Let me preface this post by saying that I am no expert on this topic. In fact, I'm not sure that anybody is. I still think it is worth discussing and hope to learn as much from you all on this as you do from me. One of the most tricky things that my household deals with financially is cash flow.
It's a total first world problem, I'll be the first to admit. I mean, most doctors have more money in their checking accounts than the average household in this country has in net worth. Occasionally my wife logs into our online checking account and is surprised to see a high five-figure or even low six-figure amount sitting there. Our investing account was smaller than that for years and years and our monthly budget is an order of magnitude less than that so you can see why that would be shocking. But it occurs due to issues with cash flow that I bet a lot of doctors struggle with, and that's what we'll be talking about today.
What Is Cash Flow?
Cash flow is completely distinct from budgeting and your savings rate. It also has little to do with your investment portfolio. It is basically the process of most efficiently getting the money to where it needs to be at any given moment. There are all kinds of factors that come into this and make it tricky.
For example, let's consider how I get money from the WCI checking account into my other accounts. I cannot “push” money from the business checking account to my personal checking account. I can “pull” money, but that is limited to about $5,000 every couple of days. If I needed to move $30K, that would mean logging in every 2 or 3 days for two weeks. I can pull the money into our individual 401(k), but that money cannot then be transferred anywhere else. I could write out a check and mobile deposit into personal checking, but mobile deposit is also limited to $5K a day. So we ended up settling on using that checking account's “Bill Pay” feature. We'd just pay a bill into our checking account. Then the credit union changed their bill pay (basically broke it) so we could no longer do that, at least if we wanted that check to get there in less than 2-3 weeks. However, our online savings account at Ally allows us to pull in much larger amounts from that business checking account. So that is the method we currently use. But that means if I want to move money from business checking to personal checking, that's a two-stage and about four business day process.
Budgeting and cash flow planning are separate. For example, our monthly budget, what our family actually spends after-tax, is about $10K. (Some of you will think that's a lot and some of you will think that's not very much at all, but it is what it is.) Our actual income in any given month may be 3-10 times that, with pretty dramatic variation.
That means the money going to investments and taxes dwarfs the actual tracked budget. If “every dollar has a name,” the name on most of those dollars is federal taxes, state taxes, charity, Roth IRAs, 401(k)s, taxable accounts, etc. Part of the way we've dealt with such huge variation in our monthly income is to properly manage cash flow. We fund the investment accounts more in the fat months than the lean months.
However, part of the solution to our cash flow issues is simply to set our lifestyle at an amount such that even in our worst month we still feel like we have money coming out of our ears. Bad month? Okay, that means less goes to taxes and charity (since we set those as percentages of income) and we'll have to put off funding that 401(k) or 529 for another month.
It doesn't mean the kids go hungry, we don't go skiing, or we can't pay the utility or insurance bills. It has zero effect on our lifestyle; it only affects our financial independence date. Having a high savings rate certainly helps cash flow, but budgeting and cash flow management are still pretty distinct.
4 Cash Flow Considerations
There are four main items to think about when determining your cash flow processes.
#1 The Return on Your Money
For example, my savings account pays 1% but my checking accounts pay 0%. My investment accounts have an expected return much higher than 1%. From a return perspective, I don't want to have money sitting in checking that could be in savings and I don't want money sitting in savings that could be invested.
The second is the cost of not having cash available when it has to be available. Usually, there are fees associated with that. For example, if there is nothing in my checking account when a check hits, that would normally be associated with a fee from my bank and probably another one from whoever I wrote the check to. So as “overdraft protection” we have a credit card. If I write a check the checking account can't cover, it goes on to the credit card as a cash advance and the interest starts ticking. By the time I notice that and pay it off, I've paid at least a couple of days of interest that I wouldn't have had to pay with better cash flow. Not having cash available could also cause you to miss out on an investing opportunity or a purchasing opportunity.
#3 Hassle Factor
I don't even look at my investments on a monthly basis. I'd prefer not to have to look at my checking account that often either. I suppose if I was willing to spend a great deal of time and effort logging in every day I could run my checking account balance lower than I do, but it just isn't worth the hassle, especially when the alternative account only pays 1%. So what if $20-30K sits in checking a couple of weeks longer than it has to. It's not worth my time to be chasing it all over the place.
