You are facing a substantial expense in about a year. You know that you will have to pay this expense, and you know about how much it will cost. You have enough money now but it is invested in diversified stock index funds – market risk but not really company or sector-specific risk. Interest rates are, as you know, very low, so you won’t make much money in a CD or bank account. How should you plan to pay for this Known Known of an expense?

Cash Out Now?

One option, the most conservative one, is to cash out all of the money you need in a year right now and put it in a safe place, albeit one in which you won’t earn much at all for the next year. This is the safest option because you know you will have the money – a Known Known problem with a Known solution. It is not wrong to do this. You don’t want to risk that the stock market takes a dive and you miss out on the opportunity to pay for your expense with what you see as inflated dollars. The risk-averse will opt this way every time. However, there are other options.

Let It Ride?

The gambler might let it ride at this point: cash out $0 and hope for an upswing in their portfolio so that they can effectively pay for their expense using “house money”, or money that they earn between now and then. Perhaps they believe they have a better insight as to the direction of the market for the next year and thus a leg up; perhaps their insight is wrong. This is the highest option on the risk/reward spectrum. Though the “let it ride” option has some sex appeal, no financial planner worth their salt would recommend it.

Split the Difference?

An alternative is to split the difference: Save part but not all of the cost of the known expense, and keep part invested. The percentage of each would be a function of how big the expense is relative to one’s liquid net worth. If the expense would put a large dent in your net worth, then cash out a high percentage of the expense now, and vice versa. Managers of accounts such as Target Date Funds and 529 accounts act this way: As the target date for retirement or for the college tuition expense draws nearer, the fund manager moves a higher percentage but not all of the account to cash or short-term bonds so that the pending expense is addressed. These managers recognize that there is still a need to keep earning something on their clients’ investments because there may be unknowns that arise.

IMO

A known expense is different than an unknown expense because you can make plans to pay for a known expense. What plan you make and execute will be a function of how large that known expense will be relative to your money on hand. If you feel good by cashing out now for all that you need, then go for it. If, however, you don’t want to give up the upside of earnings you might make on that money, then move some to cash and keep the rest invested. Don’t be foolish and do nothing because you will hate yourself if it doesn’t work in your direction.