Without proper planning for an emergency, you might have to dip into cash reserves or liquidate a long-term investment, which could disrupt your long-term investment plans. For example, retirement account assets may be subject to tax penalties for taking nonqualified distributions prior to retirement, or you may have to liquidate investments at a low point in the market. You might do better keeping those assets invested to potentially generate long-term returns, thereby keeping your overall wealth strategy intact.
Stephen Viets
It’s important to keep in mind that having a strategy for cash flow and liquidity management is complementary to investment planning. Not only does cash flow and liquidity management allow you the flexibility to access money in the event of an emergency, it’s a defensive tool to help ensure your investment plan is well positioned and not disrupted.
Here are steps you should consider to help protect your loved ones and keep an unplanned financial expense from becoming a financial catastrophe:
1. Set up an emergency account. In addition to accounts where you currently keep cash assets (including checking, savings, certificates of deposit, money markets or other cash alternatives), fund an emergency account as part of your cash flow and liquidity strategy to help protect all of your assets. Set aside enough to cover three to six months of expenses (the right amount for you will depend on your risk tolerance). Keep cash on hand in case your area loses power and ATMs are out of commission.
2. Review your short- and longer-term payment needs. Understanding when you will need to draw on your money is key to an effective plan. Establish a strategy to cover your day-to-day expenses for funds you will need to access immediately, such as for food, clothing, medical and transportation expenses. Your cash for short-term expenses should be very accessible, perhaps in a checking or savings account.
For longer-term expenses that reoccur on a regular basis, such as property taxes, you may wish to consider a less liquid investment, such as a CD. This type of investment typically offers a slightly higher return than a regular checking or savings account, and you can manage the payout schedule to around the same time you will need the money. Generally, CDs may not be withdrawn prior to maturity. CDs are FDIC insured up to $250,000 per depositor per insured depository institution for each account ownership category. There are other more sophisticated solutions available, where appropriate, to help you meet your cash flow and liquidity needs, and I suggest you discuss these with your financial adviser.
Establish a line of credit for ready access to cash, and if used, pay the funds back with an appropriate source when the timing is right. Borrowing against nonretirement investments or other approaches can provide for short-term cash needs if your emergency fund does not stretch to meet all of your expenses. These strategies help prevent disruption to your long-term investment plan and can help keep you on track toward your investment goals.
A line of credit can also help you avoid dipping into retirement accounts too early. Depending on your situation and the type of retirement account, it may expose you to potential tax consequences.
Be aware that costs and risks are associated with any borrowing decision, so it is important to seek good, objective guidance. A financial adviser can help you begin the process of determining what type of line of credit option is appropriate for you.
Life brings expected and unexpected events — an important part of every investment plan is identifying how to access cash when you need it. Talk with a financial adviser about managing your cash flow and liquidity needs.
Stephen Viets is managing director-investments for Wells Fargo Advisors Las Vegas. Wells Fargo & Company and its affiliates do not provide tax or legal advice. Consult tax or legal advisers to determine how this information may apply to you.