Are you prepared for a financial emergency?
Preparing for a planned or unplanned life event during these challenging times may beg the question: “What’s the biggest threat to my financial stability?” Job loss likely comes to mind, perhaps followed by a serious illness or a natural disaster. But, lack of cash flow should make the list too.
Consider cash flow and liquidity management a tool, not a goal: Much more than tracking your income and spending, liquidity management is also about planning for unexpected cash needs. Without proper planning for an emergency, you might have to dip into cash reserves or liquidate a long-term investment which could could potentially disrupt your long-term investment plans. For example, retirement account assets may be subject to tax penalties* for taking non-qualified distributions prior to retirement, or you may be liquidating your investments at a low point in the market. You might do better keeping those assets invested to potentially generate a long-term return thereby keeping your overall wealth strategy intact.
It’s important to keep in mind that cash flow and liquidity management planning 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 three steps you should consider as part of a cash flow and liquidity management plan to help protect your loved ones and keep a natural disaster from becoming a financial catastrophe.
- Set up an emergency account: In addition to accounts where you currently keep cash assets (including checking, savings, certificates of deposit (CDs), money markets, or other cash alternatives), fund an emergency account as part of your cash flow and liquidity strategy to help protect all 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.
- Review your short-term 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 we suggest you discuss these with your financial advisor.
- 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 non-retirement investments or other approaches can provide for short-term cash needs if your emergency fund does not stretch to meet all 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, costs and risks are associated with any borrowing decision, so it is important for you to seek good, objective guidance. Your financial advisor 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 where to access cash when you need it. Talk with your financial advisor about managing your cash flow and liquidity needs.
*Wells Fargo & Company and its affiliates do not provide tax or legal advice. Please consult your tax or legal advisors to determine how this information may apply to your own situation. Whether any planned tax result is realized by you depend on the specific facts of your own situation at the time your taxes are prepared.
Securities-based lending has special risks and is not appropriate for everyone. If the market value of a client’s pledged securities declines below required levels, the client may be required to pay down his or her line of credit or pledge additional eligible securities in order to maintain it, or the lender may require the sale of some or all of the client’s pledged securities. Wells Fargo Advisors will attempt to notify clients of maintenance calls but is not required to do so. Clients are not entitled to choose which securities in their accounts are sold. The sale of their pledged securities may cause clients to suffer adverse tax consequences. Clients should discuss the tax implications of pledging securities as collateral with their tax advisors. An increase in interest rates will affect the overall cost of borrowing. Wells Fargo Advisors and its affiliates are not tax or legal advisors. All securities and accounts are subject to eligibility requirements. Clients should read all lines of credit documents carefully. The proceeds from securities-based lines of credit may not be used to purchase additional securities, pay down margin, or for insurance products offered by Wells Fargo and any of its affiliates. Securities held in a retirement account cannot be used as collateral to obtain a loan. Securities purchased in the pledge account must meet collateral eligibility requirements.
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This article was written by Wells Fargo Advisors and provided courtesy of Richard Ricci – Financial Advisor in Washington, D.C. at (202) 364-1605.
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