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When month-to-month cash flow doesn't (really) matter

If someone handed you a lightsaber, what would be your first thought? (Probably something along the lines of "This is SO @#!$%^*& COOL!") But if you're smart -- and if you're reading this blog, I'm betting you are -- the thought immediately following that would be, "Damn...if I'm not careful, I'll cut my own leg off!"

What this article is about to explain is like that. It's cool, and it's powerful -- and if you're not careful, it'll cut your leg off (metaphorically speaking). So having said that, here goes:

When you have enough liquidity, monthly cash flow doesn't matter.

Let me say that again: when you have enough liquidity, monthly cash flow doesn't matter.

What does that mean, exactly? It means that if you've got enough cash in reserve, and a sunny day fund on top of that, then it doesn't really matter if you're cash flow positive or negative on a monthly basis. All that matters is whether the long-term projections look good; meanwhile, if you're cash flow negative for the month, you can just pull from your cash reserves (and replenish your cash from your flexibility fund if necessary). Your income relative to your expenses no longer matters in the short term, because you have enough liquidity to pay the bills many times over.

Watch your leg

Now, before I talk about how this is cool, first let me talk about how this is dangerous. It's certainly possible -- and with Seaborn clients, quite common -- to be cash flow negative for the month, but have excellent long-term projections. Maybe your income is "lumpy" -- a large percentage of it comes through RSU's, bonuses, or commissions -- so you're fine for the year, just not necessarily any given month. Or maybe you're retired or semi-retired, and can afford to start taking distributions. Or maybe you're paying for college, and will be cash flow negative for a few years in a row, but are projected to be fine after that.

But you need to be really sure the projections look good. Ideally you're running Monte Carlo simulations. And you need to have at least a reasonable estimate of your nominal annual spending, or the projections are worthless. And your projections should have a bit of conservative buffer built in -- for example, using future expectations for portfolio returns, not recent history. And you need to be revisiting these projections on a regular basis -- once or twice a year, if you're going to take full advantage of this. (If you're a Seaborn wealth management client, yes, we do all of this; just because we quote Star Wars doesn't mean we don't take this very seriously!)

And as I said before, this is only relevant if you have sufficient liquidity -- emergency savings, cash buckets for other large spending, and a flexibility fund. (Of course, if you're eligible to pull from your IRA/Roth IRA/401(k)/what-have-you without penalty, then those funds are effectively liquid -- so this applies to most retirees!)

Alright, now that you've been warned: let's talk about why this is cool.

Why this is cool

Like learning to use a lightsaber, or the Force in general, this means you need to "unlearn what you have learned". If you're reading this blog, you've likely had a lot of practice in spending less than you make, keeping an eye on the monthly inflows and outflows and making sure the former is bigger than the latter. (And if you're not really a big spender, it may just have happened naturally, without you having to work at it much.)

But if you've trained yourself in this way, then you'll likely get anxious if your monthly cash flow starts feeling "tight". Example: let's say you're one of our clients, and we've just told you that you can put an extra $36K per year into your 401(k) via a "mega-backdoor Roth". Suddenly, your monthly cash flow drops by $3000 per month, and now your thought is, "I can't do this -- how the hell can I pay the bills?"

And if you don't have sufficient liquidity, the answer is: you shouldn't do the mega-backdoor Roth (yet). But what if, in this example, you have bonuses and RSU's that amount to $36K+ per year after taxes, and meanwhile you've got cash and liquid investments of $200K+? In that case, the mega-backdoor almost certainly makes sense: if at the end of the day the choice is between having more money in cash and (taxable!) liquid investments, or more in a Roth growing tax-free forever...why not the latter?

Or let's say you have access to an ESPP that lets you sock away $15K per year into an account that purchases your employer stock at a >= 15% discount and lets you instantly sell it the day you purchase it, thus virtually guaranteeing a 17%+ profit. In most situations, this is an easy win...but what if your monthly cash flow doesn't support losing $1250/month in the short term? Well, if you've got the liquidity, that's not a problem; you can just pull money from your reserves to make monthly cash flow work until ESPP sale time, and then replenish them (and more!) when you sell your ESPP shares.

Or let's say you want to save in a 529 for college, and you don't have the monthly cash flow to make it work...but you do have a larger flexibility fund than needed. You could set up a regular contribution to your 529, and take distributions from your flexibility fund to supplement your cash flow if needed; effectively, you're moving money from your (taxable) investments to your (tax-free) 529. Again, if you have enough liquidity, why not have your funds in an account which grows tax-free (assuming you're reasonably sure they'll be used for qualified college expenses, of course)?

It's not just about finances

Now, all of these examples involve using your liquidity to optimize your finances...but you can also use it to optimize your life. Once long-term projections and trade-offs are driving your decisions, not cash flow, your freedom grows by an order of magnitude. You can take a sabbatical. You or your spouse can take a lower-paying job for a while. You can temporarily move to a location with a higher cost of living.

Any number of possibilities open to you once you realize that month-to-month cash flow in and of itself is no longer relevant -- instead, it's all about your long-term projections. It's not about losing or gaining $1500/month -- it's about retiring earlier or later, or changing your standard of living, or some other long-term tradeoff.

This is one of the ways Seaborn works differently from other financial planning firms: we prioritize building cash reserves and a flexibility fund, often if this means delaying retirement contributions, because when you have the flexibility that comes with liquidity, you have all kinds of freedom -- including the freedom to further optimize your finances! It's difficult for some folks to wrap their head around, but our clients are smart enough to see the value, once they're introduced to the concepts...and from there, the galaxy's the limit!

Britton is an engineer-turned-financial-planner in Austin, Texas. As such, he shies away from suits and commissions, and instead tends towards blue jeans, data-driven analysis, and a fee-only approach to financial planning.


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