Establishing a Cash Flow Strategy That Works in Any Economic State

Kyle Larson, CFP®

Feb 22, 2022

Creating an effective cash flow management strategy can be one of the most effective ways to get in front of the inevitable economic volatility that will occur on your path to financial freedom. Cash flow management is essentially making sure you have more money coming in than going out and helps you avoid having to play catchup in order to maintain your lifestyle.

How to Create a Cash Flow Strategy

Since everyone’s financial situation differs, no single cash flow strategy will work for everyone. A cash flow investment strategy should always be designed to fit the lifestyle needs and economic realities of each client.

That said, there are a number of tried and true methods to create a cash flow strategy that deliver steady income during the best of times and should keep you safe during times of uncertainty. I hope to guide you through the essentials of creating a cash flow strategy and help you figure out how to keep your savings protected through an unforeseen economic event.

Identify Income Sources

You’ll first want to figure out all the various income sources available. These income sources will contain differing degrees of tax implications and risks depending on the type. We typically break down income sources into two buckets:

Guaranteed Income – Income with no stock market or interest rate risk, such as: paycheck, social security, pensions (with a cost-of-living adjustment) and defined benefit plans.

Investment Income – Income dependent upon an investment vehicle that carries some risk, such as equities.

The amount of income sources available in each bucket will help inform your cash flow management strategy and help you develop a plan that balances the right amount of risk and return.

Diversify Your Withdrawals

Even in our fast, modern economy, the timeless adage, “don’t put all your eggs in one basket” still rings true. By now, you’ve analyzed your income sources and found that each requires different rules for withdrawal and levels of tax liability. We can now create a cash flow withdrawal strategy that minimizes your liability through diversification. I use a cash flow zone strategy called 3-legged stool approach where accounts are broken into three categories:

  1. Pre-tax accounts like 401(k) retirement accounts
  2. After-tax accounts like Roth IRAs (growing tax-free)
  3. After-tax investment accounts like brokerage accounts

Splitting up your pre- and post-tax accounts helps guide your withdrawal strategy by giving you flexibility to ensure the least amount of tax liability possible.

For example, when taxes are low, it’s best to withdraw from your pre-tax 401(k) account. In contrast, if tax rates rise, then it’s smart to pull withdrawals from brokerage accounts, where you’ll pay a relatively low 15% capital gains tax, or Roth IRA where you pay no tax upon withdrawal.

It’s impossible to predict what tax rates will look like 5, 10 or 20 years from now. But if your income sources are diversified, you give yourself wiggle room to develop a smart cash flow zone strategy.

Rebalance When the Economy Shakes

Along with death and taxes, we could add market downturns to the list of guaranteed things in life. Whether it’s high inflation like we’re seeing now, or a full-blown recession, the economy will take some hits over the course of your career and throughout retirement.

There’s nothing you can do to predict an economic slowdown, but you can protect yourself with a well-blended cash flow investment strategy that takes on a comfortable level of risk while outpacing inflation. While the balanced approach won’t entirely eliminate risk, it helps minimize it.

A balanced cash flow strategy is especially important during times of high inflation, such as the present. As inflation rises, money is worth less, so you need to find a way to stay ahead of inflation or your money will continue to decrease in value. This typically means investing more in equities, especially for those with guaranteed incomes that don’t have cost-of-living adjustments, such as pensions.

Generally speaking, I advise most retired people to hold a 60/40 split between stocks and bonds, which is comprised of mutual funds and ETFs. Bonds carry no stock market risk, but they also don’t grow like stocks, so they’re used as a hedge/ballast to market volatility while your equities are free to ride the stock market roller coaster.

Ultimately, the goal during the time of an economic downturn should be to minimize a short-term strategy and focus more on the long-term. Often in times of uncertainty, such as recessions, people want to sell as they understandably fear an impact to their portfolio. Don’t forget that the market has always come back and good fortune tends to favor the patient.

Understanding Spending Within Your Cash Flow Strategy

Perhaps the most common (and preventable) issue I come across when building cash flow strategies with clients is the tendency to get stuck in lifestyle creep. By this, I mean increasing one’s standard of living without the means to pay for it.

It’s fine to want your golden years to shine, but if financial stress outweighs your happiness, then it’s probably time to dial back the spending a bit. To get a handle on your expenses, I recommend breaking them up into two groups:

Core Expenses – Necessary, fixed expenses required for survival, such as: healthcare, insurance, utilities, food, etc.

Discretionary Expenses – Everything left over after other expenses, which may include travel, dining out, and entertainment.

Since there’s not much you can do about core expenses, I typically focus on discretionary spending when developing a monthly cash flow investment strategy. When addressing discretionary expenses, the primary question to ask is, “what do I really need?”

This doesn’t imply that you should cut all discretionary spending. There are always activities that are done out of habit rather than enjoyment. These are the expenses you’ll want to spend time assessing and figuring out if they bring you joy.

Seek Guidance

As every person is different, so is their financial situation. While the advice in this article will get you started on how to create a cash flow strategy, it certainly does not cover everything.

What works for one person may not work for another. In addition, life circumstances constantly change, so even what works this year might not work next year.

If you’re ready to get your retirement plans in order, contact TCI Wealth Advisors today. We would be happy to explore your financial situation and develop a cash flow management strategy that works right for you. Remember that retirement is meant to be enjoyed, not to be burdened by concerns around money.

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