The 4-Q way of protecting your finances from coronavirus driven volatility

One of the questions all investors consider is how to spread their investments. This is super essential in a volatile economic environment that we are now being forced by coronavirus.

Coronavirus is already sending stock markets across the world in a downward spiral, companies may find it difficult to service debt and hence affect bonds, and interest rates going downwards put cash and money market funds into useless investments.

How do we then allocate our funds and make sure we are not into an all-or-none, boom-or-bust kind of situation?

There are essentially 4 kinds of investments that a simple investor like us will hold over time.

  1. Cash and cash equivalents – CDs, money market, timed deposits etc.
  2. Debt – Fixed duration and fixed income products like bonds bought and held till maturity.
  3. Market Linked – Index Funds, Mutual Funds, ETF, direct stocks, REITs.
  4. Real Estate – Properties (homes and rentals), Private REITs.

The 4 Quadrant approach

The below table shows how these investments fit each quadrant of a time horizon vs. liquidity.

Financial PlanningLiquidNot Liquid
Short TermQ1 – Cash and Cash EquivalentsQ2 – Debt (Bonds till maturity, other lending investments)
Long TermQ3 – Market linked (funds and stocks)Q4 – Real Estate

For example, cash and debt instruments are typically short term reserves. While cash in savings account is highly liquid, bonds typically have a fixed maturity duration unless they can be traded in the secondary market.

On the contrary, stocks and funds may be liquid but typically yield best results only over the long term, due to short term market volatility. Real Estate is both long term and highly illiquid since it may take months and years before a property investment can yield profit or get sold.

If we allocate our resources with the 4-Quadrant principles in mind, then the short term market volatility or conditions will not bother us much. Each of the Quadrants will have enough invested/saved to go through the current phase.

For example, if I need immediate cash or want to maintain an emergency fund, Q1 is the place. There is no need to panic sell Q2, Q3 or Q4 investments.

Similarly for a medium term (2-4 years), the required funds can be maintained in fixed duration bond products (Q2) matching the maturity to a goal horizon.

At last, stocks and real estate are for the long term (> 10 years) and should be left to grow on their own. We can keep adding to them in a well defined proportion. But we do not need to panic sell them if the Q1 and Q2 are in place.

Simplest Asset Allocation

Another advantage of this approach is automatic asset allocation. Sometimes without realizing we may be overweight in one Quadrant. For example, some people may be just lazy to invest and keep their money lying in savings accounts, hence Q1 heavy.

While others may be so overweight in Stocks and Real Estate that in case of an emergency or reaction to market movements, they may sell or trade unnecessarily and hastily. Worst is premature withdrawal from retirement funds and paying penalty and taxes.

A balanced allocation to each Quadrant based on goals is the right approach.

For example, lets say I have $200,000 net worth. I can allocate the following after estimating my monthly expenses ($3000) and near term goals (Education, buying a house etc.).

Q1 – 6 * $3000 = $18,000 in money market fundQ2 – $40,000 for a new house in 2 years – Treasury Bond Fund
Q3 – $42,000 in 401-k and Roth IRAQ4 – $100,000 in present home equity

Lets analyze few scenarios here. 

  1. I suddenly lose my job – Assuming it will take 4-6 months to get a new job, I can withdraw from Q1 my monthly expenses and tide over this crisis. 
  2. I need to save for a new house in 2 years – I keep saving every month in Q2 and buy investments maturing in about 2 years.
  3. Whether the above events happen or not, the Q3 keeps growing as the funds remain invested in the market. In fact, as long as there is no crisis, I can keep making dollar cost averaged investments every single month into 401-k and Roth IRA accounts. 
  4. Q4 is even longer term and can be one’s own personal residence and additional rental properties. If Q1 and Q2 are in place, there should not be any hurry or knee-jerk reaction to sell or lose these valuable assets.  

The actual amounts or assets can vary depending on a person’s goals and needs. 

Overall this framework will also avoid a person to go into debt unnecessarily. Similarly paying off debt or mortgage can be considered money invested in Q2 and Q4 respectively. 

Conclusion

The 4-Q is thus a simple financial planning framework. Sticking to this 4-Q framework and directing one’s monthly investments to the relevant quarter helps build wealth in the long run, as well as take care of short term obligations. 

silhouette photo of person leaning on arch pillar
Photo by Suliman Sallehi on Pexels.com

 

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