Your Investments: The need for liquidity

You need to know at the end of the day that you have X amount of money available in an emergency and not a penny less.

By AARON KATSMAN
December 26, 2012 22:56
3 minute read.
Isreli currency.

Money cash Shekels currency 521. (photo credit: Reuters)

 
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Often when we are younger and we start to accumulate wealth, one aspect that we tend to neglect is the need for liquidity. I have met with numerous individuals over the years who have invested everything they have in either their business or, more commonly, in real estate. I have spent many columns writing about the need to save in any way possible. The more you can save and invest, the better. But there is another very important aspect that needs to be paid attention to, and that’s liquidity.

What is liquidity?

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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 because the price of your property will drop.

I work with many clients who are at the stage of starting to marry off their children. When we start to plan, they tell me of how much there home is worth and how much it has appreciated. That’s fantastic, and it’s definitely turned into a nice investment over the years. So what’s the problem? The problem comes when individuals put every last cent they have into their home.

I recently met a couple who told me how they keep investing in their home, and it’s now worth over $750,000. When I asked them how much liquid money they have, including investments, checking accounts, etc., it came to less than $30,000. They have a very respectable net worth, but 95 percent of their money is tied up in a property.

They have a daughter who is going out seriously, and they suspect she will get engaged in the next few months, which means a wedding in the next year or so. Their problem is how are they going to pay for it. 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.



How much

Most financial advisers 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 lose your job or are too ill to work. That sounds like a lot, but remember this is your safety net.

Should it be invested?

Now that you have started to save for your emergency fund, you may ask how the money should be invested.

Due to the nature of this money, and the fact that it needs to be readily available and that you can’t afford to take risk, many will say the best thing that can be done with this money is putting it into a short-term deposit or government bond. I beg to differ.

In today’s record-low interest-rate environment, there is little point of using a short-term deposit or government bond. They literally pay next to nothing. I think most investors are willing to “sacrifice” the $2.34 of interest they will get so that they can have their money completely available at a moment’s notice. If interest rates move back to more historic levels, then deposits and bonds would make sense, but not now.

You need to know at the end of the day that you have X amount of money available in an emergency and not a penny less. So to foolishly take risks with this money by investing it in stocks or stock mutual funds is a risk that could have severe consequences if your gamble does not pay off.

aaron@lighthousecapital.co.il Aaron Katsman is a licensed financial adviser in Israel and the United States who helps people with US investment accounts.

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