Your investments: Emergency fund: Cash is king

money (photo credit: REUTERS)
(photo credit: REUTERS)
Never ever discount the idea of marriage. Sure, someone might tell you that marriage is just a piece of paper. Well, so is money, and what’s more life-affirming than cold, hard cash? – Dennis Miller
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 common, 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?
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 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 son who is going out seriously, and they suspect he will get engaged in the next few months, which means a wedding in the next year or so. Their problem is how they are 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.
Most financial advisers recommend building an emergency cash fund of three to six months of 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 fired or are too ill to work. That sounds like a lot, but remember: This is your safety net.
Make millions?
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 that it needs to be readily available and 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 $1.97 of interest they would get if they could have their money completely available at a moment’s notice. If interest rates move back to 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 the stock market is a risk that could have severe consequences if your gamble does not pay off.
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.
[email protected] Aaron Katsman is a licensed financial professional in Israel and the United States who helps people with US investment accounts. He is the author of the book Retirement GPS: How to Navigate Your Way to A Secure Financial Future with Global Investing.