The worries that accompany feeling cash poor are a root cause of people making hurried and flawed decisions. No matter what else is happening, if people have access to cash they will view their other problems with less stress. Having liquidity allows them to think more rationally. So what criteria is used to define liquidity and what advantages come from having enough cash on hand?
On this episode of Elementality, Reese explains to the clients of his RIA why an emergency fund is not the sole reason to have adequate liquidity. Find out why understanding Liquid Term (Lt) helps clients resolve their immediate cash needs while also allowing them to make more thoughtful financial decisions.
Podcast Transcript
Reese Harper:
The point is, 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.
0:00:13.9 Speaker 2: 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’s totally tolerable if you have a good financial plan with adequate liquidity.
Abby Morton:
Hey, Elementality listeners. It’s Abby. To help you better understand Elements, we’ve chosen another episode from the podcast at Reese’s RIA, the Dentist Money show. On this episode, Reese and his co-host, Ryan Isaac, discuss the liquid term element. They talk about what you can tell clients about how to manage their cash and highlight some lesser known advantages of having enough liquidity. Enjoy.
[music]
Ryan Isaac:
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, so 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.
Reese Harper:
Some call it moolah, I think.
Ryan Isaac:
Moolah. Skrilla.
Reese Harper:
Skrilla I have heard in the past few months from…
Ryan Isaac:
Did you get the skrilla?
Reese Harper:
Some of these young graduates.
Ryan Isaac:
Young graduates talk about skrilla all the time.
Reese Harper:
All you millennials and your new words, your new fancy words we don’t understand.
Ryan Isaac:
I’m like, “What’s your income, doc?” and he’ll be like, “I’m just trying to get that paper.” [laughter]
Reese Harper:
Yeah. Yeah. Like, do you have a number? [laughter] No, it’s more conceptual. Yeah.
Ryan Isaac:
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.
Reese Harper:
Yep. Checking accounts, savings accounts, mutual funds that aren’t in a 401k or anything…
Ryan Isaac:
Brokerage accounts.
Reese Harper:
Cash value inside of life insurance. That’s technically… We’ll consider that a liquid asset.
Ryan Isaac:
Yeah, it’s liquid, you can have it without a penalty. Requires a loan, but there’s no penalty.
Reese Harper:
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…
Ryan Isaac:
I digress.
Reese Harper:
What is ever left over after that commission, you can still get access to.
Ryan Isaac:
Yeah. That’s actually a good point. I wonder what a bank would consider cash value of life insurance, if they consider that liquidity.
Reese Harper:
They usually do… Yeah, they do consider that for…
Ryan Isaac:
Do they?
Reese Harper:
For loan purposes, it’s listed in the…
Ryan Isaac:
Accessible cash liquid.
Reese Harper:
In that part of the personal financial statement, if you look at… On most of the application.
Ryan Isaac:
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 answer is that 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…
Reese Harper:
I would not consider life insurance the first place to put it.
Ryan Isaac:
Yeah, but don’t go buy it. [chuckle] That’s not the advice.
Reese Harper:
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?
Ryan Isaac:
Yeah, that’s a good way to look at it.
Reese Harper:
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. I kinda wanna jump into now is why does this even matter, and 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, so 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 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.
Reese Harper:
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, “Am I good for a while?”
Ryan Isaac:
It’s surplus.
Reese Harper:
“Am I good for a while?” The point is, 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’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, just… Of 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 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:
I think it’s just a totally different… I mean, when you’re a dentist, and your AR’s out, and you have a problem with your dental software, and you can’t collect, and you’re struggling to get caught up on all your collections, that will create a lot of pressure in your life, and having a little bit of liquidity can kind of put those pressures at bay. If you have an office manager or a hygiene department have some turnover, or if a competitor moves in and you see a decline in your collections, if your marketing gets screwed up and you didn’t realize that you hadn’t really been executing properly for the last six months and your new patient flow’s down, all of these things can be really, really stressful, and they put massive stress on your personal life, your relationships. Making good decisions as a business owner gets put in jeopardy. You’re not thinking about it from a long-term perspective, it becomes very short-term. And so the cost of debt is a pain. I mean, I hate seeing mortgage interest paid, and I hate seeing debt on real estate and 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… Instead of freaking out because things are tight.
