The cash needs of your clients vary, but each client needs to know how much cash they should have on hand based on their personal situation. Then, beyond their emergency fund, at what point are they beginning to accumulate too much cash?
For this episode of the Elementality podcast, we’ve gone into the Dentist Money™ Show archives for an episode about Liquid Term (Lt) to illustrate how Reese explains to dentists why handling cash correctly is such a critical part of overall asset management. Many advisors have requested examples for how to talk to clients about the key Elements® of financial health. Help your clients understand the advantages of managing their cash correctly by listening to how Reese explains it to his clients.
Podcast Transcript
Reese Harper:
You could carry a lot of debt, you can have a lot of stress, you can run a business and feel all the pressure from that. But it gets… It’s totally tolerable if you have a good financial plan with adequate liquidity.
Abby Morton:
Hey Elementality listeners, it’s Abby. Today we thought we would replay a portion of a Dentist Money Show. This is an example for how to explain liquid term from the Elements Financial Planning System to your clients. During this episode, Reese and his co-host Ryan Isaac, raise some common questions about cash management, highlight lesser known advantages of having enough liquidity and describe how liquidity needs to grow over time. Remember, while they’re addressing dentists, it’s a great example of how you can talk to your own clients about their needs. Enjoy.
Ryan Isaac:
Today’s podcast has to do with…
Reese Harper:
Liquidity.
Ryan Isaac:
Staying liquid.
Reese Harper:
Yeah, but why? Yeah. There’s a reason, besides the fact that I watched half of Moby Dick. I did… [chuckle]
Ryan Isaac:
Well, January is our… January is the month during our elements process where we actually benchmark this subject, this statistic. And the statistic we’re benchmarking in January is how long can someone live from today on their liquid cash. And so how about you just let us know what we view as liquidity, Ryan.
Reese Harper:
Yeah. Well, first I would just back up a little bit and I would just say for those that maybe aren’t familiar with the elements. So it’s when I talk to a lot of people who listen to the show and they catch little glimpses of… I’ve heard total term or savings rate, but the elements is a platform we built that each month has a corresponding theme. We call it an element, it’s a part of your personal finance. This month happens to be liquidity. We’re just measuring, like you said, out of all of your net worth, how much of it is liquid? And so for the whole month of January for every client, we’re just… We’re talking about questions about liquidity, how liquidity fits in net worth. That’s what we’re measuring for clients. We thought we’d take some time and talk about some of the discussions we’re having. So the first question is, what is liquidity? Liquidity can be described by… You could call it cash…
Ryan Isaac:
Some call it Moolah, I think…
Reese Harper:
Moolah…
Ryan Isaac:
I here.
Reese Harper:
Skrilla.
Ryan Isaac:
Skrilla. I have heard in the first few months from…
Reese Harper:
You get the Skrilla?
Ryan Isaac:
Some of these young graduates.
Reese Harper:
The young graduates talk about Skrilla all the time.
Ryan Isaac:
All you millennials and your new words, your new fancy words. We don’t understand.
Reese Harper:
And like I’m like, “What’s your income doc?” And he’d be like, “I’m just trying to get that paper.”
Ryan Isaac:
Yeah, yeah. Yes. Like do you have a number?
Reese Harper:
No, it’s more conceptual…
Ryan Isaac:
Yeah.
Reese Harper:
Okay? So liquid, that’s the cash portion, the money portion of your net worth that’s accessible without a penalty. That’s a good way to describe it.
Ryan Isaac:
Yep. Checking accounts, savings accounts, call it mutual funds that aren’t in a 401k or anything…
Reese Harper:
Brokerage accounts.
Ryan Isaac:
Cash value inside of a life insurance. That’s technically… We’ll consider that a liquid asset?
Reese Harper:
Yeah, it’s liquid. You could have it without a penalty, requires a loan but there’s no penalty.
Ryan Isaac:
And there might be a surrender charge because you paid your brother-in-law $50,000 to buy it from him. But technically it’s…
Reese Harper:
I digress.
Ryan Isaac:
What is ever left over after that commission, you can still get access to.
Reese Harper:
That’s actually a good point. I wonder what a bank would consider cash value of life insurance, if they consider that liquidity.
Ryan Isaac:
They usually do… Yeah, they do consider that…
Reese Harper:
Do they?
