Ask an Ex-Banker: How to Invest Unexpected Cash

A friend asked me recently for investment advice.  I sent her my thoughts by email but couldn’t resist making it into an “Ask an Ex-Banker” post.

Fear and Greed

Question:  My daughter got caught in the housing downturn and finally has sold her condo in NY but is too poor in this economy to buy a bag of chips, let alone a house in LA.  So she is trying to figure out what to do with the $90,000 left over after paying off student loans and replacing a broken car.  Do you have any suggestions for earning more interest?  K__ and I could use a suggestion as well, but none of us can stick it away for 3 years because as optimists, we are always hoping things will change.   Thanks.  Paula H., Sarasota, FL


Hi Paula,

It’s nice to hear from you.  Thanks for reaching out!

Sorry to hear about your daughter D’s housing condo mess, but, from a distance, my first thought is that it could have been worse.

Despite getting caught in the housing downturn, she came out $90,000 ahead – after student loans and a broken car – a victory.  It gives her a positive net worth, something most people in this country don’t have.

In my opinion, the first and only difficult thing about a pile of money like this is deciding whether you should put it in the ‘Risk’ or ‘No Risk’ investment bucket.

‘No Risk’ includes things like cash, a bank account, money markets, and annuities, while ‘Risk’ encompasses just about anything else, typically stocks, as well as real estate, and funkier investments as well.  We tend to assume lots of different flavors of ‘Risk’ investments, but I’m increasingly convinced all ‘Risk’ investments are fundamentally the same.  You can make money, you can lose money, but there’s no guarantee you’ll get all your money back when you need it.

If you decide on ‘No Risk’ then you should expect virtually no return, just the same amount of money available to you when you need it next.  If you decide ‘Risk’ then the investment could go up or it could go down in value, but, in the short run at least, there’s no way to know where you’ll end up.  The key advantage to dividing up the world this way – into these two buckets – is that it forces you to realize the illusion of having both safety and a good return in the same investment.  You can’t.  Anyone who offers you both absolute safety and a good return is lying.  Run away from them.

In your question you’ve already hit on the key answer/problem in your question: Timing.  If D might need the money within 3 years there’s no chance to earn a decent investment return, while also entirely protecting principal.

Earning a reasonable return right now, without taking risk, is impossible.  If you choose the safe approach, you earn nearly nothing – $900 per year, or 1% on $90,000 – which won’t buy much.   It’s hardly worth the effort of opening up the bank savings account.  Interest rates are on the rise now, but from such a historically low base that they’ve got a way to rise before return on traditional savings will be “worth it.”

On the other hand, investing it ‘in the market’ or in another risky asset like real estate means that your $90,000 could be a lot smaller by the time you try to actually get it back.  It very well might be larger too, but that’s just one possibility, not a guarantee.  If you have to have at least $90,000 when you want it back, then ‘Risk’ isn’t the right place to put the money.

So, now, to D’s particular situation.

If she’s a starving artist in LA, without a steady income right now, then it’s likely she’ll need to access at least some of that $90,000 in the short run, in less than 5 years.  To the extent she might need this money for living expenses anytime in the next 5 years, it needs to be in ‘No Risk.’  The return will be terrible, somewhere between 0% and 2%, but that’s just where we’re at.  It probably doesn’t matter where you invest.  Just stick it in a stupid bank savings account, earn the 0.9%, and be content.  Don’t even bother tying it up in a 2 year CD offering 1.9%, because it just doesn’t matter.  Another $900 per year won’t compensate for the fact that she can’t access all the money if she really needs it.

When would it make sense to invest in something Risky?  It depends on her time horizon for accessing the money.

Less than 3 years, no way.  ‘No Risk’ bucket only.

Over 5 years, start to lean towards Risky.

Over 10 years, put all of it in Risky.

If D’s music royalties or other income can reasonably cover her monthly expenses for the next 5 years, so she knows she doesn’t have to access the money, then it seems fine to pick something risky.  Put it in a low-cost, all-stock mutual fund and watch it grow.  Or use your real estate savvy to get involved in a rental building.

I wouldn’t bother with sexier higher-risk situations like oil royalties, film-financing, hedge funds, start-up businesses, or art unless she can blow the whole wad without missing it.  It might make 10X your money.  But it probably won’t.

Is there a course in between ‘Risk’ and ‘No Risk’ buckets?

Yes, for example, D may know she’ll only need a maximum of $30,000 to cover emergencies over the next 5 years.  In that scenario, make two allocations –  $30,000 into the stupid ‘No Risk’ bank account earning bupkis, and up to $60,000 in something that might earn a positive return over the long haul, like stocks or real estate.

The longer her $60,000 has to stay tied up in that Risky bucket, the higher the probability that the money will be larger when she needs it.  The key here, though – the really essential point – is to know ahead of time which money she can’t afford to lose because she’ll need it, and which money she can afford to risk, because she won’t need it, ideally until retirement.

For you and your husband K, the equation might be different.  I’m presuming you’re much more likely to have your monthly expenses covered in the next few years, so you can afford to make much riskier choices.  If you lost some of your $90,000 in a risky situation that didn’t work, you’re still less likely to depend on the principal for daily living.

Your time horizon for choosing risky investments is probably better than D’s.  For K and you, putting the money ‘in the market,’ or in a real estate opportunity seems perfectly reasonable to me, if you can weather the volatility.  It makes sense to me that you’d invest the $90,000 differently than D should.

I know I’m not giving creative investment ideas that offer both safety and good return, but the fact is that usually – and certainly now – we can get safety or good return, not both.

I hope this helps.

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4 Replies to “Ask an Ex-Banker: How to Invest Unexpected Cash”

  1. When I was growing up on the Northwest side in Chicago in the 1950’s and early 60’s the best way to get ahead with real estate was to buy a two story brick house with a rental flat on each of the two floors. Then you would rent out the two flats and you yourself would live in the basement and work at a regular job. It may not sound pretty but it made for a good life later on. I think it may be time to hunker down again.

  2. What about the car? Let’s extend the question. Suppose she can get a new car for $20,000. It’s a former demo marked down to make way for the new models so it has the full warranty. The dealer offers it for no money down and 0.9% simple interest for 5 years and no fees. Pay cash or take the loan?

  3. This is always a difficult question to answer. I recommend that the reader study the difference between asset classes and the barriers that are involved in moving assets from one class to another. Also, the reader must become intimate (and unemotionally involved) with the subtle differences between liquid assets and available assets. There’s an immediacy to available, but there’s always some kind of transaction expense when trying to leverage liquidity. In my particular circumstances, I’d go with mixture of cash-on-hand, cash in savings, high-quality bonds (short term), and a fraction in securities in mid-caps. But, I could also get all technical and really get into the weeds. A kid probably needs a mix of available and liquid capital…and a good dose of exposure to fundamental investors’ books.

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I founded Bankers Anonymous because, as a recovering banker, I believe that the gap between the financial world as I know it and the public discourse about finance is more than just a problem for a family trying to balance their checkbook, or politicians trying to score points over next year’s budget – it is a weakness of our civil society. For reals. It’s also really fun for me.

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