“A diamond is a chunk of coal that did well under pressure” - Henry Kissinger

When the unexpected, the unplanned, or the unforeseen strikes - it is important to ensure that to the extent possible, plans and tactics related to cash flow maintenance are ready, available and executable. Advanced planning plays a critical role in ensuring that you are prepared for such disruptions, and this involves a proper understanding of three key areas;

1. Total Out Flow – How much do you spend? How much is obligated and how much can be changed (fixed and variable costs)
2. What assets do you own? Do they produce income? Can you sell assets if required?
3. What income streams do you have? This could be pension plans, rental income, employment income

By knowing how much you spend you now have a target to examine. Many are unaware as to how to determine how much they spend on a recurring basis, and there are two specific methodologies/formulas to consider;

1. Gross Income – Taxes, Payroll deductions, savings, and debt obligations = Total Discretionary Spending
2. Total of funds that were spent in your chequing account – savings and debt obligations = Total Discretionary Spending

It is critical to understand, first and foremost, how much you are spending to determine (a) what could be reduced or cut (b) do your resources adequately provide for support of your needs currently? Once discretionary spending is established and debt obligations are pinpointed you should have a holistic view of what is required for total support during a time of disruption. This is the target amount to seek to support.

We then pivot to income and assets. From an income standpoint, we want to understand what sources are available to us. This could be as simple as pension or employment income, or other sources such as investment income, sale of assets, or rental income. In this space we need to know what is expected to ‘come in’, with our succession of order being pension/employment income, rental or investment income followed by asset sales. The rationale being a move from stable and replenishable income sources, and concluding with perishable sources (once an asset is sold for consumption, it no longer generates cash flow).

The goal of the above exercise is to identify ‘the gap’. In planning we determine ‘the gap’ based upon the disruption itself, as an example, if employment earnings cease then we would be seeking to supplement the net amount of employment income. In simple form, this planning takes on the same methodology as traditional retirement cash flow, but with a unique exception. Generally retirement is a planned event, whereas disruption – by definition - is an unplanned event. Therefore, ensuring working knowledge of the above areas can lead us to potential tactics as indicated below;

1. Look at what areas in spending can be reduced or eliminated - Are there consumption items that could be reduced? Lifestyle costs that could be eliminated? Should we defer the vacation as an example
2. Push off capital projects – If work has not been contracted perhaps the home renovation could be pushed off until the disruption passes
3. Seek to ensure you have cash flow available – This is a critical part of advanced planning, ensuring that you have adequate support in fixed income or cash to support a period of time. The amount of time can vary, but ensuring that you are not forced to sell assets at an sub-optimal time to generate cash flow is ideal

This methodology of assessment of out flow and in flow of money is something we refer to as ‘Cash Flow Mapping’ and is applicable to not only individuals but also organizations. In discussions with our Co-Chief Investment Officer Roger Heard, he shared the following thoughts during our current period of volatility and disruption;

“As you can imagine, in the current market environment, most of my client conversations (and I have had many) revolve around uncertainty and nerves relating to the significant number of unknowns surrounding Covid 19. I wanted to share something that has been percolating to the surface in discussion after discussion. Having a solid financial plan as a foundation for building a portfolio is critical, but I think most get that. Having a well-diversified portfolio of high quality companies and fixed income securities as well as a balanced approach over time, extremely important, but again very intuitive. Our cash flow map has been one of the elements that has surprised me the most as the concept is simple but the real benefit may not be as obvious until faced with more challenging market conditions. In a recent presentation to the Investment Committee of one of our institutional clients, we reviewed the fixed income securities set to mature over the coming three years that are to be used to fund the operational objectives of the organization. The powerful concept of not being forced to sell any position at an inopportune time in the markets was one that needed to be re-enforced. Having the cash flow plan in place helped to significantly reduce anxiety.

Discussions with clients using funds for retirement are very similar. Having anticipated cash flows over the coming few years already planned for and build into the fixed income portion of the portfolio, acts as very effective risk management tool. “ - Roger Heard, CFA

 

Planning ahead, being confident in understanding ‘what it costs’ to live life or run an organization is key. Ensuring that the tools in your investment portfolio are aligned to these specific needs allows for effective risk management, without the need to liquidate assets at inopportune times. This methodology can help turn the ‘coal’ of uncertainty into ‘diamonds’ of stability during pressure filled times.