Ryan Isaac:
For loan purposes. It’s listed in the…
Reese Harper:
Accessible cash liquid.
Ryan Isaac:
In the part… That part of the personal financial statement if you look at… On most of the application.
Reese Harper:
Okay, so for new grads, this is the big question is what should I… A lot of people are asking, “What should I do when I come out of school?” And a lot of the answers, “You gotta build some liquidity.” ‘Cause the bank needs to see when you ask for a loan, do you have some liquidity? So those are the types of accounts that would be considered liquid. Apparently life insurance…
Ryan Isaac:
I would not consider life insurance the first place to put it.
Reese Harper:
Yeah, but don’t go buy it. It’s empty advise.
Ryan Isaac:
When we look at liquidity, a lot of people end up accumulating money in a lot of different types of accounts throughout their life. And if you just think of them as, “Can I get to that in a couple of days?” Without a government penalty or without… And the way we look at it too is, have you already paid taxes on that money…
Reese Harper:
Yeah, that’s a good way to…
Ryan Isaac:
As well. We reserve another bucket in your net worth for the stuff that you have to pay taxes on and you’re penalized for removing. There’s four… So we track four categories of our elements, four places where you can build wealth. One is liquid, which we’re talking about today. One is retirement assets, we call them qualified assets. That’s like your 401Ks, your IRAs and pensions. You can put it into the practice or private businesses or into real estate. So those would be the four categories. If you think about them like a pie chart and you look at any dentist in the first maybe five maybe even 10 years of career, that pie chart is gonna be overwhelmingly real estate and practice assets. You’ll have little slivers of maybe some qualified plans, maybe you started a 401K or an IRA, maybe you have a little cash, but it’s like overwhelming. So why liquidity matters for a dentist is it’s so under-represented on the balance sheet from day one. And most dentists could spend in a whole career just saving liquid assets and barely catch up with the real estate…
Reese Harper:
Real estate and business equity.
Ryan Isaac:
Yeah.
Reese Harper:
Yeah. Anyway, that’s why it’s such a big deal. It’s so overwhelmed by the other assets on a balance sheet right from day one that it just mattered. You gotta focus on it ’cause it’s easy to go 10 years in a career and then look back and you’re like, “I still don’t have any liquid assets.” We’ll talk about this in a little bit, which I kinda wanna jump into now…
Ryan Isaac:
Yeah.
Reese Harper:
Is, why does this even matter? And why would that… Why does this matter to have a discussion about liquidity, focus on that? What does it matter if I just have all my money in real estate and business interests and I’ll save some money for retirement? But when I sell all this stuff, it’s gonna create a windfall of cash for me…
Ryan Isaac:
: Yeah.
Reese Harper:
I’m fine anyway. Why does this all matter?
Ryan Isaac:
Stress. Right? No matter what else is happening in life, when you have cash that you know you can get at and it’s enough to cover maybe like a few months of living or a few months of business expenses, or you could pay off a debt if you wanted to, that’s just… That’s a different feeling than when you don’t have it. You will tend to view your other problems in life or your other… Just other aspects of your financial life. You’ll view your debt differently, if you have cash available. You’ll view the struggles of business differently if you have cash. Would you agree as a business owner, would you say that’s…
Reese Harper:
Yeah.
Ryan Isaac:
Stress levels fluctuate with fluctuations in cash and liquidity.
Reese Harper:
Yeah, I was just thinking back to the old days of your buddy Ishmael on your opera that you went to, Herman Melville and his friends. Okay. If you think about back in the day when you had farmers and whalers…
Ryan Isaac:
They were mad, too, because they just wanted to get some oil and he just wanted to chase Moby around.
Reese Harper:
See, and that’s my point is that currency didn’t really exist back in the day, but there’s always this underlying stress about not being able to make it to tomorrow that has to do with food, shelter, basic…
Ryan Isaac:
Whale oil.
Reese Harper:
Lights, whale oil…
Ryan Isaac:
Blubber. Blubber.
Reese Harper:
They don’t have a way to turn on their lamps without the whale fat. So they gotta harvest it.
Ryan Isaac:
A common problem.
Reese Harper:
Here’s the thing, I really do think though, liquidity… After currency became a thing, we went from piling up grain in these grain bins and storing corn and whale fat to where we have to store… We store cash, but they represent a similar feeling in our lives, which is can I… Am I good for awhile?
