Why Cash Is King

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There’s a common belief out there that cash on hand is money wasting away. The argument is that because interest rates are at historic lows, keeping money in the bank is a fruitless endeavor towards building wealth. In fact, not only is your cash sitting stagnant, but at worst, it’s losing value because the interest earned on it won’t even allow you to keep up with inflation! As such, as a shrewd investor, you need to be putting those funds to use at ALL TIMES. In other words, if your money isn’t working hard for you in the markets, you’re doing yourself and portfolio a huge disservice!

Rapid Asset Accumulation Phase

Not too long ago, I used to believe in the notion that sitting on too much cash was a detriment to my goal of achieving early financial independence. When I was investing between 2012-2014, pretty much at all times, I had my cash tied up in: stocks, real estate, index funds (401k and Roth IRA), etc. Sure, I kept around an emergency fund, but it only resembled a tiny pittance of my overall net worth…

My, how times have changed… After going full throttle and working so diligently in trying to build up a net worth of a $1MM, I’m very much over the phase of always thinking in terms of: accumulation, accumulation, and more accumulation… Sure, when you’re just starting out and working towards building a strong foundation, you absolutely have to be focused on the Rapid Asset Accumulation Phase of wealth building. How else are you going to compound your money and get to early FI?

Market Cycles

But as time marches on, you start to pay closer attention to market cycles and where exactly we are at any particular point in time.

I’ve reached an inflection point, if you will… These days, I’m very clearly seeing the value of hoarding extra cash, especially as we look ahead and realize that the markets are still sitting at all-time highs!

No, I don’t believe that it is possible to time the market… But at the same time, it doesn’t take a rocket scientist to realize that at this stage of the game, we are much closer to encroaching a top than we are a bottom… When I was investing back in 2012, the same applied then — I had no way of knowing that we were just at the beginning stages of a historic bull run, but even then, it didn’t take a genius to realize that we weren’t very far removed from the bottom…

Investing At All Times!

One important realization that I’ve made is this — As investors, it isn’t necessary for us to keep injecting fresh capital into the market at all times.

This runs very counter to the belief that “compound interest is your best friend”. But notice that I didn’t say to divest from the markets… I simply said, it isn’t necessary to keep pumping in new funds like clockwork to keep the compounding machine happy.

Once your seeds have been planted, it’s perfectly OK to stop working the fields for an extended period of time, and to go on a nice, relaxing vacation, instead. Whatever previous work you had put in will still be returned to you as fruit later, anyway…

It’s taking on unnecessary risks and compromising additional principal that you should be concerned with…

Buy Low, Sell High

Everyone believes in the notion of “buying low and selling high”. But how many people actually go through with it?

When I was closing Rental Property #2 back in 2013, on the day I closed escrow, a new comp had posted, selling for $50,000 higher than what I was about to pay… Before the ink had even dried, I had instant equity built into the deal.

That was the norm back then…

Can this still happen in today’s market? Possibly, but the odds are becoming increasingly more difficult. When I closed Rental Property SH #3 just this past January, it was right before the next wave of buyer onslaught arrived. Two months later, the next door neighbor sold their house for $130,000 more than what we paid for, emphatically demonstrating to me that the sheer madness that possesses people in a seller’s market is still alive and (un)well today.

Not long after declaring that I was “done with real estate investing”, I started buying stocks again… And because old habits die hard, I got wrapped up into the game as if the year was 2012 again, and I started buying stocks left and right, under the assumption that prices were cheap…

But I was wrong… Shortly after building up my portfolio to $100,000, I had a wake-up call… I’m not sure what triggered it, but my gut feeling was now completely opposed to what I was doing… There was huge dissonance between my actions and thoughts… I knew that I had to reconsider things.

  • This bull run had been going on for 6 years now.
  • The markets were at all-time highs.
  • I had over $1MM in debt.

Clearly, rebuilding and reconstructing a dividend stock portfolio at this point in time wasn’t the best idea I ever had!

So, I took the gas off the accelerator. After more time and contemplation, I came to the conclusion that it was in my own best interest to liquidate my stock portfolio.

Instead of letting myself get consumed by greed (and chasing very, very marginal returns at this point), I made the decision to actually “sell high” and take the chips off the table.