Ryan Isaac:
Yeah. 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… I mean, that’s definitely a talking point where 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 big difference.
Reese Harper:
Now you don’t have to keep all your liquidity in your savings and checking account, right?
Ryan Isaac:
Well, that’s the second point is talking about liquidity and looking at it least once a year helps us make sure that we’re efficient with cash. That’s very common when people feel maybe paralyzed by indecision or lack of a plan, and cash just piles up in the business.
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+ years, but you can grow your money at much higher rates than you can in the bank, just by… And I think that’s kind of the feeling people have is either like the bank or.
Ryan Isaac:
401k.
Reese Harper:
The stock market.
Ryan Isaac:
Yeah.
Reese Harper:
And there’s… Really, 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 [0:10:20.5] ____.
Ryan Isaac:
Yeah. Well, we’ve talked about that before. I mean, when it’s 50 and 60 and 70 and then 100 grand, that kinda feels like, “Yeah, that’s operating capital.” When it’s 150 and 2 and then 3 and then 5, that’s a big chunk of money to just commit to something.
Reese Harper:
And 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.
Ryan Isaac:
I know no one’s feeling bad for that person.
Reese Harper:
For… Yeah. For years, though…
Ryan Isaac:
No pity for that guy.
Reese Harper:
There’s nothing wrong… They’re in a great spot, but there’s a huge opportunity cost to that. But that’s kind of… 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.” I think there’s some other things that really kind of come up that… Why liquidity… Like why it’s important. One of them that kinda 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.
Ryan Isaac:
Yeah, specifically the ones you didn’t see coming, like 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.
Reese Harper:
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… ”
Ryan Isaac:
“And this is the person I want in my business.”
Reese Harper:
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.” 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 a lease term. That’s pretty critical.
Ryan Isaac:
Or buying out a lease because the perfect building opens up with other referral sources, and it’d just be like career-changing to build there.
Reese Harper:
Totally.
Ryan Isaac:
But you gotta have some, how do they call it, moolah?
Reese Harper:
Yeah. Skrilla.
Ryan Isaac:
Skrilla, paper.
Reese Harper:
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+.
Ryan Isaac:
Like a bank. Yep.
Reese Harper:
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.
Ryan Isaac:
Well, I was gonna say, on kind of 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 like, “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… 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 it 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.
Reese Harper:
On the 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…
Ryan Isaac:
Some of these things are two, three years out.
Reese Harper:
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. I mean, if you don’t set a timeline and you don’t quantify the down payment needs for those various…
Ryan Isaac:
Try to get close to…
Reese Harper:
Financed items, you’ll carry too much cash for too long. So what I usually see is people have a little… In the opposite case… You’re saying in cases where bankers are like, “These people don’t have enough liquidity,” that’s also a problem. But there’s the case… Many cases where people have too much liquidity, and it’s because they have these undefined, unquantified goals where if you say, “I’m gonna do a remodel,” okay, well, what’s the… Is this a $150/foot remodel? Is it $175 a foot? Have you talked to a contractor yet? Do you know what the range of nice to cheap looks like? Okay, well, the cheap is probably not you, but maybe the most expensive is not you, so let’s plan on $210 a foot in your community based on what three contractors have told us, and it only took us an hour of phone calls. Now we know that, we can say the down payment is gonna be $147,000 at most, and you have 243,000. So you have $100,000 more than you need for that specific goal. Do we really wanna wait three or… The three… How long are we going to wait sitting around with more than we need? 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 as that.