Ryan Isaac:
And surplus.
Reese Harper:
Am I good for a while? Can I last for a little bit? What if something bad happens? If I can’t get by for a month or a week or six months or a year, I get stressed out. So what did they do when they started running low on their whale fat? They head back out to the ocean.
Ryan Isaac:
Grab the harpoons.
Reese Harper:
They go for three months, they store it up a little bit more. And I worry about that for us in the same way. It’s not the fact that you have a loan on your whaling boat that really bothered these guys, right. It’s the fact that they don’t have any whale fat piled up.
Ryan Isaac:
There’s no oil, yep.
Reese Harper:
And I think it’s the same thing with us. You could carry a lot of debt, you can have a lot of stress, you can run a business and feel all the pressure from that, but it gets… It’s totally tolerable if you have a good financial plan with adequate liquidity. Everything’s tolerable with adequate liquidity. You can be convinced that you’re okay, if you have liquidity.
Ryan Isaac:
Well, I was just gonna say, I can think of very specific client situations where the obsession with the debt and the stress levels with the debt of just having a practice in a building are overwhelming.
Reese Harper:
And it almost drives them to make poor decisions.
Ryan Isaac:
Yes, yeah, yeah. And then to just convince someone to just give it a couple of years of saving money and building some liquidity and, in a lot of cases, some of those people grew their businesses, got bigger buildings, got more debt, but they had more liquidity and they viewed it totally differently.
Reese Harper:
The cost of debt is a pain. I hate seeing like mortgage interest paid and I hate seeing debt on real estate, debt on practice and… Liquidity is a way that all business owners can think a little bit more rationally and approach all of your decisions with a little bit more savvy, instead of just approaching it from a scarcity or you’re… Instead of freaking out because things are tight.
Ryan Isaac:
Well, I think that’s one of the best points about the stress levels of cash and liquidity is, when you gotta make a decision and you’re low on cash, you can just get forced panicking into decisions that you normally wouldn’t make. You don’t have the luxury of flexibility and time and patience anymore. So anyway, so that’s definitely a talking point. We do have clients who are in that position where they have a lot of debt and that’s a big stress and solving it with liquidity can make a difference.
Reese Harper:
Yeah. Now, you don’t have to keep all your liquidity in a savings and checking account, right?
Ryan Isaac:
Yeah. Well, that the second point, is talking about liquidity and looking at it at least once a year, helps us make sure that we’re efficient with cash.
Reese Harper:
I don’t think people realize that there are an infinite number of ways to grow your liquidity, that don’t mean putting it in the stock market. The stock market is a great way to invest your liquidity, especially if you’re going to not need it for 10 plus years. But you can grow your money at much higher rates than you can in the bank, just by… I think that’s kind of the feeling people have, is it’s either the bank or…
Ryan Isaac:
401K.
Reese Harper:
The stock market. And there’s really there are… There’s an infinite number of ways to invest your money at rates of return that range anywhere from 1% to 5% that…
Ryan Isaac:
That’s not stocks.
Reese Harper:
That’s not stocks. And I just think that people don’t… That most dentists don’t realize that there’s a better way to grow their net worth than letting a lot of cash pile up. I mean, they do, but I think they get… They just get stuck feeling like there’s… It’s just scary, I think, to let go of the cash in your practice checking account.
Ryan Isaac:
Yeah, well we’ve talked about it before, when it’s 50 and 60 and 70 and then 100 grand, that kind of feels like… Yeah, that’s operating capital. But when it’s 150 and two and then three and then five, that’s a big chunk of money to just commit to something. If you’re younger and you’ve never experienced this much liquidity yet, that’s… Don’t worry about it. But we can tell you from experience. Just this week, I’ve seen dentists with seven figures in practice and personal checking accounts that has not been invested.
Reese Harper:
I know no one’s feeling bad for that person.
Ryan Isaac:
Yeah. For years though…
Reese Harper:
No pity for that guy.
Ryan Isaac:
There’s nothing wrong, they’re in a great spot, but there’s a huge opportunity cost to that, but that’s kind of what… And there are many people listening to this going, “Yep, that’s me.” I just haven’t been able to commit or find comfort in a financial advisor or an investment advisor, or finding investments I feel comfortable with, so at least I know that the bank doesn’t steal my money, but that’s actually not entirely true. [laughter] Another episode.
