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How Should Entrepreneurs Hold 'Just in Case' Cash? The goal for any business is to bring in more money than is going out. Once you have extra cash in your hand, you'll need to decide what to do with it.
As a business owner, it makes sense to keep cash on hand for the future. Nobody can predict the next economic downturn. And if your business is just starting to take flight, you might need some extra cash to invest when you face turbulence.
However, even with emergency savings, there are smart ways to save and less advantageous approaches. Leaving cash in a basic savings or money market account amounts to little protection from current inflation levels around 2 percent. Even if you get the industry-leading interest rates—around 1.25 percent—your savings is still likely to lose its actual value year-over-year.
Instead of keeping your cash in a savings account, one option for entrepreneurs is to invest their safety net fund in a conservative, lower-risk portfolio of securities. Garrett Oakley, a Certified Public Accountant and CERTIFIED FINANCIAL PLANNER™ at Betterment, suggests that entrepreneurs holding cash can look to beat inflation with a highly liquid (i.e. easy to access) investment solution instead.
Here, he offers tips to help business owners make the most of that extra cash.
Invest your safety net.
"We always want to keep enough cash in the business so if there is a slow time or an expense, we're not having to look for funding somewhere else," Oakley says. "If the business slows down, it probably means you, as the owner, will be less likely to pull money out of the business anyway. So, in that scenario, it makes a lot of sense to keep a safety net growing as much as possible, while preserving the principal."
Oakley typically recommends putting your safety net fund in a portfolio of securities rather than a savings account. With an investment, it has the potential to earn value, and with the right financial advice, you can reduce volatility and risk.
Betterment offers multiple types of accounts to help business owners, some of which are very conservative in their projected risk. The safety nets in a Betterment account can be an excellent alternative to traditional checking and savings accounts, while helping to give the account holder the benefits of earning more interest.
Set a clear goal.
As you begin investing, it's important to set goals, even for a safety net. Ideally, you never have to fall back on a safety net, so consider how much you want that fund to grow in the time you keep it invested. For instance, in five years, will you have a family? Could the business grow substantially? If you have more life expenses, it might make sense for you to grow your safety net fund accordingly. Without taking time to think about what you want that future to look like, you may find that you aren't putting enough money into accounts that are right for your unique interests and needs.
"Goal-based investing sets an end target, and that's the real benefit over just saving to save," Oakley explains. "When you're trying to hit a target for a goal, psychologically, you may be more likely to hit that goal because you have set that end destination. When people just save to save, they may not have a clear idea of the purpose, and they tend to de-prioritize it. With goal-based investing, you can track your progress toward reaching your target along the way."
Assess the risk.
Of course, if you're investing your backup savings, then the expected risk of your portfolio should be a concern. When developing a safety net, Oakley's advice is to keep the risk as moderate as possible, without sacrificing safe growth. Oakley's team generally suggests a range between 30 percent stock and 50 percent stock—aiming to outperform a savings account without taking on too much risk. At this range, the money can earn a return without a strong likelihood of seeing it decline dramatically if there's a large correction in the market.
"For entrepreneurs, you can invest a good portion of your safety net—three to six months of living expenses is good, plus a 30 percent buffer in a more liquid savings account," Oakley says. "For those whose income is more sporadic, the buffer could go as high as 40 or 50 percent.
Research management fees.
"In today's environment, the average management fee for a one-on-one advisor is usually around one percent of assets under management," says Oakley. Management of the underlying funds costs even more. Just like considering the fees associated with a bank account, it's important to consider the underlying fees involved with investing your savings. High fees eat into your returns, decreasing the reason why you'd invest your savings at all.
Many advisors today, including Betterment, keep fees low by investing in index-tracking exchange-traded funds (ETFs) that can outperform actively-managed mutual funds when assessing the returns after taxes and fees. Oakley recommends placing your focus on take-home returns rather than just performance in the market.
"Your investments can see a strong performance, but if fees eat up that return, your take-home value could be lower than a low-fee solution with less striking performance," Oakley says.
Know how and when to access your money.
When your savings are invested in the market, you should be aware that it takes longer to withdraw your funds when comparing a withdrawal from a bank account—but not that much longer. Generally speaking, it takes an average of three to four days to access your money if you need it. Since your advisor is actually selling shares, part of that time involves selling shares in a way that minimizes taxes. There's also usually a settlement period, which accounts for another chunk of time.
"Still, when compared to many other investments an entrepreneur could make, three to four days is still a short period of time to wait for your money," Oakley says. "It's always important to think about that if you have an expense coming up. Give yourself a little extra time for the trades to settle before you see your money."
As you consider how to save effectively while growing a business, having an advisor is an important step to maximizing your money while making sure your personal finances don't occupy too much time. Whether you invest it, keep it in the business, set it aside for your own future, take care of your valued employees, or a combination of all the above, a low-cost investment advisor, like Betterment, can help make sure your extra cash is well taken care of.
Investing in securities involves risk and there is always the potential of losing money. Visit www.betterment.com for more information.