Top 5 Reasons This Physician Holds $500,000 in Cash

Today’s Top 5 list is a guest post from VagabondMD, a late-career interventional radiologist who has been a regular reader here, and a frequent contributor of wisdom on the WCI forum. In his early fifties, he is looking forward to reducing his workload to part-time status this fall.

Take it away, VagabondMD! 

Top 5 Reasons I Keep a Half Million Dollars Under My Mattress*

 

(* my wife asked me to add here that we really do not keep any money under the mattress. None at all. Really.)

 

It is personal finance dogma to maintain a liquid (i.e. cash) emergency fund which would be expected to cover three to six months of living expenses in the event of job loss, illness, or other personal or financial catastrophe.

While this is considered by many to be the first thing that you do in your financial plan, before contributing to 401(k) accounts or 529 plans, many are woefully unprepared for what life throws at us on a fairly regular basis . A well-publicized 2016 survey revealed that the majority of people could not manage a $500 surprise car repair without going into debt, let alone being let go from work.

On the other hand, there are many in the personal finance blogosphere who scoff at the idea of a 3-6 month cash cushion. There are other alternatives to resorting to idle cash, including tapping your home equity line of credit, selling investments from a taxable account, and invading the Roth IRA.

VagabondMD

speed vagabonding

Why leave three to six months of expenses, thousands of dollars, in a lowly savings account (currently yielding 1% or less) when you can have the money at work in the stock market, in real estate, in your business, or somewhere else (anywhere else) where the expected returns are much greater? I am going to tell you why.

But first, i would like to dispel some of the hyperbole in the title. My current cash cushion is not $500,000, but, as I demonstrated to my wife last week, it is $475,000, which I would expect to cover 5 years of living expenses in the event of a sudden, unexpected dual job loss. Second, not all of the money is in savings account or in one bank, but it is distributed in two online banks, one local bank, and two brokerage accounts, in checking, savings, and money market accounts and in CDs. (If you add in the very liquid savings bond position, the total would be north of the $500k.)

On to the reasoning…

 

1. Recessions happen

 

We have lived through two major recessions in our professional lives, 2000-2002 and 2007-2008. In both cases, we had countless friends in “good, stable jobs” that lost these “good, stable jobs” and witnessed the financial and personal carnage that this wrought upon them.

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Like my CPA friend who was previously a Comptroller for a Fortune 500 Company who, after a seven year period of unemployment beginning in 2008, now does part time bookkeeping for a solo law practice.

Or my IT friend, an executive in an international financial firm who was forced to train Indian software engineers to replace him as his US-based job was eliminated and moved abroad after the tech meltdown. Neither of these guys saw it coming. I do not see it coming either, and I do not generally do well with carnage— it’s not in my DNA.

 

2. Fear of Locking in Losses

 

It is very likely that when there is another financial upheaval, some of the other assets that you own will lose their value and or their liquidity. It happened in the early 00’s and again in the late 00’s.

Do you really want to be forced to tap your Roth IRA when the S&P 500 fund in it is down 50%? Or sell your house or investment property when no one can get a mortgage loan to buy it? Both are great ways to lock in a loss.

 

3. Why Play a Game You’ve Already Won?

 

William Bernstein, the esteemed neurologist and author, said in his book, The Ages of the Investor: A Critical Look at Life-cycle Investing, “When you’ve won the game, why keep playing it?

The gist is that if you have enough saved to live in retirement, reduce the risk you take with your portfolio, especially later in life and as you approach retirement. In personal finance parlances we often talk about “The Number”—how much of a nest egg you need to call it quits on the day job.

Is it a big number pulled from the sky like $1 Million, $5 million, $10 million or $100 million? Is it a multiple of annual living expenses like 25x in the Trinity study or a more conservative and ambitious 33x? “The Number” is a rather elusive concept, but even while we are working, we are presently a bit north of our Number, by about, say, $500,000. Having a large cash position pays homage to Dr. Bernstein’s concept by taking some chips off the table.

 

Minnesota 51 Iowa 14

had a 44 point lead. still played the game.

 

4. Interest Rates Are on the Rise

 

Interest rates are likely rising in the next few years, after a prolonged period at historic lows. Janet Yellin largely promised this in December. As interest rates go up, the value of your bond holdings will decrease. In this environment, is it really crazy to have a chunk of your fixed income allocation where there is no interest rate risk, in a savings account?

 

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5. Following a Three Bucket Strategy

 

My wife and I are in our early 50’s, working full time in demanding medical and legal positions. I plan to cut back to part time later this year, and we both expect to be retired from our current professional jobs in three years. The $500,000 cash position transitions nicely to the cash bucket of a Three Bucket Strategy.

If our equity investments continue to increase in value in the next few years, we are on track. If the stock market takes a dive between now and then, we are still on track. Either way, we hope to spend our retirement alternatively working as tour guides in Florence, Italy and Yellowstone National Park.

 YosemiteFlorence

Cash is Not Trash!

 

In fact, cash is still accepted in many places for good and services. In one’s personal finance portfolio, I prefer not to think of it as an anchor holding back returns but the lifeboat that might save you when the boat hits the iceberg. Or maybe the dinghy that takes you ashore when you are tired of sailing.

