Optimizing ‘Your Family’ Capital’s Balance Sheet

A critical input to understanding an operating company’s current health and growth potential is the balance sheet. The balance sheet is a great tool that can provide insight into the foundation of a firm. Financial professionals, including investment bankers and private equity professionals, spend countless hours advising companies on how to achieve their next goal by optimizing their balance sheet using senior and mezzanine debt, equity, and other funding.

The same level of thoughtfulness should be placed into optimizing your family’s balance sheet. As the CEO of ‘Your Family’ Capital, you should analyze your personal net worth statement in much the same way that an investment banker would analyze the capital structure of a company. Constructing a personal balance sheet is an important first step and should include all investment accounts, private investments, real estate, and liabilities. On a regular basis, this should be updated and reviewed for planning purposes. This review can be used to set goals, manage risk, and plan long-term strategies to set ‘Your Family’ Capital on a path to optimal financial success.

Given it is the start of a new year, this is a great time to take stock of where you currently stand and look for opportunities to strategize around some of the different components of your balance sheet.

Cash and Cash Equivalents:

This is a topic that is often stressed over, especially with financial professionals. Your human and financial capital overlap significantly and thus it is important to have slightly more cash on hand than other professions. If you are a family with one main earner, the amount of easily accessible cash should be roughly 7-10 months of total monthly spending. If you are in a family with dual incomes, the amount of cash cushion decreases to between 4-7 months. It is important to have enough cash on hand to be able to weather both a bad employment and market environment. However, hoarding cash can be a drain on your potential earnings.

Qualified and Non-Qualified Accounts:

It’s important to take stock of what types of tax vehicles you own and what’s inside each of them. Having a variety of accounts (IRA, Roth, taxable account) with different tax structures can be a valuable resource to manage taxes while growing your assets and eventually living off them in retirement. It’s also important to own investments strategically in different accounts. ‘Tax-ugly’ assets, such as REIT’s or high yield fixed income, should ideally be owned in tax-deferred accounts. Whereas, ‘tax friendly’ assets, such as stocks and municipal fixed income, should be owned in taxable accounts. Understanding the nuances in all of these and setting a plan in place can create financial flexibility.

Assets Outside of the Estate:

As your career and wealth continue to grow, it’s important to keep an eye on what is included and excluded from your estate. In Illinois, the estate tax exemption is $4 million per person. Given the lower exemption threshold within Illinois, it can be beneficial to shift assets away from your estate to entities such as 529 plans, donor advised funds, and children’s trusts. Establishing a strategic plan for shifting assets away from your estate is a balancing act between your personal goals and your legacy.

Financial professionals spend much of their time focused on their clients and careers. They scrutinize and pour over the analysis to give the best recommendation to their client. With this level of dedication, it can be easy to fall victim to the cobbler’s children parable and neglect your own finances. However, as shown above, it is important to analyze your own balance sheet as well. Making sure you review these items at least annually can make a major difference later down the road.