We recommend that everyone have a specific plan to manage the cash balances in their bank accounts (“cash plan”). At Geometric, we work with our clients to create such a plan at the start of every new engagement.
A good cash plan both (a) ensures that clients maintain enough cash and (b) creates a discipline for investing any excess cash. This prevents the two primary mistakes people make with their cash balances: either maintaining too little cash (leaving them vulnerable to a sudden life disruption) or letting cash balances accumulate for too long (and ending up with a large, unproductive sum missing out on market returns[1]).
Our cash plans address three key questions:
- Which bank accounts are needed (and what is each account for)?
- What should be the target balance for each bank account?
- How often should we reset bank account balances back to their targets (and what to do with any excess cash)?
Which accounts are needed?
We recommend maintaining as few bank accounts as possible. This is often as simple as maintaining one checking account and one high-yield savings account (“HYSA”), though some prefer or need to have more accounts.[2] The checking account holds working capital (e.g., for ongoing personal expenses), and the HYSA stores (a) an emergency cash reserve and (b) any additional cash that should be earmarked for a large upcoming purchase (e.g., an upcoming home down payment).[3]
Note that we discourage keeping any non-invested cash in investment accounts. For those who are still working and accumulating wealth, it’s wise to both mentally and physically distinguish between savings (i.e., cash in bank accounts), which is for short-term needs, and investing (i.e., positions in investment accounts), which is for long-term needs.
How much cash to target in each account?
Once we determine which accounts to maintain, we set “cash targets” for each (i.e., target balances to which the accounts should periodically be reset). We often recommend that a client’s checking account target be 2-3x their average monthly expenses and that the client’s savings account target be 1-2x their checking target (and therefore 2-6x their average monthly expenses), but the appropriate targets for each client are context-dependent, factoring in variables including:
- The monthly surplus or deficit run by the client, and the amount of that surplus/deficit
- The timing and amounts of large bonus inflows
- Capital committed to any private equity investments
- Any large, one-time upcoming expenses that won’t be funded through normal cash flow (e.g., an upcoming down payment on a new house purchase)[4]
These targets are not intended to be permanent – they should be revisited as the client’s income or expenses materially change. That said, notably, we do not change a client’s cash plan in response to concerns or predictions about the stock market or economy – that is an indirect form of market timing, which is a path to reduced expected returns.
How often to reset bank balances back to their targets?
Balances will obviously fluctuate up and down with daily expenses. A cash plan must define how frequently we check in with a client to help reset their bank accounts back to targeted levels. We find checking in three to four times a year works well, ideally timed around any large inflows (e.g., bonus payments). We use those opportunities to check in with our clients about their cash balances and strategize on how to best deploy any excess cash for investing or debt paydown. If bank balances are below their targets, we discuss how we can free up some additional liquidity from investment accounts. Either way, because clients already have an established cash plan by this point, this process is relatively quick and mechanical, and therefore cash is invested quicker, spends more time in the market, and captures a higher expected return over time.
Creating a cash plan requires some upfront thought, but doing so allows our clients to put their cash management on autopilot and redeploy their mental energy elsewhere.
[1] A related pitfall of accumulating too much cash outside of one’s investment portfolio is the risk of getting psychologically trapped out of the market, wondering “when is a good time to invest this large cash sum?” This can create a vicious cycle, as cash balances and market anxiety both continue to grow, which can become paralyzing.
[2] For example, married couples sometimes prefer two individual checking accounts rather than one shared account, or individuals with international complexity sometimes keep an additional account open to facilitate overseas transfers. Multiple HYSAs, sometimes across more than one institution, can be necessary to ensure FDIC coverage for high balances. These are all good reasons to maintain more than two bank accounts – our point is simply to maintain the fewest number of accounts that work for a given situation.
[3] For Geometric’s clients, the HYSA can also serve a third purpose: to hold extra cash that might be needed for unpredictably-timed private equity capital calls.
[4] These situations often require a bit of planning to ensure that all balances remain FDIC insured, such as keeping the checking account and HYSA at two different banks, and/or being strategic about which accounts are owned individually versus jointly (when applicable).