Paul Meloan – Vested Interest

Our first installment in what I hope to be an ongoing series of pieces about the building blocks of personal wealth management will be about cash.

You know, the stuff in your wallet.

This is not going to be about Fed policy, quantitative easing, or the rise of a global currency system, but rather the role of cash in a personal wealth strategy.

Cash is one of the primary asset classes that comprise any personal wealth strategy.  I hope to address many of the others in the coming entries, such as bonds (debt), real estate, equities (stocks), commodities, and illiquid alternatives (private equity, hedging strategies).

All of us need to spend money in order to live.  Ok, I am sure somewhere on the planet you can find tribes of people who hunt, gather, make their own clothes, and never have contact with the outside world.  Then again, they probably do not read blogs either.  The rest of us spend cash.

Fewer and fewer places require actual currency in order to make a purchase.  In thinking about every place I have been in the past week, I can only come up with one where currency was required, and that was the concession stand where I purchased a cup of coffee for $2 at intermission of a play.  Even the parking meters in Bethesda, Maryland now permit you to cover an hour’s parking using a debit account based on your mobile phone.

Of course, buying into your neighborhood poker game with a personal check is just tacky, so I guess currency will always have a place in the world.

I still feel awkward making micro purchases with a credit or debit card, but I am getting over it.  My local Starbucks and Panera are facilitating my transition to cashless by making the process almost as fast as cash.  Sometimes it is faster, when the cashier struggles to figure out the change on a $2.76 purchase when I give them $3.01.

Ok, so that’s pocket money.  What about other reasons to hold cash as an asset?  Think about the following needs:

1.  To make an immediate, but unplanned expenditure (eg, the hot water heater ruptures).
2.  To make an imminent, planned expenditure (you plan to buy a car in the next six months).
3.  To avoid the risks of assets that fluctuate in value (this has other, significant costs.  I will address them later).

Those are the primary, rational reasons to hold cash.  To be certain, other irrational reasons exist as well.  You probably won’t have to knock on too many doors to find someone in their tinfoil hat hoarding a few thousand in cash in a coffee can, buried somewhere in the backyard.  I am not going to concern myself with them.

So, how much cash to hold then?  Like many economic questions that have been studied to death, this really comes down to an emotional decision once the primary economic factors are addressed.

Consider the following questions:

1.  How likely is it that you will face a significant expense that comes as a complete surprise?
2.  If (read: when) it does occur, how will you address it?

If you own a home or drive a car, the need to place your hands on several thousand dollars for unplanned repairs can happen at any time and for any reason, or no reason at all.   A recent study publicized at the Freakonomics blog highlighted the fact that many Americans would be unable to raise $2,000 in cash in thirty days if they needed it.  Several innovative ideas were noted that could help people improve their rate of savings.

If you didn’t have cash on hand, where would you get the money to make the repairs?

1.  Liquidate other assets (bonds, stocks)
2.  Tap into debt capacity (home equity line, credit cards).

Each of those has its own costs as well.  With stocks or bonds, there is usually a minimal cost of liquidation, but more importantly they are assets that fluctuate in value, and by liquidating you may be selling into a time when the market is feeling not-so-fresh.  If your roof was leaking in March, 2009 and you liquidated $10k of your stock portfolio to repair it, you not only parted with that cash but the $7,000 or so of growth you would have missed from then until now.

A home equity line and credit cards have a cost of borrowing (interest) that may be significant.  If you have pre-arranged those with a low interest rate, that could remove some of the sting of an unplanned need to utilize them.

So, those are the factors I urge you to consider when the question arises how much cash to hold.  Next week I will write about all the places to place your cash: banks, money market funds, CDs, and the mattress.

Paul Meloan is the co-founder and co-managing member of Aegis Wealth Management, LLC, in Bethesda, Maryland USA. Before Aegis Paul was a practicing attorney as well as working in the tax practice of Ernst & Young, LLP.

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