What To Do With a Lump Sum of Cash?
Check out my thought process on dealing with personal cash like a business
Dealing With Cash Like A Boss
If you’re anything like me, you try your utmost to view your own personal finances through the same lenses as analysing a company’s three key documents: balance sheet, cash flow statement and income statement. I mean why not? Analysing these filings of a company is activity 101 when it comes to determining the health and prospects of a company/potential investment and beyond that, helps management and investors identify levers to pull if they don’t like what they see. We gain great insight and strategically position to make insightful decisions through these practices so why should handling our personal finances be any different. Granted, valuation multiples and tools of that nature perhaps aren’t that relevant and maybe some lines in the financial statements may be left blank if we tried to do a like-for-like imitation. Nonetheless, we can use broad principles to help make better personal decisions.
Photo by Adeolu Eletu on Unsplash
For instance, one of the major tasks for a CEO (especially of a public company) is to efficiently allocate investor capital as well as free cash flow generated through operations of the business. If a company hordes cash usually there must be a justifiable reason otherwise it gives license to disgruntled shareholders to make noise. In other words, management teams must decide what to do with unallocated cash given its inefficiency as a standalone medium - it’s eroded by inflation, bears stark opportunity cost and so on. Remember, shareholders invest in order to put capital to work.
*Apple & Co. are obviously an enormous anomalies*
The capital allocation process considers (but not limited to) the following:
Paying Down Debt
Refinancing Debt
Paying Dividends
Buying Back Shares
Buying Other Companies
Capex Expansion
These strategies help determine the best use of cash such that return on equity is of an acceptable level for shareholders. Although these are all business decisions, as individuals we can all relate to them at least to some degree. Think about it, many of us have existing debt whether in the form of loans, mortgages or student finance. On that basis, when receiving some cash from outside your normal income stream, question marks start arising as to what should be done with that cash. Personally, I am in this position now and so will walk you through my thought process.
First, let me convert the aforementioned capital allocation checklist into one that is directly useable for an individual:
Paying Down Debt (paying off student loan)
Refinancing Debt (remortgaging and credit card consolidation usually aren’t cash heavy strategies)
‘Paying Dividends’ becomes ‘Giving Oneself Spending Money’
‘Buying Back Shares’ becomes ‘Investing in Your Own Skillset’
‘Buying other Companies’ becomes ‘Investing in Companies’
‘Capex Expansion’ becomes ‘Big Ticket Purchases That Make Life Easier’
This list is intentionally ordered to reflect my priorities. It will be different for everyone and in practice I may do number 3 before I do number 1 but the point is approaching it in like terms to that of a CEO. I make sure I have a strong handle on number 1 before deciding not to allocate cash to it because I do not want any headaches. Nevertheless, it creates a useful framework to structure my strategy so even if I blow it all, I know I have considered all other avenues and it is within the realms of my capability.
Let’s unpack these points slightly to get a feel for the logic behind them. At the top of the tree is paying down debt.
My most expensive debt is student finance which costs 3% plus RPI, in a zero interest rate environment so this makes me sad. I have many arguments against the construction of the benchmark interest rate used for our repayments but I will save that for another blog, just know that it is flawed. The key consideration here is how much will I potentially save in future interest costs if I repay at a faster rate? Femi and I built a calculator back in 2018 to specifically optimise for that. The structure of the student loan repayment schedule is such that accruals are frequent and the automatic payout is so small that it takes longer to pay off the principle payment and therefore more interest piles up. This obviously doesn’t matter if you don’t intend on earning beyond a certain threshold over your 30 year threshold but if you intend on making decent money beyond that then you should definitely check how much of your interest bill you could shave off. On top off that, although paying off bigger chunks of student loan debt may seem boring, the sooner it is eradicated the sooner I can free up even more monthly cashflow - check your payslip to see how much goes out every month, it’s a real amount that makes a difference.
Photo by Nizzynomics Calculator
If I was a company, I’d probably raise cheaper debt to pay off my more expensive debt as per strategy 2 but because I am an individual and the terms work differently, paying it down is the more efficient choice. Moreover, if you ask me where to get a very liquid low risk 5% investment yield such that investing rather than repaying would be better, I would struggle to find a sensible answer. As it stands, I will allocate some of this cash to voluntary repayments to help me pay it off quicker.
In terms of strategy 3, it’s summer and I have worked hard all year so I’ll keep the analysis short and sweet: I’ll definitely allocate some spending money. Given the current situation there is not much to do so I will have to get creative. Moving onto strategy 4, I actually did this during lockdown. If you recall from my blog: The Wealth Gap Unpacked I spent nearly 400 hours learning to program so that I could weave certain tools into my trading, portfolio and risk management processes. As well as the time investment, some courses required payment and I decided to bite the bullet and do so as an investment which is now paying off. As a result, no allocation is needed there for now.
Strategy 5 pertains to investing in companies which is one of my favourite activities.
I worked in an investment bank for 4 years which is a very strictly regulated place and during this time was not allowed to directly invest in public companies on a personal basis as there would be a conflict of interest with day to day work. Hence, my investment portfolio is constructed with ETFs and private VC style investments instead.
Photo by Twitter: @Joshnizzy
However, now that I have called time on my investment banking career, I will have more flexibility to do so and can now execute on my shopping list so cash will most definitely be allocated here. On the final strategy 6, companies usually have a capital expenditure pipeline which is necessary to help drive revenue or reduce costs. for simplicity, think machinery and things of that nature. Personally, lockdown has taught me that I need a dishwasher. No joke. This will significantly improve my happiness. When I lived with my parents and was cooking less, doing the dishes was a breeze and now my hands are asking for a break. As such, cash will be allocated here too.
Let’s circle back. I will be allocating a new pot of cash towards four strategies with the following percentage budgets:
Overpaying some student loan [40%]
Giving myself some spending money [10%]
Investing in companies [40%]
Doing some capex in the form of purchasing a dishwasher [10%]
I implore you to use a similar approach whenever you receive cash outside of your normal stream of income or if you have a positive cash position at the end of every month.
I’ll leave it there for this week and will catch you on the other side. Please remember to pick up your rubbish when you leave the park this weekend.
Peace ✌🏾
Josh