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The Importance of Cash

The Importance of Cash

June 04, 2020
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As states continue to reopen their economies to varying degrees, people are getting more and more eager to return to normal — or, at least adapt to a “new normal.”

Reviewing our original timeline, it’s looking like we may have been a bit optimistic. GDP appears to be bottoming, but we are a little more than halfway through the quarter, and some states are likely to keep restrictions past the June 1st deadline. However, we do believe we are beginning the long climb out of the economic downturn. 

Update on Death Rates

Daily deaths rates continue to drop and are now consistently below 1,000 per day. CDC data still has the peak in Mid-April. In addition, based on the data below [as of April 29th,] the CDC current estimate for the [Case] Fatality Ratio is .004. 

Source: https://www.cdc.gov/coronavirus/2019-ncov/hcp/planning-scenarios.html

This is in line with our internal model we created early on. The best fit was a 2.4 R0 and a CFR of .0035. We estimated 100,000 deaths. It became difficult to align as the lockdown changed the shape of the distribution curve.  As a comparison, Anthony S. Fauci, director of the National Institute of Allergy and Infectious Diseases, has said that the mortality rate for seasonal flu is 0.1 percent.4 

These are still crude numbers and are based on an estimate, but IF they turn out accurate, a second wave of this magnitude should not be feared. Similar to the flu, it would still pose significant risk for some, though.

The State of the Economy

The fast economic data was positive last week, with building permits and housing starts increasing. Travel is also showing positive signs. We are now at 318,499 passengers per day (as measured by TSA checkpoint screenings). This is a big jump from the April 14th low of 87,534 BUT still way below last year’s 2.6M for the same day.  

Booking for vacation in Florida is increasing from their lows and is already 50% higher than beginning of the year. Bookings for European trips and Hawaii are still in a slump, as people are still feeling more cautious around longer flights.

As the economy is opening up, the market responded and finally made it above 3000 points on the S&P 500. Regarding price points for dollar cost averaging, support is now at 3000, and the next resistance level would be 3125. 

Cash Planning

With many accounts recovering their January values, we have been filling cash hubs back to target. So, we thought this would be a good time to review the importance of cash hubs for those nearing or in retirement.  

We have mentioned the early years for retirement are the “Red Zone.” They are crucial in determining the outcome of retirement. This is often illustrated through “Sequence of Return Risk”.  Let’s look at an example.4 

In both tables, we start with $2M, and we take $140k at the beginning of the year.   We are using real returns between 1978 to 1987. The only difference is we reverse the order of returns.  If you did not take any money out, the return would be the same for either situation. However, needing to take money out makes for dramatically different results.  

Here is a simpler visual.

As you can see, when returns are negative in the early years of retirement, pulling money out significantly reduces capital. You have to sell more shares to generate the same amount of cash need.   Unfortunately, we cannot control the timing of returns. One strategy would be to not take money out of your investment account in negative years.  

This will certainly improve the situation. You took less money out for one; however, where did you get the money? Are you still able to fund your lifestyle?  Unlike the Federal Reserve individuals can’t just print the money they need. 

For this strategy, a cash account would be needed. This is why we recommend clients keep two years of cash in their hub accounts as a source of funds.  

In this scenario, we take the money out at the beginning of the year and spend it, so we need the first year 140k, and two years of reserve 280k or 320K of additional funds. However, this means we have 320,000 of additional investable funds. 

What would happen if we just put it all in the market as a fair comparison? The additional funds technically are not touched so they get a compound rate of return of 15.17%. This is a big jump in the ending account value of an additional 1.3M versus the original 2M account and simply taking cash out when needed.  (This is a detailed example and lends itself better to a video explanation. Watch for the recap on our Gatewood Wealth Solutions YouTube Channel to view. the full breakdown, as well as more detail on using a cash hub.)

Dollar Cost Averaging

Let’s review a concept called Dollar Cost Averaging.  In this scenario, we are going to assume we have $100 to invest every month for 5 months. So, $500 total to invest. We are going to buy a stock that starts at $10 per share and moves from $5 to $20 and ends at the same value $10.  

We could buy everything on the first day. Spending $500 at $10 per share would be 50 shares. We were happy at $20, sad at $5 and made no gain at the end of the period.  

Instead, what if we buy $100 each month? We get 10 shares the first month. The next month our 100 buys 20 shares. We are excited and feel smart the next month when the stock hits $20, and we just purchased 20 shares, but our strategy tempers our enthusiasm and only purchase 5 shares. Next month, we feel the pain of the drop, but increase the share purchase to 20 again.  

We end up at the same price we started ($10), but instead of 50 shares, we have 65! There is a gain of $150 versus just buying everything at the beginning. We bought more shares below $10 than above! It lowered our average strike price and we made a profit by buying more at lower prices and less at higher prices. 

Here is the rule; you will lower the average price per share by dollar cost averaging. This is a positive when BUYING shares.  

Dollar Cost Ravaging

However, there is always the other side of the trade. What happens when you are selling shares?  

Same rule. You are going to lower the average price per share. If we start with 50 shares and raise 100 per month, the first month we sell 10 shares and have 40 remaining. The next month, we gulp, as we sell 20 shares to raise 100. Then, we breathe a sigh of relief the next month as we sell 5 shares and have 15 left. We are going to make it. 

BUT, then the stock drops and we do not have sufficient share to generate $100 and have to settle for $75. We get $375 or about $7.5 per share.  Dollar Cost Averaging turned to Dollar Cost Ravaging and lowered our average strike price.

For more detail on any of these concepts, contact your Lead Advisor, or watch the recap on our Gatewood Wealth Solutions YouTube Channel. (Please note videos may take some time to post due to Compliance review.)

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Sources:

1https://investors.modernatx.com/news-releases/news-release-details/moderna-announces-positive-interim-phase-1-data-its-mrna-vaccine

2https://www.marketwatch.com/story/feds-powell-tells-60-minutes-hes-not-out-of-ammunition-to-fight-the-recession-2020-05-17

3https://www.cnn.com/2020/02/06/investing/tesla-sp-500/index.html

4Hypothetical example for illustrative purposes only. Beginning value $2,000,000 in IRA; S&P 500 historical return during 1973-1987, including dividends; $140,000 withdrawal each year: $0 withdrawal in years after a negative return except for required minimum distribution. These numbers do not reflect fees and charges associated with an actual investment. Historical S&P 500 returns from Bloomberg. The S & P 500 Index is a list of securities frequently used as a measure of U.S. Stock Market performance. Required minimum distributions from the IRA under Federal Tax Law. Source of diagrams from Northwestern Mutual’s brochure, “Down Markets Matter”, 67-0788 (0715).

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Disclosures:

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested into directly. 

The economic forecasts set forth in this material may not develop as predicted and there can be no guarantee that strategies promoted will be successful.

All investing involves risk including the possible loss of principal. No strategy assures success or protects against loss.

Dollar cost averaging involves continuous investment in securities regardless of fluctuation in price levels of such securities. An investor should consider their ability to continue purchasing through fluctuating price levels. Such a plan does not assure a profit and does not protect against loss in declining markets.

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