for me?” There’s two main kinds. An immediate is, “Hey, I’m Peter and my wife, Veronica, can make financial decisions for me whenever she wants. She can go do things for me today.” Or there’s a springing power of attorney, which says, “Only if I’m incapacitated and two doctors write letters saying I’m incapacitated, then she can go make financial decisions for me.” Obviously a very important document. Without it, someone has to go to probate court for often six months, pay tens of thousands of dollars to get conservatorship to be able to handle things for you.
Then, we all know about having a will. If you don’t have a will, the state’s got one for you. A lot of states say half the money goes to your spouse, half goes to your kids, or if you’re single it goes to your kids, or if you don’t have kids, to your siblings and parents. Nobody wants the state to decide that for them. No one wants the state to appoint a conservator. Have a will. Name who’s going to raise the kids if you’ve got them, who’s going to get your inheritance and when, are you going to make a charitable request or not, and you take control of who’s going to handle things. You name that person. We call that person an executor.
Lastly, for those that want to avoid probate, which is people that have hundreds of thousands or more in taxable investments or real estate, or multiple assets, you want to have, instead of a will, you want to have what’s called a revocable living trust. It just takes the place of a will. Instead of an executor, we call the person who settles your estate a successor trustee. We still have beneficiaries. We decide when the beneficiaries get the money. The difference is with a trust, we take your assets and we re-title them so they’re owned by the trust. So if you’ve got a bank account, an investment account, a real estate property, we change those titles, those ownership forms, so instead of being owned by Jonathan Clements, they’re owned by the Jonathan Clements trust.
Let’s say 30 years from now you pass and your successor trustee, the probate court says, “Hey, we want Jonathan’s stuff to come to probate court.” The successor trustee is able to say, “Jonathan didn’t own any stuff. It was all owned by his trust.” The court says, “You know what? Trust didn’t die,” that’s why a lot of people call them living trusts, “Go do it yourself.” The advantage is it moves privately. No one knows, Jonathan, what you owned. It’s quickly, no one has to wait for the process, and it’s infinitely less expensive because we’re not dealing with courts and lawyers and all of those things. Most of our listeners, a trust combined with these powers of attorney is the way to go. Make sure your adult kids have these things in place your parents have these things in place, and most importantly, that you do as well, so your wishes are fulfilled and you’re not a burden to the people you love the most.
Jonathan: So Peter, to what you said, I just want to add two things. One, if you have a living trust, make sure you go through the process of re-titling the assets so they are owned by the trust. I can’t tell you how many people who have acted as executors for their parents have reported back to me that when they went to settle the estate, countless assets weren’t owned by the living trust, to the extent that basically the living trust was useless. It was a fine document, it looked good when the lawyer drew it up, but nobody followed up and moved the assets into the trust and therefore, it didn’t function as it should.
The second thing, you mentioned the beneficiaries to the trust. People should also take the time to check they have the right beneficiaries on their life insurance, they have the right beneficiaries on their IRAs and their 401ks, because those assets will pass directly to whoever you’ve named as beneficiaries and presumably you don’t want all that money going to your ex-spouse.
Peter: Very good advice. Most trusts are unfunded, so make sure you go through that extra step of re-titling, otherwise the trust is worthless.
Jonathan: And so Peter, for my tip of the month, my suggestion to those who are approaching retirement is to think about the possibility of working part-time in retirement for at least some period of years. I think this is a great thing to do for three reasons. First, you have the financial security of having a little income coming in while you transition to retirement. We often talk about the 4% withdrawal rate. If you have a part-time job that pays you $20,000 a year, that’s like having a nest egg that’s half a million dollars larger. So having a little part-time income can make the financial transition to retirement that much more comfortable.
Second, during that period you can go through what’s call a phased retirement. That’ll give you a chance to test drive what you want to do with your retirement years. We all have ideas about how we want to spend our retirement and we may discover that what we imagine is going to make us happy doesn’t. By having a part-time job, you can test drive different possibilities and see whether this is the way you want to spend the final decades of your life.
And finally, an issue a lot of people talk about these days is you want to have not just a financially secure retirement, but you also want to have a retirement where you have a sense of purpose. Having a part-time job can give you that reason to get out of bed in the morning. It can give you that identity that allows you to feel better about being retired.
So, my tip of the month, consider working part-time at least during your initial retirement years. It could make the transition a whole lot smoother.
Peter: And if you don’t have that, a lot of people give thought to what do you enjoy doing. Are there hobbies that really matter to you? I’ve seen my happiest clients either do exactly what you said or they have something that is fulfilling to them outside of work. They’ve got that soft landing.
Jonathan: Anyway, that’s it for us for this month. This is Jonathan Clements, Director of Financial Education for Creative Planning, and I’ve been talking to Peter Mallouk, the president of the firm, and we are Down the Middle.
Disclosure: This show is designed to be informational in nature and does not constitute investment advice. Different types of investments involve varying degrees of risk and there can be no assurance that the future performance of any specific investment or investment strategy, including those discussed on this show, will be profitable or equal any historical performance levels.