By doing so, I effectively profited more in short-term capital gains than what I would have earned as a dividend growth investor over one full year of investing.

Most importantly, I got to pull my principal back out of the market. Now, my principal has been converted to cash and I feel much better.

Risk and Reward

As I mentioned above, I used to view holding lots of cash as a sign of weakness; it meant that money wasn’t working hard for me and losing its value over time, instead.

But as a highly leveraged investor, I’m learning that having a ton of cash in the bank is exactly what the doctor ordered! For one, it gives me absolute peace of mind. Although cash doesn’t earn much interest, it doesn’t lose principal either, which is very important! Cash is also liquid, and whenever this market finally decides to turn, it’s true power will be fully revealed!

Yes, I realize that earning constant returns can be appealing, but looks can be deceiving! For instance, if a dividend growth stock pays a 3.0% annual dividend, but the principal gets shaved by 20%, are you still really coming out ahead? I believe the constant stream of passive income is psychologically reassuring, but it doesn’t tell the whole story…

Let’s use an example: My Theoretical $100,000 Portfolio

Starting Principal: $100,000
Annual Dividend Yield (3%): $3,000

Let’s say this bull run continues for 3 more years. Each year, the dividends grow and the yield-on-cost (YOC) increases one full percentage point (for simplicity sake).

Year 1 Dividends: $3,000
Year 2 Dividends: $4,000
Year 3 Dividends: $5,000

So, I would have earned $12,000 in passive income over 3 years. That’s awesome! That’s $333.33/month more towards my early FI fund!

On the surface, of course it feels like I’m making tremendous progress. But if after 3 full years, the market finally decides to turn, and I lose 20% of my principal, my portfolio will be valued at only $80,000. Even if you re-factor in the dividends, I would still be out $8,000.

Although the above scenario may never play out, I don’t believe that a 20% correction is unrealistic either, at this point in time… It could very well happen.

As such, I just wasn’t comfortable enough with the risks to keep moving forward with my stock portfolio. Don’t get me wrong, this isn’t a knock on dividend growth investing; it’s a reflection on how hot the market is at present day.

Cash Deserves a Break!

A majority of the cash that I am holding at the moment was acquired through refinancing two rental properties; I pulled out ~$200,000 in equity. So, it’s important to factor in where the source of the cash came from…

Yes, I would agree that if I was just saving pennies from my 9-5 for many years and building up a chest vault to ~$200,000, then you could easily argue that my returns could have been much greater had I chosen to invest that money, instead. Really, how long would it take a person to save $200,000 in cash, after taxes?

But in my case, that’s not how things happened… There was no lost opportunity to account for. In fact, I gained this newfound cash by earning massive returns on some leveraged deals:

Rental Property #2:

Purchase Price $290,000
Downpayment: $58,000
Original Loan: $232,000

Refinance: $440,000
Loan-to-Value (75%): $330,000
Cash Out: $98,000 ($330,000 – $232,000)

The above is simplified and doesn’t include any principal paydown, which would have increased returns even more, but you get the general idea…

I profited $208,000 ($440,000 – $232,000) in leveraged returns off of my downpayment of $58,000. This is a return of 258% in just over 2 year’s time.

Lather, rinse, and repeat for Rental Property #1. It’s about the same story.

So, clearly, my original cash downpayment worked very hard for me! I think that it deserves to take a break now… Again, it’s all too easy to be deceived into thinking that cash always has to be in the game hustling to earn its keep; it doesn’t.

Just like when I visited Rome last August, I quickly realized that the most successful restaurants were always closed during that time of year… The owners were doing so well that they decided to take a break and go on vacation holiday!

The reality is also this — If I want any semblance of a chance to win such deals again in the future, I will ONLY be able to do so if I have ample cash in the bank ready to deploy at a moment’s notice.

When your cash does well and performs admirably for you, I think that from time to time, it too deserves a break!

Cash IS Cash Flow

The last important point I would like to make is this — Cash IS cash flow! These days, I feel like way too much emphasis is being placed on earning passive or semi-passive income, at all costs.

Sure, you can build wealth using the time-tested and proven DRIP approach (earn cash flow and re-invest it). But who says you can’t pay the bills using cold hard cash?

