Every Dollar Has a Job
Investing your money ultimately comes down to preserving it, growing it and a whole lot of messiness in between.
I recently wrote about the importance of building a cash reserve to soften the blow of unexpected expenses. The financial and psychological benefits of holding cash in high-yielding, liquid investments far outweigh the opportunity cost of spending or investing that cash in higher returning but more volatile assets.
Of course, too much idle cash beyond what you need for emergencies, taxes and other near-term expenses may cause you to miss out on opportunities to compound your wealth.
There are all kinds of approaches to assigning dollars for specific uses.
Bucketing is a popular approach and one that I frequently use to build a basic framework around short, intermediate and long-term cash needs for clients.
Many institutions implement asset-liability matching so that every dollar invested is tied to a specific cash need at some point in the future. The farther out the cash need, the higher the risk an investor can take with the allotted cash and, hopefully, earn a higher return.
Why are these approaches essential to your business and personal planning efforts?
Systems minimize guesswork. And when it comes to making big money decisions, you can’t afford to shoot from the hip.
Within your business, cash that is earmarked for short-term needs like taxes, emergencies, working capital deficits and general operating expenses should be treated differently from cash set aside to replace equipment or for research and development.
For your personal planning, dollars set aside for emergencies and ordinary expenses should be treated differently from dollars socked away in a 401(k) or other retirement account.
The messy middle for goals between three and 17 years, things like buying a house or new car, planning a vacation, or paying for kids’ education, warrants consideration for the risk you should take. Yes, you want to grow your dollars but not at the expense of falling short of what you need for a specific goal in the future.
Your dollars are invested with a specific purpose with a defined end date. No more getting in or out of the stock market – an impossible bet to get right consistently.
Even the most basic framework for matching dollars with future needs will make your money decisions much easier especially when factors outside of your control disrupt your original plan.
Gone are the days of worrying about being in or out of the market. Once the yield on each dollar is invested based on an eventual need, you can free up your headspace to focus on higher-impact decisions.
