Personal finance can mean many different things to each person of family.
There are many components such as budgeting, college savings, investing, estate planning, tax planning, etc… The list can be endless depending upon how complex and large your estate or asset base is.
In this piece, we’ll cover the liquid asset portion and how to allocate those investments to maximize your long term return while keeping our eye on risk management and protecting our capital.
We break down the types of investments into three of our own personal banks. The funds within each bank get managed very differently and never get commingled unless of an emergency.
The first bank is our sleep at night safety bank.
The purpose of this portion of money is to ensure you take are of your family, your responsibilities and plan in case of an emergency.
Working folks and retirees needs are very different when it comes to the safety bank. Those who have current earned income should keep at least 7 months worth of expenses on hand in the form of liquid assets such as cash, bank CD’s and Treasury Bills.
Those who are retired and live on a fixed income should treat their “safe” money differently. They should have 5 years worth of expenses in short term fixed income instruments that mature no longer than five years in the future.
How do you figure out how much to place in these 5 year or less fixed income securities. It’s pretty simple really.
You need to have spending money each and every month. Therefore, you need enough cash on hand to pay expenses for around three or four months. The remaining funds should be invested in small portions for diversity and a staggered or laddered maturity schedule. For example, you would want some of your CD’s or Treasury Bills maturing every month if you could, or at least every three months. After one matures, you would take enough money to make sure you have your 3 months of spending money on hand, and invest the rest in something that matures in five years or less.
If you would like an easy took to see what an investment would grow to in a certain period of time based on a predetermined interest rate, then check out these free online calculators for assistance.
In times when interest rates are low, this can pose a challenge because the income from these low risk investments remains bleak.
The second and third banks are reserved for your more traditional investments.
The second personal bank is where we do our stock market investing, or swing trading.
This is where a different type of money management needs to take place. This is the bank that will actively feed the other two banks. This is where the money will be made.
Our swing trading account needs to managed like a business, just like any other personal finance situation.
Here’s how we do it.
Let’s say we have $300,000 in our active swing trading account.
The first rule, don’t lose money.
The second rule, don’t make an investment without a plan. You need a reason why you bought the security, a target or objective price where you would sell, and most important – an escape hatch if your wrong. You need to be able to emotionally detach yourself from these investments so you’re able to identify when your wrong so you can then cut and run.
Here’s how to manage risk in a trading account
Members of my trade alert service are taught to never invest more than 10% of your swing trading account in any one equity. In this case, with a value of $300K, position size is $30,000. As the account grows, so does the position size and so on.
Each trade we take has a well defined price where we’re wrong and must exit the trade. These stop out points are never more than 10% below the purchase price and many times much less. This enables us to put the risk reward in our favor. Win big and lose small.
With the model outlined here, you can never lose more than 1% of your account value on any single trade or investment. This is proper risk and money management.
The third personal bank is for our longer term asset based investments
These would include things like investment or rental property, art, gold, gems, and anything else that holds or can increases in value over time.
How much of your total personal bank should be in this third component is more of a moving target. To manage risk properly, from time to time you should purchase assets with portions of the gains from your swing trading account. Over the longer term, it’s about accumulating these assets that create wealth.
There is no perfect answer that fits everyone, but I hope this provided a basic understanding of how to think about managing your growing personal fortune.