Finance Tip: “The Cash Flow Buffer”

This particular tip is used in business often. It is exactly as it sounds a buffer. Keep in mind that opinions I express in my blog may or may not be good advice for you personally. You should investigate all financial advice thoroughly before pursuing any course of action. So a cash flow buffer is a concept that many people might confuse with an emergency fund in the context of personal finance.

With the job market shifting to a more hustle economy, you might not be earning a steady paycheck any more. You might be doing contract or consulting work and who knows you might kill it for 8 months, then the next 2 months your down 60% on your earnings. This isn’t as farfetched as you might think. This happens a lot now. What I am seeing in the news articles I read are people busting their tails for 6 months, doing uber eats, working a full time gig, then maybe one more side hustle and banking a large chunk of change. Only to then slow WAY down to recover for 3-4 months, rinse and repeat.

The job market in the U.S. has changed a lot in the 35 years since I started at burger king in the mid 80’s. So one of the approaches I take with family members I advise financially is treat the working part of your life as a business. We set up a balance sheet, expenses etc. We build an emergency fund of 6 months of expenses (if there isn’t a whole lot of debt) and then work on the Cash Flow Buffer. There it is again, lets define it. A Cash Flow Buffer is the number of days you could continue to pay your bills out of your regular bill paying account if income were to stop.

Inflation is falling, but its still very high

Again this isn’t an emergency fund! So you have 5K in your checking account, you lose all your jobs you have no money coming in. You spend 3500 a month for expenses this would mean you have a cash flow buffer of 45 days. So many would assume you would then begin to tap your emergency fund, and that would be correct. AT THE END OF THE 45 DAYS. You see the buffer is meant to create space for you so you can replace income.

That 5K will keep you afloat for 45 days that’s your real window until you have a real emergency on your hands. The buffer assumes you are not replacing your income. Businesses use this tool a lot, particularly seasonal businesses who do a large % of their sales at a specific point of the year. For you in the new gig economy this might be useful for you to gauge as you navigate the new normal for working.

So how you do it is, look at your monthly spend. Take out all the non-essentials and come up with a number. (rent, electricity, food, water). If you lost all your income today how long could you pay for things without tapping your emergency fund? You see the concepts here are more for discipline purposes. The last thing we want to do is hit the emergency fund because if we tap into that, we know that things are really bad, it’s for emergencies.

Think about your personal cash flow buffer. I keep about an extra month of bills in my checking account so my buffer is 30 days which is light. I am confident that I would be able to replace my income (or a good chunk of it) before 30 days. Ideally you have a 30-60-day buffer here that you would use BEFORE the emergency fund.

I know it’s confusing, but if you start treating your financial situation as your own personal business and economy you might find that these things make sense.

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stressed-out-woman

Quick Finance Piece: Is this a recession?

Yes, it is.

So before I go too far let me do the normal disclaimer. I am a finance professional and any advice you see on my blog is my own opinion only and is not meant as investment advice. So that out of the way, yes we are in a recession. “But the media says we aren’t in a REAL recession”. I don’t trust the media, if you do I can’t really help you….

An economic recession has been defined for decades as two quarters of economic decline as measured by GDP. Now that’s not the technical definition but that is what has been used as the gauge for many years. The United States is in a recession. Now there are DEGREE’S of recession and that is where the nuance comes in.

This is not a hard recession by any means. We have great job numbers (which is an interesting situation in of itself), but we have horrible inflation, a slowing housing market etc. You see what you aren’t hearing much about is the horrific impact that Covid shut downs had on industries and supply and demand economics. You shut down global production for 6 months, you just don’t flip a switch and it comes back to normal.

The ride shouldn’t be to bumpy this time around

Throw in a war, a decrease in domestic Oil refining, divisive politics, on and on. The situation is dynamic and fluid there is no one catch all correction to fix this. You had decades of artificially low interest rates now creeping up again. A hard recession would see the market decreasing, layoff’s and a higher unemployment rate.

Companies are reporting good earnings that means DEMAND is still there and that bodes well for a quick recovery. They call that a V shaped recovery. I suspect we will see another decline in the 3rd qtr. and possibly into the 4th but the basis for good economic outcomes are there. First, the job market is healthy, you can work and make money. Second, demand for goods and services is still robust, so companies are still making profit (which fuels point 1).

I think 2023 will be a better year economically, unless again something extraordinary happens (a pandemic, another war. Be prudent here and tighten things up as best you can and save a bit more than usual but I don’t suspect things to get horrible soon, but things will still remain in the current state for the near term.