#4 Safety Factor
Finally, there is the safety factor. Risks of identity theft, loss of a device, a transfer error, etc all go up the more you mess with your cash flow and the more you seek to minimize hassle and increase returns.
Credit Can Help With Cash Flow
I'm not a big fan of being in debt. Our only debt is our mortgage, and as noted in previous posts, that will be gone soon too, or at least the ability to make it disappear will exist. But credit can improve your cash flow dramatically. Sometimes there is a cost for that, sometimes there isn't, and sometimes you're actually paid to do it.
For example, I'm now making my quarterly estimated federal tax payments by credit card. It costs me 1.87% to do that. However, my Fidelity AmEx (now Visa) pays me 2% to do it. It's nice to make a little money, but the cash flow improvement is dramatic. Instead of the IRS depositing my check on June 15th, the credit card company may not pull it out of my account before August 5th! I get the use of that cash to ease my cash flow problems and boost returns for almost two months longer.
Speaking of Taxes
Taxes, especially for the self-employed but really for everyone, provide their own cash flow issues. Many financially naive employee doctors aren't aware of the difference between what is withheld from their paychecks and what they actually owe. Sometimes they even look forward to getting a big fat tax return check, not realizing that what they're really doing is making Uncle Sam an interest-free loan. The self-employed have similar issues. They are responsible to do their own withholding and make sure all their taxes get paid. That can get especially tricky in a state like Utah where you are allowed to pay the entire tax bill for the year on April 15th of the next year.
However, even if you have to make quarterly estimated payments for your state (and of course the Feds) that amount is only somewhat related to the amount of taxes they actually owe. This is an issue we've had the last 2 or 3 years with our payments as we ended up writing a huge extra check in April each year to cover our tax bill. I think we've finally stumbled upon the best way to manage this issue.
To stay in the “safe harbor” and avoid any penalties and interest, each quarter we send the IRS 1/4 of last year's tax bill multiplied by 110%. So even if we end up owing a lot more than 110% of what we paid last year, there won't be any penalties or interest. We've been doing that for at least the last couple of years. But this year we're keeping an amount in our savings account earmarked for taxes equal to 27% of gross earnings. Last year our tax bill was 25.2% and for various reasons I expect it to be a little higher next year percentage-wise. But 27% ought to be pretty close for us.
The June quarterly estimated payment has always been the tricky one for us. My partnership sends us a check at mid-month each month from February to December, but the January check (from December earnings) comes out the last couple days of December as an estimate to be trued up with the February check.) The “truing” can be positive or negative. But at any rate, that means that you get three paychecks to make your April quarterly estimated payment, but only two checks to make your June one. You then get three more before September and the January payment is cake, since you get four months to save it up (just be sure not to blow it on the next year's Roth IRAs or HSA.)
The Partitioning of the Savings Account
Our savings account is really a dozen different savings accounts, all earmarked for different purposes but all lumped together. Our emergency fund is there, our allowances (the money we can blow on anything we want without needing permission from the other) are there, the money for next year's disability insurance is there, the money for next year's life insurance is there, the tax money is there, the money we plan to donate to charity that year, and even amounts for upcoming investment account “bills” are there. Altogether it is a sum that is a multiple of our emergency fund. The idea being that if something happens such that we're living on emergency funds, all the other upcoming bills are already taken care of. Maybe we'd be better off investing more of that, but having all that cash helps us to worry less about money and to stay the course in a market downturn.
The Hassle of Changing Banks
One last comment about banks–changing banks is a pain with all the accounts and bills that are tied together with automatic payments. I'm willing to put up with some minor hassles and lower returns to avoid the major hassle of changing banks. I suspect everyone feels the same. That's why banks are willing to pay so much or offer such nice benefits in order to get you to move your money there. Your account then becomes somewhat sticky and less likely to leave, even if rates or service gets worse. But depending on how much hassle you are willing to deal with, you may find that changing banks (and brokerages) frequently can be worth a few hundred bucks.
What do you think? What cash flow techniques do you use to minimize hassle and fees while maximizing returns? Any tips or tricks for your fellow readers? Comment below!