While there is some opportunity cost of the cash reserve account not earning market returns, the cash reserve account serves a few purposes. One, from a psychological standpoint, it allows clients to sleep well at night when the market goes through a rough patch because they know they have enough cash to cover their core living expenses for a long time. Two, it gives our firm the opportunity to decide when to refill their cash reserves based on how the market is performing. If things are going well, we can refill cash sooner by selling stocks at a “high point.” If the market is not doing well, we can sell bonds, which presumably have maintained their value, so that we can hold on to the stocks and await their rebound. The worst mistake is to be forced to sell investments at the wrong time, with the market down, because then you lose the opportunity to recover your loss. This strategy has worked very well for many of our clients, especially during the 2007-2009 Great Recession.
The bottom line is that investors need to understand how a dividend works and that there are alternative strategies that we believe accomplish a similar goal, but are more prudent. While dividends may be used as a self-control device or to avoid regret, they are not free, guaranteed money.
Brett Horowitz is a principal, wealth manager at Evensky & Katz / Foldes Financial Wealth Management.