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Yet Another finance secret finance professional won’t tell you (but I will)

So another finance piece, as I write this the U.S. is in an official recession. This piece isn’t about recessions, inflation or politics so you can exhale. We are going to reveal another secret though that finance professionals don’t like to admit. So a quick disclaimer, I am a finance professional. I have been working in the finance and accounting field for over 30 years. This blog is not a finance advice blog; this is my own opinion based on my experiences. Any advice you receive regarding finance should be researched thoroughly by you as an investor and verified through multiple sources.

Now that out of the way here is the opening salvo “When things are good, everyone is a genius.” The last decade up until the pandemic really the stock market overall was pretty good. You had good annualized returns and many people made a lot of money. So being a finance professional and advising people to go into the market wasn’t a genius play. Of course if you aren’t fluent in finance you might have perceived it as such. Interest rates were low for a long time so there really wasn’t anywhere else to go with investing except real estate.

But the secret? Everyone is a genius when things are good, what about when things are bad? What about when you are in a bear market (when indices drop 20% in a calendar year)? The secret is, the real finance geniuses were diversified PRIOR to the bear market. Any finance professional could have told you to put your money in an index fund prior to covid and you would have made fantastic gains. The real economic geniuses advised you to diversify with money spread to commodities, bonds/treasuries, real-estate and precious metals (this is a commodity, but not a traditional commodity).

As an example, what if in 2016 your finance professional advised you to have 15% of your portfolio in “Gas & Oil”? That would look pretty good now wouldn’t it? Same with bonds, treasuries, wheat, gold… you get the picture. The secret here Is diversity of investment result in a wider spread of assets which can absorb declines in any particular sector.

Like it or not, the world still runs on Oil based products.

Now that does mean you would have had less in technologies for the same period and not enjoyed that growth. I concede that, but the savvy investor doesn’t play the short term they play the long term and sustained diversified portfolios over the long haul 10-30 years normally perform as well as a strict stock portfolio. Don’t get me wrong here, I personally believe the majority assets you are investing in should be either growth stock mutual funds or blue chip mutual funds.

100% of a portfolio though?  No, you diversify specifically for bear markets and sharp down turns because they always happen. It’s not a matter of if, it’s a matter of when and how long will it last. For calendar year 22 as of 6.30.22 the markets are down 20.3% now this has come up in July, there is no denying that but you’re still down overall. On top of that we have large inflation numbers devaluing the purchase power of your dollar. So what 1.00 would buy last year now buys .92 that’s an 8% decrease (rough estimate). That isn’t equated well in your portfolios return.

Meaning you made 10% on the stock sale but the money you received purchases 8% less than it did meaning the value of that 10% return to you in real time is a net positive of 2%. Again, the secret here is diversity. Always have part of your portfolio assigned to cash, bonds/treasuries, commodities and that will provide you a decent buffer for the next bear market because this will happen again.

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One area where you underestimate your spending.

Inflation is running rampant. Gas prices are off the charts, rent has gone up, interest rates are rising. The key here is your income is likely not matching the pace. Maybe you got a 5% raise last time (if you are lucky). Inflation at 8%+ you’re losing money in nearly every area. Look this post doesn’t have to be long today, I’m not going to fill it up with elaboration on inflation.

There is likely one area in your life where you are underestimating how much you spend. That area is food. Yes, those $4-dollar coffee’s you buy twice a day, that organic ketchup on and on. Food prices rarely go down and the creep on food prices happens gradually. Here’s the rub, that food that you purchase, unless you buy a lot locally, has to be processed, shipped and stocked. All of that goes into the price point. So gas is going up? All of the food you’re buying at the super market was trucked in, someone had to pay for gas to get those products there.

Here is a link to a world food price index Now this is something finance professionals use to gauge real inflation numbers. I’m not suggesting you delve deeply into this. What this site does is aggregates average prices around the world for common food categories (meat, milk, sugar) and comes up with a “global average”. In 2004 the FPI (food price index) was 65.6 today it is 158.5.

I don’t care how much they charge for coffee.

A remarkable increase right? The key here is this never goes back below the prior year’s index. Unlike gas, housing and interest rates food prices keep going up. This is why your food cost is one of the most important budget numbers you have to know because the “price creep” is real. You are always going to be paying more for food, and now with inflation you are paying more for everything so chances are you are starting to lose wealth AKA purchasing ability.

