Your Coranavirus Financial Playbook Part I
Your Coronavirus Financial Playbook - Part I
“There are decades where nothing happens, and there are weeks where decades happen.” - Vladimir Lenin
The Coronavirus is impacting our communities, our economy, and our health in an unprecedented way. When and how this situation will be resolved is impossible to predict.
Moreover, the health policy response to coronavirus, social distancing, is impacting workers and business owners in different industries and professions very distinctly. Local small-businesses, service employees, and the hospitality industry are suffering disproportionately. Grocery stores, big-box retail, and many tech companies are thriving for the time being.
Amidst this storm, the stock market is reacting to the uncertain environment by entering a bear market, adding to the emotional distress that workers and retirees are feeling.
We love our Minneapolis and Portland local communities, and our heart is breaking for everyone affected by current events. We want to help. To that end, we are opening up our playbook for how we are guiding our clients through this crisis - unique in its human and economic toll. We hope it is of service to you and we wish everyone health and well-being over the coming months.
Below is Part I of our Coronavirus Financial Playbook. We will post Part II shortly.
Step 1: Know Your Cash Flow
In times of economic hardship, Rule #1 is to know your cash flow. You simply must understand the balance between your cash inflows, cash outflows, and savings. We suggest doing a full budget analysis of all monthly spending, segmenting it into mandatory and discretionary buckets. For example, your grocery bill, to an extent, is mandatory, but your Netflix subscription is discretionary.
We take a ‘Zero Shame’ approach to budgeting. Do not judge yourself and do not judge others in your family. Budgets are information, nothing more, and once we have the necessary information we can start making productive changes to our spending and savings on a go-forward basis.
This is also a good time to check in on your budget at the end of every week. Did you overspend? If so, why? Are you saving more than you expected? Can that cash be moved elsewhere?
Action Steps to Know Your Cash Flow
- Do a Full Budget Analysis of all monthly spending. Segment spending into two columns: Mandatory and Discretionary.
- Adjust your budget for expenses that simply will not be possible over the coming months, including travel, bar tabs, concerts, etc.
- Prioritize which expenses you will cut first, second, and third if income drops or job insecurity increases.
If possible, be kind to local businesses during this analysis! Spotify and Amazon will be fine. The taco place on your street corner and your yoga studio are going to have a challenging 3-6 months.
Step 2: Know Your Current Emergency Savings
Budgets are all about flow. They measure how money moves in and out of your life over a period of time. But you also need to understand where you currently stand financially. We call this your personal balance sheet and, during a crisis, nothing is more important than the emergency savings section on your balance sheet.
We suggest our clients maintain two separate emergency savings accounts. The first is held in cash in your checking or savings account. We suggest you open a second account for this to separate your emergency cash reserves from your normal checking account. The second is an allocation to money market or short-term bonds in your 401k, Traditional IRA, or other retirement accounts.
The former allows for an immediate source of liquid funds in case of an emergency. The latter allows for an intermediate-term funding source (usually 2 years) during a time of prolonged income, economic, or health insecurity (or, worst case scenario, all three).
Keep in mind that there is a 10% IRS penalty on early distributions from your IRA or 401k. However, if your income is lower during your time of need, it means that your marginal tax rate is lower as well, which may help neutralize the impact of the penalty. Additionally, it appears as if the IRS may waive this penalty for funds withdrawn during the Coronavirus epidemic (though the withdrawals would still be taxable)..
The amount of emergency reserves we suggest our clients hold in these accounts vary based on their profession and other risk factors. However, a good rule of thumb is to hold at least 10% of your gross income in cash and 20% of your gross income in money market or short-term treasury bonds within your retirement account. Entrepreneurs, contract workers, salespeople, retirees, and anyone with variable income will likely want to hold more in cash.
We have been criticized in the past for this conservative approach to emergency cash reserves, but the coronavirus is stress-testing our cash and emergency reserves recommendations in real time, and so far the feedback has been extremely positive.