Reese Harper:
That should become another episode. We’ll cover it next week.
Ryan Isaac:
I think just some other things that really come up that… Why liquidity, like why it’s important? One of them that kind of sticks out to me is there’s a lot of emergencies that come up in your life that you need to protect yourself against, but there’s also opportunities that you need to take advantage of.
Reese Harper:
Yeah, specifically the ones you didn’t see coming… The ones you’re not… I mean, which is life, all the stuff you don’t see coming that you’re not planning on, emergencies and opportunities.
Ryan Isaac:
Yeah, as a business owner. It’s that perfect hire that you may not have felt like you could afford, but you had enough liquidity laying around where you thought, “You know what? I don’t really need to be as worried about that, I’m gonna splurge for… ”
Reese Harper:
And this is the person I want in my business.
Ryan Isaac:
Yeah, this is the right associate, this is the right hygienist, this is the right office manager, this is the right key hire for my practice, and because I’ve got that liquidity, I’m not that worried about taking a little bit more risk on payroll to grow my practice to that next level. I think that’s a crucial one, I think there’s also real estate investment opportunities for you to relocate your practice or purchase space at the end of the lease term, that’s pretty critical.
Reese Harper:
Or buying out a lease because the perfect building opens up with other referral sources, and it’d just be like career changing to move there, but you gotta have some… Well they call it Moolah, H…
Ryan Isaac:
Skrilla.
Reese Harper:
Skrilla, paper.
Ryan Isaac:
Maybe buying a new practice that just comes on the market, maybe you’re a new associate and you’re… The only way for you to really be able to… Maybe the seller wanted to do seller financing, maybe that was a variable for them, but they wanted a down payment that was 100,000 plus.
Reese Harper:
Yeah. Unlike a bank.
Ryan Isaac:
And they were willing to do it that way, but they wanted to earn the interest on the sale. You may not be able to qualify or fit the profile that that seller is looking for if you don’t have the liquidity. There’s a lot of things…
Reese Harper:
Well, I was gonna say on kinda the same situation, but just on the personal side, this happens with primary residents frequently, where people aren’t planning on moving, they kind of always have in their head, I don’t know if that one house down the street, we love that yard and maybe if that ever opened up or sometimes you just don’t know those things, and then the perfect opportunity comes along and you kinda wish you had the means to take advantage of it. So we wanna make sure we’re checking in once a year to say, do you need to buy anything, if you’re saving 10 grand a month, and it’s all going towards stuff that is for the long-term, or putting into accounts that could decline in value during certain markets, we wanna make sure that you don’t need any of that money in the short term. Whether it’s for business or personal or anything else.
Ryan Isaac:
On that same vein, I think that it’s really easy to be imprecise in the amount of liquidity that you keep around for those things that you’re talking about, so you know you’ve got a remodel coming up, and so you kind of keep a certain amount of money around, but you don’t really know exactly when that remodel is gonna happen, and you’re not really sure.
Reese Harper:
Some of these things are two, three years out.
Ryan Isaac:
And my point is, I think a good financial advisor can help clarify a timeline that’s realistic and appropriate for your situation, both for practice expansion, second locations, associate hiring, relocation of your practice, purchasing a new home, a remodel, expanding your practice by buying another location. If you don’t set a timeline and you don’t quantify the down payment needs for those…
Reese Harper:
Yeah. Try to get close to it.
Ryan Isaac:
Various financed items, you’ll carry too much cash for too long, because what I’ve seen in the last three or five years, for example, is a lot of clients have way more cash than they need for those specific goals, and they’ve… Even if it would have been, “Okay, well, I have 100,000 too much,” or “I have 200 too much,” or even 50 too much. You would have earned 45% return over the last three years just by taking that excess liquidity that you have and deploying it into a long-term investment portfolio. And my point is that throughout our lives, the lack of quantifying our goals and clarifying our timeframes causes our net worth to not grow as fast as it could, it’s just as simple that.
