Importance of a Cash Reserve Fund
Knowing the importance of a Cash Reserve Fund
can help reduce stress and worry during market uncertainty.
I lived across the street from my grandmother Ivey Stone while growing up, which was one of the most fortunate aspects of my childhood. She was fun to spend time with but was also full of wisdom, and I often remember things she did or said as I’m navigating life.
One of the things I remember her saying to me at some point was that she would normally fill up the gas in her car once the indicator got down to about ½ a tank. She didn’t want it to get too low and get busy with life or have some unexpected event that would force her into an emergency situation. After all, she lived through the Great Depression and the gas shortages of the 1970s, so I expect she remembered the feelings and emotions scarcity can bring and desired to avoid those if possible.
One of the other benefits of this practice, however, was that by making the choice to refill the tank before needing to was that she had more options and control over when to get gas, the gas station she used, and the price she paid. Many of us have probably experienced getting low and having to stop at a station with high prices or perhaps located in a sketchy area simply because it was the only one around. I thought of the practice of hers last year when the cyberattack on the Colonial Pipeline precipitated a gas shortage in the southeastern United States. Most if not all the pumps in the Atlanta area were typically out of gas by mid-morning, and we witnessed panicked behavior of people filling up their cars and as many gas cans as they could find when fuel was available.
In a similar way, many who are approaching or already in retirement are concerned about the falling investment markets this year and what that will mean for their lifestyle going forward. Will they need to delay retirement because their financial assets are declining, or will they have to cut back on their spending as a result? Chances are with a little understanding about the importance of cash and how money should be structured in retirement, the answer to these questions is “No.” Cash is like fuel in a car, which from a financial sense, enables one to navigate life smoothly. There can be many sources of cash in retirement from pension payments to Social Security to earnings on investments. Because of the uncertainty surrounding investment earnings, if a large portion of a retiree’s cash comes from this source, it will likely be uneven and likely won’t exactly line up with when the money is needed.
As a result, we have developed a Retirement Income Model, which seeks to optimize the flow of cash to retirees even when investment markets encounter wild swings like this year. A key feature of this model is the Cash Reserve Fund, which is sized based on a retiree’s anticipated 12-24 months of upcoming withdrawals needed from their portfolio. The money in this fund is used to provide a smooth flow of cash, and in this way functions like a car’s gas tank. It will need to be filled periodically, but if we don’t wait until it is empty, we can refill it when investments have performed well and produced earnings. And if investments aren’t performing well, we can wait and use a little bit more of the reserve until investment growth returns.
The simple addition of a reserve fund provides a buffer between daily life and often wild market fluctuations. I have seen retirees who implemented a cash reserve fund experience less stress and worry, because of the greater flexibility and control they feel when it comes to selling investments. They are more confident that they will have a smart place to get money when it is needed, which helps them focus on living out a more meaningful retirement.
While she passed away several years ago, I doubt Ivey Stone would have worried much about gas during last year’s shortage. She would have had at least ½ a tank at the start and would have figured out good times to fill up her car when it was available. We can do the same with your investment portfolio and the use of a cash reserve fund.
Will Stone, CFP®
President, On Purpose Financial Management
Financial Advisor, Raymond James
Any opinions are those of the individuals stating them and not necessarily those of RJFS or Raymond James. The information contained in this report does not purport to be a complete description of the securities, markets, or developments referred to in this material. There is no assurance any of the trends mentioned will continue or forecasts will occur. Any information is not a complete summary or statement of all available data necessary for making an investment decision and does not constitute a recommendation. Investing involves risk and you may incur a profit or loss regardless of strategy selected.