Ryan Isaac:
Yeah. I think that’s great. It can definitely work against you in both situations for sure. Another… A big one where liquidity starts to make a big difference that we wanna make sure we’re catching earlier in career, if possible, is planning for, later on in your life, when you’re a little bit older, some bigger qualified retirement plans, things like pensions, 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 a pension plan or profit-sharing. They look better when you’re older. And so, preparing for that…
Reese Harper:
Older being it works in your late 30s, but it looks better in your 50s.
Ryan Isaac:
It does, yeah.
Reese Harper:
And so…
Ryan Isaac:
The bigger the disparity between an owner and the average age of employees, basically, the better.
Reese Harper:
Yeah. Don’t hesitate to try to get clarity on this.
Ryan Isaac:
Yeah, that’s part of… We look at that once a year too for everybody.
Reese Harper:
We’ll look at it in your mid-30s. We wanna know what the ratios look like.
Ryan Isaac:
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.
Reese Harper:
What do you mean by balanced?
Ryan Isaac:
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 suck 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 a 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’re transition out of working, we’re okay to put all of your money into this qualified plan and lock it up and have it inaccessible.
Reese Harper:
Yeah. 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 pigeonholed into having all the money come out of the 401K pension-type accounts, right?
Ryan Isaac:
Yeah, for sure. Yep, yep.
Reese Harper:
So I’ve got to…
Ryan Isaac:
And along the way too. I mean, if all of it’s sitting there along the way, those things will happen where you gotta go rob the thing and pay a penalty and taxes.
Reese Harper:
All of these issues we talked about previously, you can’t pull that money out of 401K without 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.
Ryan Isaac:
Yeah, and you think about the impact of that. I mean, if you can get a bigger retirement plan for the last decade of your career and it… I mean, if it could save tens of thousands of dollars a year in taxes, which usually, they do, that could be a multiple six-figure decision by the time the money is invested and grown. One of the last things we’ll talk about is the effect that liquidity has on the way you invest money, so it’s kind of along the lines of what you’re saying. If you have different… Think about buckets of money that you’re gonna access at certain points in your life after you’re done working. Maybe 55 to 65 is this bucket. Maybe it’s some of the practice equity, and then it’s some mutual funds from the brokerage account, and then at 70, then we’ll finally hit the cash balance of the defined-benefit plan or whatever. Won’t that change the way you invest money? If you know you’re liquid enough to last you until the government makes you take money from your pension, will that allow you to invest the pension differently than you would other accounts?
Reese Harper:
Oh yeah, no question. I mean, how would you advise people on that?
Ryan Isaac:
Yeah. I mean, totally. If you know that you don’t need the pension money until you’re 70, that means you have a longer time horizon on the account, and the rule of thumb is that the longer the time horizon, the more risk you can afford to take, and so that alone… I mean, depending on when you live and when you retire in the market cycles and when you access the money, that could be a big difference in money if it’s invested slightly more aggressively. If you have your pension money that’s the last thing you’re gonna touch, it can be invested differently, and that could make a big difference. Your spending will change throughout your career and your retirement too. Early… Like end of career, early retirement, probably into your 60s, spending’s gonna reflect pretty similar to what it was pre-retirement. We know that just statistically and having seen people, but there will be a point later in your 70s and 80s when spending will slow down as you slow down.
Abby Morton:
Next time on Elementality.
Reese Harper:
When you master the emotional jobs, you own the client relationship.
Carl Richards:
Yeah, for sure.
Reese Harper:
And the functional jobs that you’re so skilled at will continue to be replaced by technology, will continue to be scaled by technology. It’s not gonna be the place where you wanna hang your hat deeply if you’re really trying to increase the value that you can charge for and be rewarded for in the market.
Abby Morton:
To find out more about Elements, go to getelements.com/demo. Elementality’s executive producers are Reese Harper and Carl Richards. Elementality is produced by Tad Henderson and directed by Abby Morton. Have a good one.