Actions Steps to Know Your Current Emergency Savings
- Review your checking and savings accounts and tally your cash on hand.
- Based on your budget analysis, how many months of mandatory expenses can your cash on hand cover?
- Add up any cash or bond funds in your retirement accounts. Could these offer a secondary bridge of cash during a prolonged period of income insecurity?
Step 3: Segment Investments into Time-Horizon & Goal-Matched Buckets
Every dollar of your investment portfolio serves a purpose, and you should be able to match it to a short-term, intermediate-term, or long-term need or goal.
Take the time to review your investment portfolio personally (or with your financial advisor) and segment all of your investments into goal and time-horizon matched buckets. Yes, this may be painful after a drop in stock prices, but it is necessary work that can offer a great degree of clarity.
Short-Term (1-3 Years):
This bucket includes secondary emergency reserves, monthly cash flow needs for retirees, large upcoming expenses, a downpayment for a home, etc. It should be held in cash, CDs or high quality short-term bonds.
Intermediate-Term (3-7 Years):
This bucket may include planned expenses like education costs, retirement income, or other goals. It should be held in high quality bonds, ideally with maturities matched to the timing of the cash outflow. Stocks are not suitable for this time horizon.
Long-Term (7 Years):
This bucket includes long-term goals such as retirement, buying a vacation home, paying for college for young children, etc. Typically, this portion of the portfolio is allocated to stocks, but it is critical that you are fully aware and comfortable with the risks associated with owning them. Many people underestimate the frequency and severity of downturns in the stock market. As March 2020 has shown, it is never easy watching your portfolio rapidly decline in value. However, if you are comfortable with volatility over short to medium term time horizons, the odds are that you will be rewarded by owning stocks for the long run. History has continuously demonstrated that they provide the greatest opportunity for higher long-term returns.
Ideally, this work was done prior to a bear market, but there are still benefits to reviewing your portfolio and personal balance sheet now. Do you have excess cash, beyond what’s needed for emergency reserves or other expected expenses? Congratulations, you can now add to the stock portion of your portfolio at dramatically cheaper prices.
Are short-term term goals being put at risk due to an over-allocation to stocks? You may want to consult with your financial advisor about the best approaches for mediating this issue. One counterintuitive option may be to reduce 401k contributions for the time being to build cash.
Ideally, you don’t want to sell stocks when they are down, especially if it is deemed long-term money. However, in a true emergency you must do what you have to do. Just be sure that any selling is reality-driven and not driven by fear and emotion. Recessions are generally great times to invest.
Actions Steps for Segmenting Your Investments
- Identify your financial goals and the time horizon associated with each one.
- Based on the amount needed for each goal, allocate your portfolio between short-term, intermediate-term and long-term dollars.
- Educate yourself on the risks associated with stocks. If you are comfortable with volatility (which is sometimes severe) over short to medium term time horizons, they remain the greatest opportunity for higher long-term returns.
- Determine the appropriate investment allocation for each bucket.
- If needed, work with a financial advisor to determine your appropriate investment allocation. It’s important that you understand the risks associated with everything that you invest in.
If you are unemployed or at high risk of losing your income, this is where you stop. You circle the wagons, you protect cash, and you watch expenses like a hawk. Additionally, the federal government and states alike are putting in extraordinary measures in an attempt to curtail some of the economic pain of our global health crisis, including direct payments to individuals and families. Here’s a short list taken or under consideration:
- Bolstering unemployment insurance
- Providing paid sick leave
- Pausing Federal student loan payments
- Sending direct payments to individuals and families
- Extending the tax filing deadline to July 15th
- Various forms of help for renters and homeowners
- Tap into tax-deferred accounts without 10% IRS Penalty
Last, if you are looking to explore your options during a time of income insecurity, we suggest you check out the following resource for additional help:
Soon, we will post part II of our Coronavirus Financial Playbook, including what to do if your income is secure, how to think about investing during recession, and steps to take to help your local community.