Let’s say my monthly expenses are $1,500/month, or $18,000/year. With $200,000 in the bank, that’s over 11 years of living expenses. In my own case, that’ll take me into my 40’s, and I’ll still have my 401k and Roth IRA, and rental properties working hard for me along the way… Not much is lost if you’ve already got lots of investments in the game. But again, you shouldn’t have to feel like every dollar you earn has to be participating at all times!

Depleting principal is never the underlying goal, but let’s not forget that it’s nevertheless a very viable option.

And as always, life doesn’t have to be so binary… You could deplete principal for 1, 2 years, while you wait for the tide to turn… When it inevitably does, you’re back to winning high-margin deals again… Which over the long-run, may serve you much better than having to compromise and settle on mediocre investments (when times are good). Don’t invest just for the sake of “putting your money to hard work”.

It’s not always about hard work… Smart work is the best approach.

Summary

Cash in the bank gets a bad rap, which is unfortunate. In a downmarket (which is the only way for us to go at this point!), cash is indeed king, and those who don’t have it will be wishing that they did.

There was a point in time when I dismissed cash as well, thinking that it was a stagnant “investment”, but those times have quickly changed…

These days, cash gives me peace of mind and helps me support my leveraged real estate investments. Further, I appreciate the fact that my principal will be held intact and not have to face disappearing into the night when times get rough, like many other assets will.

Too much emphasis is placed on passive income “returns” and not enough on protecting principal. From my own experience, I know that if you can put cash to good use, you can score deals that will blow DRIP cash flow returns out of the stratosphere… Over many, many years.

These are the type of deals that I’m after… and these bargains can only be had in a bear market when fear is paramount. We are not operating in that environment at this time. So, I’m content with hanging out on the sidelines now…

But when the next opportunity arrives and it’s time to go hunting again, I’ll be most glad that I have cash on hand.

Cash is king in a bear market… and that’s how you make the most money!

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UKCashFlowDiariesMidwestern LandlordCurtis@PayOffMyRentalsFI Fighter Recent comment authors
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Financial Samurai
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I believe in having good cash cushion, but shouldn’t cash be generated through c cash flow?

In your refinance example, you took out cash but increased your mortgage debt by $98,000. You’ve got to pay more cash flow a month to service debt. Why not just raise the cash through income and savings instead?

S

Even Steven
Guest

I agree with you on a couple points and like the article, so we got that going for us;)

I agree that having cash in the bank can certainly be a good think and like you mentioned it depends on the phase you are in and also the percentage of your financial world, for example to have 80% in cash in your early 30’s for example wouldn’t make much sense.

The only thing that I question and more of a question would I do it myself was the cash out refinance. For either of our real estate investments, refinancing to take out 100K to have the money sit in the bank wouldn’t make much sense to me for our financial situation. I should point out that we are almost doing the opposite by paying down the mortgage to eventually increase the rental income and thus have no debt.

On a side note I want to add your FI date to my site, I’ll try to ping you on Twitter as well. Thanks.

jon
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jon

I view your cash cushion as an inevitable capital cost associated with leveraged REI. It is not a bad thing, it just needs to be factored into your calculations when thinking of buying a property. A DGI investor who does not use debt and does not time the market cares only about consistently increasing cash flow because they have no expenses associated with their investing. It is really an apples/oranges situation.

No Nonsense Landlord
Guest

“Really, how long would it take a person to save $200,000 in cash, after taxes?” Coincidentally, that is my goal for 2015… It does make for less stress having less mortgages and less debt.

The market is a bit frothy. It’s hard to tell where it goes from here. Maybe a small correction, maybe -10%. But likely not a bear. When you have cash flow, you can let the market run it’s course and continue to do dollar cost averaging. That is how you make it in a choppy or down market.

Cash is a good thing. I have made offers in the past that I would not have gotten if I could not pay cash. I had two cash deals that required $130K and $205K in recent years. I was able to turn that cash into a great investment.

While your cash is in the bank, you are paying ~4% interest, plus 2% inflation. If you pay off a loan, you get at least the interest rate on the loan.

