The Importance of a Cash Cushion

The economy was great going in to corona

It seems like it was just yesterday that everyone was driving to work, rush hour was in full effect, and everything was functioning like normal. The economy was doing great, unemployment was at a low point, and everyone was planning their summer vacations.

Now the streets are empty. A blanket of anxiety has descended over society as we know it. Many in the service industry and elsewhere have found their jobs furloughed and in some cases gone entirely. Everywhere we look there are news articles on how the airlines are suffering, hotel industries are suffering, startups are suffering, every company is suffering, and needs a bailout.

The same thing is happening to people. There is talk about sending checks in the mail for people who need relief. Interest on student loans has been put on hold. Taxes have been delayed. Why do so many people and businesses need bailouts right now? As messed up as the coronavirus is, it serves as an important case study on economics.

A sudden change caught everyone unaware

Going into this coronavirus fueled economic pullback, business was booming. We had been on one of the longest bull runs in the stock market in history, from 2008 until now. Everybody, both businesses and the people that make up those businesses had been lured into a false sense of security.

For this reason, investors were leveraged up to their eyeballs. That is, they were using debt in order to better take advantage of the booming economy. By taking out loans so they could buy more investments, they were making money on the money they had, and the money they borrowed, for double the profits.

Real estate investors were taking out as many mortgages as they could, using cash-out refinancing or HELOC loans in order to get more mortgages for the value of what they had paid off on properties they already owned. stock analysts were trading on margin (borrowed money) or derivatives trading (buying stock options) both of which are ways to borrow stocks or money for higher profits.

Good times caused a false sense of security

The average Joe wasn’t participating in any of these crazy stunts, but they too became complacent in the bull market in their own way. When everything is good, it’s very easy to not prepare for the eventuality that things turn bad. We become used to the status quo, and the longer it stays the same, the more comfortable we become.

Even people who are normally unwilling to take risks can be lured into this trap. The safer the situation, the easier it is to justify not having a plan B. Many Americans thought to themselves, my wife and I both have jobs that are secure and paying great! If one of us gets laid off, the other’s income will hold us over. I’ll be able to get a new job in no time with how low unemployment is, and worse comes to worst I can just sell some of my stocks!

Coronavirus lock down caused financial instability for the masses

Then enters the novel coronavirus. In a matter of weeks, many of the worlds’ most economically prosperous countries go from business as usual to full halt. Restaurants close down everything but delivery orders, gyms are empty, even bars have to close up shop. People are hit with a double whammy of being unemployed as well as hearing that there’s a strong possibility of a recession that will make going back to work harder than it would have been just a month ago.

If this is your situation now, don’t despair. The good news is that together as a nation and as a world, we will work together to weather this storm and will come out of the other side stronger and smarter for it. Take a look at the government programs that are available to you, and keep your eye on the headlines for help from the stimulus packages that congress will inevitably pass.

You can prepare financially for the next disaster

The even better news is that since you are reading this article, I’m here to arm you with the information you need so that you’ll never have to be in such a stressful situation again! Prudent financial planning can protect you from just about everything barring the government collapsing or full-on apocalypse.

The secret to avoiding disaster in the short-term but hard-hitting scenarios like a pandemic is simple. It’s the very first step in any effective financial plan: start by saving a cash cushion equal to 3-6 months of living expenses. The cash cushion is something that isn’t talked about enough and is tied closely to last week’s article about credit card debt. Many Americans choose to have a credit card as a back up to cover them if things go south, but as you’ll read, there’s a ton of things that can go wrong with that approach.

Plan for the worst case rather than hoping for the best case

Instead, I offer you the following piece of advice. Rather than have 3-6 months of living expenses in short term debt available, keep that much in liquid assets that can’t lose value, whether that be in the form of cash you’re holding in a bank account or as bonds that you hold in a taxable brokerage.

This gives you a double safety net of protection, with perks compared to just having a credit card. If things go WAY south, then you have credit cards that you can rely on after your cash reserve runs out. If things clear up quickly, then you still have your credit card safety net as you rebuild your emergency fund, with the added benefit of not having to make any interest payments. Think of it as an interest-free loan to yourself.

A little bit of food for thought for those of you who prepared well and always keep a cash cushion: If your job is in an industry that is seeing an increase in demand rather than decrease, or that you know will remain constant such as healthcare, trash removal or water treatment, you have an excellent opportunity here. Invest any extra money you make or savings that you accrue from social distancing and pump it into index funds. The stock market is on sale and you can get some really great low-cost index funds for almost half off!