Tighten up your food purchases, make your coffee at home, pack a lunch instead of eating out. Food continues to go up because we all need it; you die without out. Are you over spending here? Are you aware of exactly how much you spend a month on food? I look at how much I spent and I was blown away. I started a victory garden and that helped. Sure I don’t buy tomatoes anymore but coffee? Meh…

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Historic Inflation – The most important # you need to know is 3.22%

So another finance piece today. I am not going to go through my normal disclaimer hopefully by now you understand you should be diligent about your finances and obtain information from multiple sources. I’m thankful you consider me one, today we are going to talk about inflation. Yes, its real, and it isn’t exclusive to one region we have global inflation. The numbers I will use in this post will be U.S. numbers but in my research it tracks, mostly, globally.

You are probably wondering what the 3.22% is, that is the historic average inflation rate over the last 108 years. That’s ON AVERAGE, which is important. We have years in there where we have 13.5% inflation (1980) so it’s really important to have good perspective here. Historic inflation isn’t as important as “life time” inflation. That metric is the inflation rate in YOUR life time. For me? Its 3.95%. None of the numbers I am throwing at you include 2022 which right now is approx. 8.5% (give or take). As it isn’t a full year of data we can’t use it for these purposes.

Here is a link to the historic chart I am using. So a few important things to remember.

  1. The distinction between historic and life time inflation rates.
  2. The likelihood of sustained inflation.
  3. Globalization

I distinguished the 1st item already, but items 2-3 are intertwined. We had a sustained period of high inflation in the U.S. from 1973 – 1983 (roughly) that’s a long time. That was in my life time, it might be yours too. What normally happens, and is happening now is wages increase as inflation increases but rarely at the same rate. As an example, it’s likely that in 2022 we will come in between 6-10% inflation for the year, it’s unlikely that your income increased by that same amount. The thing that is a killer about sustained inflation is multiple years where your income doesn’t match or exceed inflation = less wealth overall.

Inflation decreases your purchasing power.

You may make more but it doesn’t buy as much, basically. Globalization is a fairly new phenomenon in the inflation equation. In the 70-80’s it was far less then it is now. So what happens in one major country affects the global consumption and production metrics. If China can’t produce as much of X as it normally does, the price of X goes up, or inflates. Add in a pandemic here and there and well you get the picture.

There is only one sure fire way to combat inflation for you personally and that is increase your income by more than the current inflation rate. The problem is most can’t do that. So the second best way to combat inflation is to ensure your income and investments are increasing more than the average inflation rate in your life time. So for me, that means I need to increase my income and investments every year by 3.95%. Now that is just to remain as is, if I want to improve my financial situation (my ability to consume more) I need to increase my return by MORE THAN 3.95%.

Take a look at the link above and see what your life time inflation rate is. This is the minimum target you should be striving for in all of your investments and your income. Trying to figure it out monthly or on an annual is probably not going to work, but hey if you can make 8.5% in these markets I tip my hat to you. For now, shoot for 4% minimum, 6-8% would be ideal and reasonably attainable if you have investments.

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Anxiety: How to deal with a Recession

Yes, you are going to hear this word “Recession” more and more. Let’s establish clearly what a recession is. A recession, in economics, is a downward trend in the business cycle characterized by a decline in production and employment, which in turn causes the incomes and spending of households to decline. Inflation is part of this but basically the best way to measure a recession is to check on what the GDP (Gross Domestic Product) is in your country. If it decreases for two consecutive quarters, it’s a recession.

The GDP is a broad measure, but it encompasses many different economic factors. In the U.S. the 1st quarter of 2022 declined from the previous quarter. So in July we will get the 2nd quarter results for the U.S. and it’s likely to decline again based on the inflation we are seeing. We also have the oddity of the economic conditions from the Pandemic. Manufacturing was silent for long periods decreasing supply (which makes things more expensive). You also had governments increasing their production of currency in the form of aid (increasing the money supply, makes it less valuable). Last, you had many people leaving the workforce. Boomers retired and many people went to the “Gig” economy.

This is putting pressure on companies as there are not enough workers. When you have a shortage of labor, what generally happens is the higher end positions fill up first. What is left is the lower pay jobs that most don’t want to do. So you get this weird situation where there are jobs to be filled but those looking for work don’t want them. Then you get a war, which impacts commodities (oil and wheat) which inflame all of the above.

A storm is brewing, are you ready?

So this is a perfect storm of economic factors. It would be a real stretch to say that a recession isn’t coming. For those of us with anxiety this is going to be the next fear proposition. This will come at a time in the U.S. where mid-term elections are happening as well. It’s going to be a mess if you have anxiety. I wish I had some wonderful advice to get through this, I really don’t. Over the summer the noise will pick up, you will be bludgeoned with it. If a recession drags through the end of the year earnings will be impacted for companies and the employment situation might flip as well.