Jerry Harrison
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Jerry Harrison

stopped all investing (401k,ira,taxable, etc) for three months to build cash, pay real estate taxes, get some maintenance work done on vehicle and house, buy a little physical silver, and actually spend money on myself ( I need new running shoes). Ill wait for a downturn before i start investing money again.

carlos
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carlos

this is sheer madness. Let me get this straight, you refinanced your homes using them as ATMs. Presumably took out a higher interest rate than what you originally had, paying the fees associated with that so that you could get the money out and let it sit in the bank idle? incredible. You are forced to raise your rents to offset your new costs which means your income will be higher on paper and your principal repayment will be higher (which is not tax deductible) implicating much higher tax bill at the end of the year. So you are borrowing money paying interest on that money in exchange for money to sit in a bank account erroded by inflation and losing purchasing power.

If this looming bear market hits, your hand is forced and you will hemorrhage money because you will have to slash your rent prices if the demand does not exist and your renters lose their jobs. In fact that is in the cards anyways bear market or not. These over paid renters of yours are getting outsourced to countries with cheaper labor. That is not a glitch that is a trend. Its the fed’s cheap money that is causing the frenzy not economic growth. Don’t believe me? Why have interest rates not rised (because the fed is afraid it will send the weak economy to the pits). read their notes. I do not believe this bear market is in the near term horizon so you will have luck on your side once again.

Tony @ Inequality Today
Guest

I totally agree with you. Everyone knows “be greedy when others are fearful”. However, few people can do it because most people have no cash left at the bottom of bear markets. That’s why long term investors like Jeremy Grantham who always have cash on hand can buy at rock bottom prices.

Mr. Belevedere
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Mr. Belevedere

Fi Fighter, I think you’re on the right side of it. You’re going against the grain, and the best investors always seem to do so. The news isn’t really talking about housing quite yet coming roaring back…they mention it, but not like they do a stock that is on fire. Usually once the news starts running with it, that’s the end.

Anyway, I love your method of refinancing. If you’ve ever been invested in a stock at say 50k investment with 10% return, and then the stock flops and cuts the divy, you’re now at 25k with a 5% dividend, that’s no fun. It only takes one or two of those to realize why real estate is great for minimizing risk. Once you pull all your investment out, your risk is minimized to a credit rating.

If you don’t sell, or refinance, equity is useless except for bragging rights.

Nice job. Fantastic!

Curtis@PayOffMyRentals
Guest

I also got my hands on $200k about the same time you did, but it only cost me about $1,400.00 one-time fee. I got a credit line from my bank. They used 5 of my houses as collateral. All I have to do is email my bank and the requested funds up to $200k are deposited within the hour. I pay 5.5% interest. I’ve requested funds 3 times now and tested the waters. No transaction fees and I only pay interest on the money when I borrow it.

I think that would have been a better way to accomplish what you’ve accomplished. It’s just as effective and a heck of a lot cheaper over the long run.

Midwestern Landlord
Guest
Midwestern Landlord

Fi Figher,

You have been on a roll lately with a lot of good content. So much in fact it has been a little hard for me to focus on what I want to comment on. I absolutely agree with you beefing up the cash reserves with the refi’s. Borrowing money at a low fixed interest rate over 30 years when tenants are paying for the monthly obligation is a GIFT. I wish I had the opportunity to do what you are doing, however, in my area I do not have anywhere close to the appreciation that you are seeing in the Bay area.

CashFlowDiaries
Guest

Hey FI,

Wow heck an of article. I must say that was a bold move on your part taking out that refi for the sole reason that you are assuming you know what is going to hit the fan. This is one of those moves where a lot of people are not going to agree with you, especially real estate investors. Mainly because as you said its just sitting in the sidelines right now. But if youre right and all of a sudden we are in the position where we need CASH, then you will be genius who saw it coming.

I know if I pulled out a refi on one of my properties, I would invest it right back into purchasing a new rental property but that is my plan to retire. Cash flow from rentals will be my FI. Im slowly working my way there. Im actually having a ton of luck in the midwest with rentals (indy). The appreciation isnt much, but it is super stable and the cash flow is amazing! Im averaging at 20% cash on cash returns on all my properties so far.

Look forward to future articles.

UK
Guest
UK

Hi
you say you are not a market timer – but you actually describe market timing.
Since the last 100 years S&P was mostly at all time high – that’s why its always expending higher in average of 8% a year~.
Investor that cannot stomach 20 – 50% correction should not be in the market at all. Because it will always happen and you cannot time it. You can wait out while the market will take another 100% higher to avoid 20% – 30% correction.

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