The Danger of Cash Flow Thinking
I have a friend at work - let's call him Don (the name has been changed to protect the foolish). After many white board sessions, my friends and I convinced him to put a full 15% of his salary into our company's Employee Stock Purchase Plan(ESPP). As I have discussed before, if your plan is set-up properly and you can sell your shares immediately, participating in a ESPP is a financial slam dunk.
Now, Don wants to buy a house... "Great!" I say - a house is one of the best net worth growers in existence. I heard through the grapevine, however, that he plans on ceasing his ESPP contribution so that he can afford the house payments. What!?! You are no longer going to participate in a plan that generates an annualized return on your investment of over 100% almost risk-free.
Looks like we're going to need another white-board session. I'm afraid Don is viewing the ESPP payroll deduction as an expense and not as an investment. He has a good handle on his cash flow (most people do) but he's missing the net worth boat.
When you are faced with a cash flow shortfall you need to ask yourself a few questions:
- Is this shortfall permanent or temporary? - If you make some fundamental change (like buying a house) that hurts your cash flow, you need to take a step back and re-evaluate all of your savings, debt and spending.
- What is the opportunity cost of reducing my savings / investment rate and how does that compare to my debt costs? - This is the analysis that Don needs to do. His ESPP investment has an annualized return of over 120%. A HELOC or good credit card has an annual cost of 7-15%... any questions?
The bottom line is that Don needs to look for alternate ways to shore-up his cash flow crunch. Eliminating his ESPP participation is a cash flow positive move that comes with a severe net worth cost.
2 Comments:
I would tell your coworker to wait on the house.
Unless you guys live in an inexpensive area, every major metro area could experience some deals over the next year.
Good point... our area isn't 'bubblish' but there has been 30% + appreciation from just a few years ago.
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