In a recession, cash is king, or so I’ve been told.  In a U.S. recession, U.S. long-term government bonds are king, if there is little perceived threat of price inflation, and if you get out in time.  But that doesn’t make for a very good quote.

There is something to be said for having cash – or more accurately, liquidity – in a recession.

First, it is a form of wealth preservation.  Many assets such as stocks, real estate, and commodities are likely to fall in value in terms of prices in a recession.  You are better off having money sitting in a savings account earning 0.1% interest than having it in stocks that are falling 50% in a market crash.

Second, when asset prices do fall, having cash enables you to buy things at a discount as compared to what they were and probably to what they will be in the future.

Of course, it is impossible to know when things have bottomed out, but you don’t have to be precise.  If you had bought real estate any time between 2010 and 2012, you would have likely done well. If you had bought stocks any time in 2009 or 2010, you would have done very well up until now.

A third reason to have liquidity during a recession is to have access to the money you need, especially for emergencies.  The worst financial scenario for most people is the loss of a job.  If you have a large cash cushion, this certainly makes a big difference.  It doesn’t make everything right, but it can help a lot to alleviate stress. It can buy you more time. You may not have to be as desperate when looking for a new job.

These are just three broad reasons for wanting to have liquidity in a recession.  And not knowing when a recession will happen, it makes for a good argument that you should always have some liquid money available at all times.  Just having some cash in the bank can reduce anxiety in an uncertain world. If you actually reduce your stress level, then the reduced rate of return is worth it.  You are getting a better rate of return on your health.

Locking up Your Money

The problem today is that many people find that the large majority of their net worth – if they have a positive net worth – is locked up.  It is typically locked up in two things: a home and a retirement account.

If you have significant equity in your house, this doesn’t necessarily do you a lot of good when times get tough.  You could do a cash-out refinance to access some of your money, but then you are just sending your mortgage balance higher again.  There are usually costs to refinancing, and you don’t always know what the rates will be.  They will typically be lower in a recession, but not always.  You also don’t know if house prices will go down so much that it will wipe out most of your equity.

I am an advocate of trying to pay down and pay off your mortgage as a goal.  If you can actually pay it off, then this is a great boost to your cash flow, as you don’t have to pay that mortgage payment each month.  You will still pay property taxes, and probably insurance, but the principal and interest from the mortgage will be gone.  This adds a great deal of financial security if you can get there.

But unless you can actually pay off your mortgage, you have to be careful about paying it down. When you are paying it down, you are locking up that money.  If you already have a significant emergency fund, then this is probably fine. But if you have little in liquid savings, then I would generally advise not paying extra on the mortgage unless you are close to paying it off.

As for a retirement account such as a 401k, you are also locking up money when you contribute. You typically can’t take a withdrawal from a 401k if you are still working for the employer that sponsors it.  And if you lose your job or switch jobs, then a withdrawal is going to cost most people income taxes plus a penalty.

I think it is a good idea to get the employer match if you get one, but even here I am not firm in this.  There are opportunity costs.  And again, you are locking up your money.

You can have a large 401k balance, but it will be frustrating if you are stressing out about your day-to-day expenses of living.  It almost seems kind of silly, but this is a common situation. You can have a high net worth yet be struggling with your cash flow situation in the present.

Conclusion

It is good to have a long-term goal of building wealth.  This should include a goal of paying off your mortgage if you own your own home.  It should also include retirement accounts for most people.

However, you have to balance that with your liquidity, which is your happiness of today.

It’s not that you should be planning to splurge your money on cars and the latest gadgets.  I am talking about happiness in the sense of peace of mind.  You can be paying down your mortgage and maxing out your retirement contributions, but if you are stressed out about how you will pay your bills next month, then you are not in balance.

You should have liquidity for a recession.  You should have liquidity for emergencies.  You want cash on the sidelines for the unknowns in life.

If this gives you some peace of mind and allows you to sleep a little better at night, then it is completely worth it.  Your physical health is even more important than your financial health. And if you feel financially healthy, that can help reduce stress, which can make you more physically healthy.