recently met with a young couple that had just bought an apartment and paid 95 percent down in cash. With their remaining savings, they wanted to buy a rental property and take a large mortgage to fund the purchase.
Readers of this column are aware that I love when people save money, and especially young people, but sometimes it pays to spread your investment across the board and not just focus on real estate. Often when we are younger and we start to accumulate wealth one aspect that we tend to neglect is the need for liquidity.
What is liquidity?
Liquidity is the ability to quickly convert an investment into cash, without losing any of the principal that you’ve invested. For example, a savings account is highly liquid.
In contrast, real estate is considered to have low liquidity because of the time it takes to sell the property and the fact that if you need to sell quickly, like a fire sale, you will end up paying the piper as the price of your property will drop.
I work with many clients who are at the stage of starting to marry off their children. Last week in fact, I met with a couple that had accumulated over $7 million in property, and were generating over NIS 750,000 annually in rental income. They had large mortgages on each property and all the rental income was going to pay off the mortgages.
They bought the property in 2006-7, so while they had a huge capital gain, they had no free cash flow. And volia! Their son just got engaged. Mazel tov! Believe it or not they have to figure out how to pay for the wedding. The $7 million in property is nice, but it doesn’t pay for the Viennese table. You can’t take a saw and cut off a room and say, “Take a bedroom, it’s worth $50,000.”
It just doesn’t work that way.
Cash is king
Most financial advisors recommend building an emergency cash fund of between three to six months your net monthly income. If you net NIS 10,000 a month, you would want to have a minimum of NIS 30,000 that you have earmarked for this emergency fund. This will help you survive for a limited period of time if you get made redundant, are too ill to work or pay for an engagement party.
That sounds like a lot, but remember this is your safety net.
In addition to real estate and an emergency fund, individuals should save on a third track and that’s investing in a stock/bond portfolio. Along with the diversification of investing in non-real estate and historically higher returns than property, investment portfolios are liquid so you can divide up your portfolio with short, mid and long term investments. That way you get the growth that stocks provide, but also have the liquidity that if you get the phone call in the middle of the night that your child is engaged, you don’t need to start scrambling over how to raise funds for the wedding, rather, just sell off some of the short or mid-term investments and the money is available to you three days later.
Again don’t get me wrong. Real estate is a perfectly reasonable investment vehicle. Investors just need to understand the long term ramifications of keeping all their money tied up in property. Instead of buying another property, you would probably do yourself a favor, take that money and invest in a well-diversified portfolio, and start saving in more liquid, financial investments as well.
The information contained in this article reflects the opinion of the author and not necessarily the opinion of Portfolio Resources Group, Inc. or its affiliates.
Aaron Katsman is author of the book Retirement GPS: How to Navigate Your Way to A Secure Financial Future with Global Investing (McGraw-Hill), and is a licensed financial professional both in the United States and Israel.