Money Management

The Value of Cash

/ Patrick Facey / 1 Comment

When building wealth, it’s only natural to put a lot of focus on how to best invest our money in order to make it grow. When savings begin to accumulate, so do the anxieties about what to do with it. We all know that the interest rates paid on savings accounts are abysmal, so the knee jerk reaction is to get the money out of savings and into some sort of investment. While it’s true that the monetary return of holding onto cash is less than stellar, having cash on hand can produce benefits in seemingly unnoticeable ways.

  1. Unexpected Emergencies: Of course the main reason that having some savings is beneficial is for funding the unexpected events that will undoubtedly occur. Creating an “emergency fund” is personal finance 101, and for good reason. Having to come up with cash on short notice for car or house repairs can be stressful. Without adequate savings available to easily pay the bill, it may be tempting to reach for the credit cards–a move that can snowball an otherwise minor financial setback into something worse if not handled with care.
  2. Unexpected Opportunities: Unexpected events also come in the positive variety. Occasionally, we come across great deals or unique investments. Every day there are people trashing things that you treasure, and others launching business ventures that few (but maybe you) understand. Or maybe even the stock or real estate markets experience a sharp decline. When the stars align and these opportunities present themselves, having cash readily available to make a move is invaluable. Sometimes there just isn’t time to apply for a loan or borrow the money elsewhere. It would be unfortunate to miss an amazing deal because all of your money is tied up in an index fund.
  3. Self Insurance: The reason we need insurance in the first place is to protect against the expense of losing an object or encountering an unfortunate occurence. Therefore, there is value in paying a company to cover that risk of loss for us. The catch is, insurance companies employ highly skilled actuaries to determine the rate that will be charged to a customer based upon the probabilities of a claim. These companies also operate for a profit, so we can be sure that we aren’t often getting the better side of that deal. By maintaining a larger amount of cash, we can begin to assume more risk in some areas of our lives. Rather than paying the risk premium to a company who has the odds stacked in their favor, we can assume higher deductible arrangements and begin to turn the statistics in our favor. Of course self insuring every aspect of our lives isn’t prudent, but self insuring some of our physical possessions could be a good start towards meaningful insurance savings.
  4. Peace of Mind: Arguably the best things that money can buy are freedom and security. Having money that isn’t subject to the whims of markets, or claimed by creditors for debts, simply brings a level of comfort to life. Assurance in the fact that we have some economic safety in the midst of life’s uncertainty is of special value.

Recognizing the value in holding onto cash can be tough. It’s easy to feel that we’re losing money when we’re not fully invested, but not having enough money available when it’s needed most may be the costliest error of them all. The “right” amount of savings is based on individual preference, but finding that sweet spot can produce some of the best returns that money can generate. 

The Best Strategy For Investing in Retirement Accounts

/ Patrick Facey / Leave a comment

Tax advantaged accounts, commonly known as retirement accounts, provide us with a number of benefits during the wealth building process. When optimized, attributes such as income tax deferral, tax free investment growth and creditor protection can act as beneficial forces to building and maintaining wealth. However, choosing what accounts to fund and which investments to fill them with is no easy task. Between allocation amounts, types of accounts, and investment choices, there are countless combinations to choose from. The best strategy for an individual looking to use tax advantaged accounts will of course vary, but for the average federal employee it might look something like this.

Overview: Traditional TSP contributions up to employer match -> Fully fund Roth IRA -> Remainder of annual contribution limit in traditional TSP

  1. Traditional TSP up to Employer Match: For federal employees, this means that a minimum of 5% of your salary needs to be contributed into the TSP. Because of the 100% match by the government on that first 5%, taking this first step shouldn’t even be considered optional.If your basic pay is $50,000, a contribution of $2,500 to the TSP will immediately earn you another $2,500 because of the match and agency contribution. That is a guaranteed, instant doubling of your money. No other investment or debt payoff will provide you that kind of return. Even if you have high interest credit card debt, making this investment will still increase your wealth more so than using those funds to pay down the debt. By electing to make these contributions in the traditional format instead of Roth, you also enjoy a bit of tax savings during the year that the contributions are made.
  2. Fully Fund a Roth IRA: Another reason for choosing the traditional contributions in the TSP is that some of the tax treatment can be diversified here. By choosing to fully fund a Roth IRA, instead of simply continuing to put that money into the TSP, you gain a few added benefits.(NOTE: Those in the highest income tax bracket will likely want to use a Traditional IRA here instead of the Roth due to the more beneficial tax break, although funds accessibility then becomes much more limited.)
    1. Funds Accessibility: The ability to withdraw money without any penalty on the funds that you have contributed into a Roth IRA is a huge advantage of this account. For most of us, financial objectives change over time and/or life happens. Having the flexibility to withdraw the full amount of funds that have been contributed into the account, as if it were a savings account, is invaluable. Additionally, if investments within the account have done well, the earnings can simply be left in the account to continue growing, tax free.
    2. Investment Diversification: An IRA is a great place to hold tax disadvantaged investments, such as real estate investment trusts (REITS). Since dividends and capital gains within an IRA occur tax free, holding securities that don’t get preferential tax treatment in taxable accounts is a good way to add some diversification, as well as tax efficiency, to a portfolio. Since most portfolios primarily consist of stocks and bonds, this is usually beneficial.
  3. Max Out the Traditional TSP: Making all of the contributions in the first two steps is excellent progress in itself towards building a well funded retirement. By doing so, at least $10,000 has been added to your investment portfolio for the year, which is a nice accomplishment. At this point, there should still be $10-$15k in allowable contributions to the TSP for the year. Continuing to max those contributions out to the fullest extent should be the next order of business. The tax breaks and general attributes of the TSP, such as low investment costs and appropriate diversification, make this account the ideal home for the remainder of your available investment funds. Also, each year only permits us one chance to make those TSP contributions and reap the tax deductions, so we should strive to make the most of them.

If you’ve managed to fully fund the TSP and an IRA for the year, congrats! You’re a little closer to comfortable retirement, or maybe even early retirement. If funds are still available for investing after these accounts have been maxed out, the available investment opportunities become even more varying. In any case, it’s a nice accomplishment that will hopefully become recurring during the wealth building journey.