It’s Comp Season – What Should I Do With All This Cash?
For many law firms, we are in the thick of “comp season.” For many lawyers, the first couple of months of the year are when you receive the lion’s share of your compensation for the prior year. This creates some degree of consternation and begs the question – “what should I do with my cash?”
The answer depends on your current balance sheet. Often lawyers who are earlier in their partnership years accumulate short-term debt throughout the course of the year in order to fund their monthly expenses. After financing your capital account buy-in and writing those quarterly tax payments, sometimes there isn’t enough cash to keep the household running. In those cases, it’s common to tap a personal line of credit at your bank. If this describes your situation, I encourage you to first pay down your credit line with your excess cash. Get yourself into a strong liquidity position and make sure that you have sufficient cash to finance your lifestyle over the coming year.
Over time, as your comp increases and your need to tap your line of credit decreases, you will find yourself in the enviable position of having a pile of cash and needing to find a good home for it. Now, what should you do?
Rebalance Your Portfolio
New cash is the best tool for rebalancing your portfolio. It allows you to invest money into the areas of your portfolio that are underweight relative to their target without having to sell other investments, which could trigger capital gains. Rebalancing is a fancy way of stating rule #1 of investing – buy low, sell high. Fresh cash enables you to place money into areas that have struggled of late and are “on-sale”, hence buying low. Of course, this all presupposes that your portfolio is built with a strategic, purposeful framework. If you don’t have a portfolio with specific target weightings for each area of the stock and bond market, you should start with getting that in place. At BDF, we’re always happy to help with that!
Pay Down Long-Term Debt
I regularly get the question – “Should I use my cash to invest or to pay down my mortgage?” My answer is it depends. There is a simple “math answer” to this question which states that if you have very cheap debt, you are likely mathematically better off keeping the debt in place and investing your cash. The lower your mortgage rate, the easier it will be to earn a higher rate of return on your investments than you’re paying in mortgage interest. However, there is also what I call a “sleep at night” answer to this question, which in my opinion, is equally valid. If the idea of paying off or significantly paying down your mortgage helps you sleep better at night, then you should listen to that inner voice and pay down your mortgage. There is a freedom to waking up in the morning knowing that you don’t owe anyone anything. Being debt-free also sets you up well for retirement by giving you greater spending flexibility.
With the US economy continuing to do well, many law firms are experiencing tremendous growth and profitability. That profitability flows through to law firm partners in the form of significant distributions. Make sure you are making the most of these good years by having a sound game plan for how to effectively deploy your distribution.
Justin works closely with clients to design wealth management plans that take into account the full spectrum of their career and personal concerns with a specialization in advising law firm partners. Justin earned his MBA from Northwestern University’s J.L. Kellogg School of Business.