Financial Account Framework
Investment objective, liquidity, and time horizon are three variables that can be used as a basis for a financial account framework. Financial accounts are considered those that comprise financial assets and includes bank, brokerage, retirement, education accounts, and others based on personal circumstances.
Group 1 accounts are those accounts whereby you are likely to draw on the funds within 1 year. This could include bank accounts for checking and savings and typically these funds would be held in very conservative vehicles where protection of funds is critical. Sources of income that provide cash flow, such as salary and wages, would generally flow through these accounts.
Objective is to provide liquidity over a short time horizon, thus in order of priority the objective is Capital Preservation and Income.
Mixture of assets would reflect safety of capital.
Group 2 accounts are those accounts whereby you are likely to draw on the funds between 1 to 3 years in the future and/or these accounts could be considered emergency funds to supplement liquidity if the need should arise. These accounts could include various investment accounts where the mixture of assets would take into consideration that these accounts require safety of principal coupled with a market return for income and capital appreciation.
Objective is to provide a market return for income and be a secondary source of liquidity. However, since the timeframe is 1 to 3 years there could be an assumption of market risk, thus in order of priority the objective is Income, Capital Preservation, and Growth.
Mixture of assets would reflect safety of funds combined with a moderate tolerance for market risk.
Group 3 accounts have a time horizon of greater than 3 years in the future. These accounts could include investment accounts for retirement, education, or possibly a brokerage account intended more for active management to take advantage of price anomalies (for trading gains) and capital appreciation. Since these accounts have an extended time horizon, they could have a higher risk profile to enhance return over a longer term.
Objective is capital growth over a longer term time horizon, thus in order of priority the objective is Growth and Income
Mixture of assets would reflect capital growth, a higher tolerance for market risk, and generally not act as a source of liquidity.
However, two things need to be noted. First, accounts migrate between each group over time. For example, an education account can have an initial time horizon of 18 years before it is expected to be drawn from. That same education account, over time, moves from Group 3 ultimately toward Group 1 and the mixture of assets should reflect the period in which funds are expected to be drawn down. Retirement accounts would be another example where the mixture of assets would change over time. Second, economic and market conditions may impact the mixture of assets and every category. For example, an investor may have an expected retirement 20 years out, but if market conditions deteriorate this investor may want to hold more cash to offset a decline in asset prices and hold that cash until prices stabilize. This is not meant to suggest timing the market, it is meant to point out the need to pay attention to economic and market conditions, and the impact on asset prices.
Having an account framework in place allows the investor to have a consistent and disciplined approach toward managing their accounts to meet their various financial objectives.