Yes, this is a mess. So as someone with anxiety how do we deal with this? STOCKPILE CASH NOW. I normally recommend people have a 3-6 month emergency fund, I would now recommend 6-9 months, a year if you can. What is that? You take the average of your monthly bills time 9 months and that amount of cash should be sitting somewhere for you to easily access it. I know that’s a tall order for many but that cash will allow you to weather a short to mid-term storm.

Start tightening up the budget now. Start selling extra possessions you don’t really need/use and bank that money. Hopefully you don’t need it, but I suspect 2022 is going to be a down economic year for the world. I don’t see things improving much until after the U.S. mid-term elections and even then there are no guarantees. Build up your cash reserves now.

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Some important facts to remember about our current inflation

So I have talked about it on my blog and it is the next boogie man to present itself which is great news for institutional media. They have to have something to scare you with, Trump is gone, Covid is clearing up (WATCH OUT FOR VAIRANTS!!!!!) and there are no wars so we get inflation. Should you be concerned about inflation? Yes, on a scale of 1-10? 3 -4. Inflation kills economies over the long term if (a big if) wages stagnate. If inflation is 3% annual and wages increase 2.5% annual your net to consumer is .5%. In one year that’s survivable. Over 10 years? That’s a problem.

Here are a couple of quick facts to remember about the current inflation situation in the U.S.

  1. The Economy was forced to slow down: We can argue why Walmart was open but local store X wasn’t, or why healthy people were precluded from doing what they want. We can’t argue that government closures and shutdowns due to covid had an adverse effect on production.
  2. Production decreased due to Item 1: Less cars were made, saw mills didn’t produce boards, ammunition production was decreased. And on and on…. The shutdown created a negative production situation as demand did not decrease concurrently due to government stimulus.
  3. Money still flowed: Yes, many people lost their jobs, but government printed money to subsidize those losses. So you had some money, or the same (maybe you worked from home) but you had less places to spend that money.
Maybe Bitcoin is the answer?

So what you have is companies forced to close and the economy slowed. This wasn’t part of the natural business cycle. As a result, less goods were produced, and people lost work, and government printed more money to get to those people. It’s the perfect scenario for short term inflation. Want another example? More people are on the roads now that things have opened up, gas prices go up. Why? Because refining gas was slowed during the pandemic because people weren’t traveling.

Again these are all short to mid-term issues which should begin to clear in the “new normal” my guess is by the start of the 4th qtr. (10.1.21) at the latest. Now anything can happen from now until then. A war, another pandemic, a massive oil spill, political upheaval so there are no guarantees. That said the underlying driver of capitalism is still very powerful, supply and demand. I want something, you have it we make a deal.

Inflation is the new boogey man, many of my younger readers have never experienced it or have read about it in the abstract in places like Venezuela or Liberia. It’s highly unlikely that, that kind of long term sustained inflation hits western economies because of supply and demand inherent in capitalism. Could it happen? Yes, if one of the 3 items on my list continues to happen, even in small doses. Don’t be pulled into the fear mongering, it is a click driver and most rational people can see that. Inflation is here yes, is the world ending because of it? No

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Finance Lesson: Many of you are going to see this for the first time

What is “this”? It’s called inflation. Many of you have never seen it and don’t really know what it is. You will begin to, if you haven’t already, hear more about inflation. As your Gen X friends will tell you, in the 70’s and early 80’s inflation was high. Mortgage interest rates at 15%+, yes that’s right you know those rates that are 3% or less now? Goods and services, in proportion to income was very expensive. Gallon of gas in 1980? $1.19 a gallon. I know doesn’t seem like much does it?

Not a lot of corollas back then, hybrids? Didn’t exist yet. You had gas guzzlers that were getting horrible gas mileage. Median income for a family in 1980? 21,000.00 Annual. However, the consumer price index from 1977-1980 increased 13.5%. That means, basically (not precisely) that the item you bought in 1977 was 13.5% more expensive just 3 years later. Now this wasn’t everything of course but it was inflation that was out of control.

Enter 2021. Notice the housing market is hot? Have you been to Home Depot to buy some plants or fencing for your yard? Prices are on average 6.5% higher than 2 years ago (for many goods and services not all). Now this is a result of covid, plus people going back to work plus government stimulus. So we have the trifecta of an inflationary period, increased government subsidy (more money in the market) more people working (more money in the market) and industries shut down for extended periods.

