by Archie M. Richards, Jr., CFP^®
April 29, 2002

Hold cash for some financial purposes. But in many other cases, invest the money instead, as follows:

1) You need cash, obviously, to pay the family's bills.

2) You need cash for small emergencies, such as repairing the car or fixing the house. If you have four children at home, two houses, three cars, and four cats, many small emergencies arise. A credit card helps, but it's cheaper to accumulate modest reserves in the bank or a money market fund.

3) You need cash reserves for large expenses, such as a home's downpayment, that are coming up within eight years. (Beyond eight years, add the money to your long-term investments.) These reserves are best invested in bonds or certificates of deposit that mature when the money is needed. For tuitions, talk with a mutual fund about a tax-advantaged 529 Plan or Coverdell Educational Savings Account.

4) For major emergencies, hold no cash. A house fire, automobile accident, lawsuit, long-lasting disability, nursing home care, the death of you or your partner - any of these disasters could knock your family's finances for a loop. The risks should be insured.

To reduce the premiums, choose relatively high deductibles. If a fire occurs, you might pay the first $5,000 of costs. If you become disabled, support yourself for the first 90 or 180 days. Pay for the initial dollars of loss, but let the insurance companies come up with the heavy money.

5) For major emergencies that are not insured, hold no cash. Set up a home-equity line of credit instead. The bank provides a checkbook for you to obtain the money when it's needed. The interest is low. It's also deductible, which cuts your taxes. Some banks charge an origination fee for setting up the loan and a dormancy fee if the loan isn't used.

You might also sell investments you hold outside of your retirement plans. To reduce the tax effect, choose the investments you've held for at least a year. To cut the taxes even more, select the ones you've held for at least five years.

Money that's been in a Roth IRA for five years can be withdrawn tax free. If you began a Roth IRA in the first year, 1998, you can make tax-free withdrawals beginning in 2003. Withdrawals from traditional IRAs are taxable at high rates and may even incur penalties. Better to leave those plans alone.

6) For long-term investments, you need no cash. Assuming most of your investments are in stocks, do not attempt to take advantage of lower prices later on. About two-thirds of the time, the stock market doesn't go significantly lower. It rises. None of us consistently knows when the market will fall. But in the long run, stock prices go up. Therefore, the best time to become fully invested is when you get the money.

If you wait to buy at lower levels, you'll be wrong more often than you're right. Yes, I know; in the last two years, the stock market hasn't exactly gone through the roof. But don't let this cloud your vision; keep you eyes on the horizon. Get invested and preserve the opportunity to participate in the market's long-term uptrend.

In summary, for small emergencies, reserve cash in a money market fund. For large anticipated expenses, use CDs or short-term bonds. For large unanticipated expenses, purchase insurance. For uninsured emergencies, use a home-equity line of credit or sell some of your investments. In your investment program, put your cash to work and keep it there.

Some people are confused about price-earnings ratios, which are often called PEs:

If the price of a stock is $40, and the company's earnings per share for the year are $2, the price is twenty times the year's earnings ($40 / $2). The price-earnings ratio is 20. If the annual earnings stayed the same year after year (which they don't), the buyer would have to wait 20 years for the cumulative earnings to equal the price paid up front.

Investors don't usually have to wait that long. Corporate earnings don't stay the same. They grow.