A client asked me a good question recently, and it’s one I hear often enough that I figured it deserved a post. There were a few planned expenses on the calendar for this particular client for the coming year (the fun kind, the kind you work your whole life to be able to afford). The question was whether to ask for the money a little at a time as each bill showed up, or to pull it all out in one lump sum now.
My answer was neither, exactly. When I know an expense is coming within six to 12 months, I like to set that money aside in a money market fund or other liquid, safe alternative such as a savings account.
Parking money in a safe spot isn’t glamorous, and it’s not supposed to be. A money market fund is a mutual fund—not an insured bank account—but these funds have proven themselves over the past 50 years, generally earning more than bank-sponsored money market deposit accounts. (There have only been two instances where investors lost money in money market mutual funds in that time, amounting to 2% and about 5%. Moreover, the government has imposed stricter rules on these funds to protect investors against losses going forward.)
Here’s the thinking behind it. Money you plan to spend soon and money you plan to leave alone for years are really two different kinds of money, even when they may live in the same account. The long-term money can sit through a rough patch in the market, because it isn’t due to be used for some time, and therefore would be expected to recover. You don’t have the luxury of waiting for a market recovery if you need the money soon.
Put another way, if the market has a bad month right before you need to write the check, you may be forced to sell at a loss. There’s no do-over on that, and the only reason you sold then is because the calendar said so.
Setting the money aside early takes that problem off the table. You’ve already decided how much you’ll need, it’s already sitting somewhere built for stability rather than growth, and a bad stretch in the stock market between now and then lands on your long-term money, not your vacation fund.
Here’s how it works with us. You tell us roughly how much you’ll need and roughly when. We look at the portfolio and come back to you with a proposal for which holdings to sell to raise the needed cash. Given your approval, we make the trades. Nothing moves until you’ve approved it. Once the trades settle, the cash waits in the money market fund until you use it.
You don’t need an exact number, either. A reasonable estimate is fine. If it turns out you need more, we’ll look at where it can come from with the least effect on the plan, which depends on what you hold, which accounts it’s in and what the taxes look like. If you need less, we can talk about putting the rest back to work. What I’m really after is advance notice—ideally 6-12 months out. A little lead time lets us be more strategic and prepared.
The same client conversation previously mentioned then turned to whether the portfolio itself needed any changes. We’d reviewed the portfolio allocation before the meeting, and the honest answer was no. The mix was close to where it was supposed to be, so we really didn’t have any further adjustments to make.
Recommending sitting tight is a slightly awkward thing for an advisor to say, because people sometimes expect advisors to earn their keep by making portfolio changes as economic and political conditions change. But a portfolio that’s on target doesn’t need fiddling, and every trade carries some cost, even though that cost may be small. Consequently, some of the best advice we give is to leave things alone!
I also told this client that the questions are pretty much the whole point. We’re here precisely so people can understand what’s going on with their money and have someone addressing their concerns. If people didn’t have questions, no one would need an investment advisor.
For those of you playing along at home, here’s the one thing to do this week. Look at the next twelve months and write down any significant expenditures you already know are coming, whether that’s a trip, a roof, a car, a wedding or a tuition bill. Put a rough number next to each instance and send the list to your advisor. If some of that money’s still invested in potentially volatile investments, ask about setting it aside now, while you still get to choose the timing—instead of letting the calendar choose the selling date (and price) for you.