Reese Harper:
Okay. I think that’s great. I think it can definitely work against you in both situations for sure. We wanna make sure we’re catching earlier on, in career if possible, is planning for… You see, later on in your life when you’re a little bit older, some bigger qualified retirement plans, things like pensions or cash balance plans or profit sharing plans, they’re better for you in terms of cost and efficiency when you’re older than most of your staff, that’s kind of part of the formulas that actuaries use to determine how much you have to give to staff if you use… If you use a pension plan or profit sharing. They look better when you’re older, and so preparing for that…
Ryan Isaac:
Older being it works in your late 30s, but it looks better in your 50s.
Reese Harper:
It does, yeah.
Ryan Isaac:
And so…
Reese Harper:
The bigger the disparity between an owner and the average age of employees, basically, the better.
Ryan Isaac:
Yeah. Don’t hesitate to try to get clarity on this.
Reese Harper:
Yeah, that’s part of… We look at that once a year too for everybody.
Ryan Isaac:
We’ll look at it in your mid-30s.
Reese Harper:
We always wanna know.
Ryan Isaac:
We wanna know what the ratios look like, but you’re right.
Reese Harper:
But if you think about it though we always try to encourage clients to accumulate their assets in a balanced way, which is why we’re talking about these things.
Ryan Isaac:
What do you mean by balanced?
Reese Harper:
Let’s say you have 10 grand a month that you save, you don’t want all of it to go into a pre-tax retirement plan, that’s gonna be taxed later, that’s illiquid, that’s a penalty you can’t get at, if you have no other means of liquidity. We wanna create some kind of balance. So having said that, if we know that later on in career, there might be an opportunity to really sock away a lot of money to take the bulk or maybe all of your monthly savings and put it into those kinds of plans to save on taxes, we’re gonna wanna make sure that we have some kind of liquidity buffer before we get to that point, ’cause I’d love to have a 50-year-old client and say, “We’re gonna take every penny you have every month and put it into this pension plan, ’cause you’re gonna save huge amount on taxes, but it’s okay, ’cause you’re also extremely liquid. You’ve spent the first 15 years of your career building liquid assets, and we’re quantifying what the practice and the building are, so I know what kind of liquidity event we’ll have when you transition out of working, we’re okay to put all of your money into this qualified plan.” And lock it up, and have it…
Ryan Isaac:
So just to back up a little bit on this, it sounds like what you’re saying is, when I get to a point where I start withdrawing money for retirement, I don’t wanna be pigeon-holed into having all the money come out of the 401K…
Reese Harper:
Yeah, for sure.
Ryan Isaac:
Pension type accounts, right? So I’ve got to…
Reese Harper:
And along the way too. If all of it it’s sitting there along the way, those things will happen, where you gotta go rob the thing and pay a penalty and taxes.
Ryan Isaac:
All of these issues we talked about previously, you can’t pull that money on a 401K without a pretty significant consequence. So if you build up the liquidity prior to really tackling the tax deductible contributions, you’re just in a really great position at the peak of your career to really minimize your taxes.
Reese Harper:
Yeah, and you think about the impact of that. If you can get a bigger retirement plan for the last decade of your career, and if it could save tens of thousands of dollars a year in taxes, which usually they do, then that could be a multiple six-figure decision by the time the money is invested and grown.
Ryan Isaac:
Yeah, I’m just going through this right now with a 44-year-old client. It’s been a perfect example of how I would ideally like to see this happen, which is early on in their career…
Reese Harper:
When those kind of plans didn’t make as much sense, right?
Ryan Isaac:
Yeah…
Reese Harper:
When you couldn’t max it out or…
Ryan Isaac:
Let’s say I’ve known this person for 10 plus years now and worked with them since they’re mid-30s, and so I’ve seen the graduation from dental school like almost no liquidity, and I’ve seen them go from their mid-30s clear into their mid-40’s…
Reese Harper:
Like a child, you watch ’em grow up.
Ryan Isaac:
I’m like his child, but yeah. Just kidding. So you’ve got, you’re in your mid-30s, and the tendency, I remember early on was, “I wanna pay off our house. We’ve just gotta pay off our house, if we can just pay off for house then everything’s gonna be fine.”
Reese Harper:
Yeah…
Ryan Isaac:
Well, I remember them telling me, “This is the be-all end-all house, we’re never gonna leave.” And then at 41, when we’re in 2007 stock market crisis…
Reese Harper:
There’s deals of a lifetime.