It is flexible, it gives you options, and it is there when you need it. Earlier in my career, even when my human capital was near its peak, I preferred to have an out-sized cash position and over time, with more life experience and a professional career in the bottom of the eighth inning, I value it even more.

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[PoF: Today’s guest post is a good example of personal finance being personal. I wouldn’t choose to hold so much cash, citing math as the principal reason. VagabondMD has his reasons, which are largely based on risk tolerance and the ability to sleep well at night. 

There is no right answer, but each of us can have a best answer as it applies to our personal situation. 

The question of bonds and rising interest rates is an interesting one. The resale value of an individual bond will fall when the interest rate rises, but what happens to bond funds isn’t entirely predictable. When some bonds reach maturity, they are replaced with new bonds at the new, higher interest rate. If you’re interested, Schwab has explored a number of periods of rising interest rates and the effects on various bond funds. Hint: we should be OK.

Personally, I keep a miniscule cash cushion of one to three months’ expenses, or less than 4% of VagabondMD’s $500,000. I like to put my money to work, but that’s just me.]

 

To read more from the prolific guest author, Vagabond MD, see all of his articles:

 


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What do you do? Would a large cash position make you feel better or worse about your future prospects? Will you continue to play the game after you’ve already won?

 

108 comments

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  • Gasem

    Phil was the best investment decision I ever made. I’m in the middle of 70 mph winds. The feeder band that pounded Miami all day has made it to me, Power is still on most of the time. Proof God loves me.

    I have tips in the form of a DFA fund. One advantage to having someone like Phil is I get access to institutional grade funds, which often have slightly different rules compared to say Vanguard’s S&P fund. DFA is the brain child of Eugene Fama and others and they figure out further efficiency in an index like having rules that allow trading a stock that enters or leaves the S&P in a different time frame than a standard index fund. This buys a little more return. DFA studied what is the most efficient cash equivalent for inflation protection and came up with a fund of long term TIPS, so I use that DFA has very low cost funds et. So own both muni for convenience and tax free return plus short term paper will tend to follow inflation closely. For TLH there are several sorta equivalent funds (very similar performance) that fit wash rules so it’s not hard to harvest. Phil is connected. He is in Buffets roll a dex and has lunch with him every year, and he is very up to date on fine tuning modern portfolio thinking vs return. Maybe I’ll write a guest post on that.

    I strongly recommend his books especially if you’re a resident or med student or early attending. You can spend hours and hours searching forums or read his books and have an excellent handle on how to invest. Your portfolio follows his perspective very well

    Best

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  • Well said, PoF. I have a hard time explaining at times my reasoning for keeping my powder dry. From now on I’ll refer them here.

  • Paul

    As I write this I have 712,513.94 in bank products. The rest is a split between bond and stock funds. We are retired with no debt so anyone reading this obviously knows how much I agree with this article. Would it be nice to have another 500K in this market the last 3 or 4 years, yes. I have reached the point where I just don’t care. (Whew, that is easy to think but hard to write). I am actually starting to pull out some of the stock funds and put them in bond funds. Yes, interest rates will go up but I believe over time the funds will rise back up. We have been retired almost 5 years and without SS we have lived on dividends, interest and an annuity payment. Our net worth is higher today than when we retired. And no, we don’t eat Alpo, as a matter of fact we are getting ready for a 2 month stay in Hawaii….ahh, Hawaii… So the whole point is you will know when you are comfortable and that point is different for everyone just like there are no 2 snowflakes alike! Have a great day everyone!

    • Aloha, Paul! You are clearly of the “You’ve won the game, so why keep playing” mentality. It’s an abundance mentality, and I like it, even if it doesn’t necessarily jive with my own thoughts on what I plan to do with my money.

      I think the absolute dollar amount is more meaningful in relation to the size of the total portfolio. If we’re talking 10% to 20% or less, which I suspect we are, there’s nothing wrong with having that amount of cash / fixed income on the sidelines.

      My family and I are spending nearly all of February in Hawaii. Kauai, Big Island, and Oahu.

      Surfs up!
      -PoF

      • Paul

        Aloha Nui Loa!
        I spent 30 years there and it was wonderful. While you are on the Big Island I recommend Huggo’s for a great dinner if you are on the Kona side. It is on Alli Drive just a mile or 2 from Kona. It would take 15 pages to give you all my favorite spots on Oahu but two I will mention are Roy’s in Ko Olina and if you like sushi here is the spot: https://www.yanagisushi-hawaii.com/reservations. Have fun!

        Aloha,
        Paul (It is really Kimo but no one here gets that unless they are from Hawaii LOL)

        • Thank you for the recommendations! We are sushi fans. The kids, not so much.

          We’re spending time on the Kona side, and the Hilo side (and a couple days in a Yurt near the volcano park), so we should see much of the island.

          Best,
          -PoF

  • kile

    Great explanation of your rationale. To build on it, Wade Pfau (noted researcher on retirement issues) has studied asset allocation going into retirement and would support a low equity % in the early years (aka hold more cash). Then in retirement, slowly build the equity % back up. I can’t find the exact article, but I recall that he recommended having equities in the 20-50% range when starting retirement. The main reason was to manage sequence of return risk in the first decade of retirement.

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