Am I contagious?
High amount of money and less goods and services = costs rise.

That in essence is inflation. Inflation is a good monetary solution to one or both problems. Meaning if prices are going up, demand is high (or goods are in shortage) that induces economic activity in those areas. A deep freeze in Florida kills the orange crop, oranges go up in price. Everyone gets 1000 in cash from the government, you are willing to spend more for the oranges now because someone gave you more money to spend. That gives the person producing the oranges more money to reinvest in orange production, increasing the supply and driving the cost down, overtime.

The issue here is time. The simple examples I have given are all in the abstract of time meaning the end game, increased production of oranges as I exampled, could take years. Now if the money supply decreases (the gov stops sending stimulus) you still have to pay the higher price for the oranges. This ushers in the inflationary period. The other lever that mitigates this scenario is increased wages, this is likely to happen as more and more of the world opens up.

In the short term you should expect to pay more for goods and services. It is a sellers’ market so to speak and if you have a skill or service that is in demand (construction, physical labor, lawn care etc.) this is an opportunity for you to make a lot of money. On the flip side, things you want are going to start costing more. That coffee you love every morning? The trucking company delivering to your shoppe is paying more in gas now, it’s likely that cost will transfer to how much your coffee costs.

Inflation is the reality of a good economy going through a natural ebb and flow. It’s not fun when things go up in price, unless you’re the one selling the item and making more money. I believe we are entering into an inflationary period, many of you have never seen it and will wonder what the hell is going on. $3.00 a gallon for gas? Very likely. Remember to keep an eye on your spending and keep an eye on wages for your chosen profession. It’s likely that as costs go up, so will wages but you must be willing to leverage your skill set (and possibly move jobs) to make more to mitigate the costs.

I think we are heading for a good period for workers, things are opening up and there will be good jobs to be had. The down side is inflation is starting to creep in and it’s been so low for so long I don’t think we can escape it this time.

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Stimulus & Economics: Some basics & things to ponder

Yes, we are doing a finance piece today. As with every finance piece I try and do a disclaimer. This blog and this post are my opinions based on years of working in the finance industry. These are not meant to be financial advice but rather a perspective on what is happening in the finance world. Before making any financial decision consult several sources to make an informed decision.

We know that there is another round of stimulus on the way if you live in the U.S. “Trillions” a number that is thrown around a lot. Going to let you in on a little secret, there isn’t a warehouse full of trillions of dollars waiting to back up the stimulus. For lack of a better term, all of these transactions are “numbers on a screen”. As an example, you may have 10K in your checking account. The bank does not have 10K cash sitting in their vault with your name on it.

Cold Brew Ice Coffee, A great stimulus!

What does stimulus do? It provides money so people can spend it and stimulate the economy. You buy a happy meal at McDonald’s. Someone has to get it ready for you, someone has to make the ingredients, someone has to make the container for the fries… you get the point. That is stimulus at its heart. It’s not just giving you money, it’s the residual effect of what happens when you spend that money and how many people are affected by it.

The down side? The value of money decreases. Its simple supply and demand right? The government through stimulus is increasing supply. At some point there will be so much money floating around that it takes more to buy a product. If everyone has more money, why would someone who produces a product not raise the price? Not only that but the cost to obtain money, interest rates, have been very low for years (decades). So what does this mean? It means that the more money that goes into the economy (even electronically) the less valuable it is.

Why are antiques worth so much? Because there are fewer and fewer of them every year. Did you try and get a new gaming console this year? Hard to find right? And the price if you did find one, oof. Want a ticket to a football game? Not cheap right. You get the point, the less of something there is the more valuable it becomes due to demand.

What does this mean for us? First the short term effect is positive people get cash and can spend it now and then give that money to someone else. That is the best outcome of stimulus and it absolutely works. Sustained stimulus (2,3,4 checks) this is problematic because its necessary due to an artificial condition. Demand is there, but supply of goods and services are reduced due to the pandemic. So more money pours into the economy to keep people afloat.

What happens when things get back to the new normal and people are vaccinated? The money doesn’t go away it’s still out there, so you get inflation. For many of you under 30 you’ve never really experienced severe inflation. Prices go up, income stays the same. It’s very simple, the more of something that exists (material items) the less valuable it becomes, that includes money.

Always be mindful of your personal economy. 30 mins a week minimum you should invest in your budget, savings, investments, spending habits. Become an expert in your personal economy, make sure you are financially educated in how you handle money. The world will carry on, the economy will wax and wane. Things have been good for a while now, even with a pandemic and decades of government spending inflation remains at bay for now.

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