Ryan Isaac:
Yeah, they bought another house and moved out anyway. And so the fact that we didn’t end up paying down the house in the first place, we built up liquidity and we were investing money and we started to get a nice, nice reserve, and then when they bought that next house, they also financed 70% of it and maybe put 30% down, but sold some of the equity on their previous house. But they kept liquidity, they kept saving money and building up liquidity, and their taxes were really low because they had 179 expenses, they had their own equipment, they had the TIs that had cost segregation study on their building to bring their taxes down. They really didn’t have high taxes during their late 30s…
Reese Harper:
Comparatively. Yeah.
Ryan Isaac:
Compared to what it would be later. And now we’re 10 years in, they’ve got a million plus… This is an average GP that you just earned at the average income level as most GPs do across the country, but he spent the first 10 to 12 years building a massive amount of liquidity and growing that.
Reese Harper:
There’s a lot of back and forth on that though, that wasn’t easy for him.
Ryan Isaac:
That was not easy. I mean, that was an emotional, traumatic journey for me to have conversations with this person every year about like, “Oh, my accounts just went down, my accounts just… My accounts went up. Let’s put more in.” “No, we can’t chase returns, we’re doing this consistently,” “should we shift to more aggressive? It’s going awesome right now.” “Oh, let’s back off. I wanna be more conservative.” “I’m scared about… ” And it’s really hard, and now we’re shifting entirely. The entire automatic draft, which I think for this person is 25% of their gross income, which is somewhere between 11,000 and 12,000 a month, and that entire deposit now is shifting pre-tax.
Reese Harper: But you would not be comfortable telling him, “Yeah, put 100% of your monthly savings… ”
Ryan Isaac:
I could’t tell him to shift his savings to pre-tax…
Reese Harper:
If he was not liquid.
Ryan Isaac:
If he didn’t have any liquidity in after-tax monies because he wants to retire earlier. So if he wants to, if work’s gonna be optional in your 50s, we can’t have all the money in the 401k because you can’t even pull money out until you’re 59, and ideally we’d like to wait till you’re 70 and a half to pull that money out. So it’s this nice smooth curve of low taxes, accelerated depreciation, but instead of paying off… I mean pay off some high interest rate debt and just get to where you’re… We call your balance sheet, it looks proper, it has the right debt-to-income ratio…
Reese Harper:
It puts the balance in balance sheet.
Ryan Isaac:
It does, it puts it right there.
Reese Harper:
Put the balance back in balance sheet.
Ryan Isaac:
Like a lot of public companies, a lot of companies have this shift where they have to fix their balance sheet to make the bad debt be not quite as bad as, refinance things. If you have a low debt-to-income ratio and all of your interests on all your debt is reasonable, it really is a time in your early career to accumulate liquidity because your opportunity cost is not just the return, but it’s the entire calendar year of liquidity that you won’t be able to ever go back and get. You can always pay the debt down in the future year, and the cost of doing that, some interest expense, but you don’t get to relive a whole calendar year and build up that liquidity, and it has a compounding effect that’s really not only financially essential, but it’s emotionally, I think it puts you ahead in terms of your financial maturity. You’re learning how to invest, you’re learning how to think through these difficult issues as an entrepreneur, and like, “Should I hire someone, should we expand, should we buy this, should we refinance?”
Reese Harper:
Learning how to evaluate different investment opportunities along the way.
Ryan Isaac:
Yeah and if you don’t have liquidity, you don’t even have those opportunities, and I just think it matures people financially better to be more balanced as they pay down debt throughout their career and when you get into your 50s and your early 60s, if you’ve done it properly, it’ll all be gone anyway, but you’ll have just a net worth that’s probably millions of dollars more than you could have had otherwise.
Abby Morton:
Next time on Elementality.
Leah Coleman:
You have to think about starting a company in your first year, you’re still trying to figure out who your company is and what your brand is and what your process is. And I came from an old school world where we print it out, the e-money deliverable, and gave it to a client in a conference room and it was really thick and then we threw them in a portfolio and charged them AUM, right? So just trying to figure out how was I going to modernize what I thought financial planning was…
Abby Morton:
You can learn more about the Elements Financial Planning System at getelements.com/meet, and schedule a time to speak with one of our friendly financial planning experts. Elementality’s Executive Creators are Reese Harper and Matt Glazer. Elementality is produced by Abby Morton and directed by Jordan Haines. Have a good one!