Recently I met with clients to do their annual financial review. While we were still exchanging pleasantries they said that they wanted to thank me. They proceeded to tell me that when they had originally come to meet with me eight years ago they were thinking about using their entire savings and buying a house for $350,000. They said that I had advised them to keep about $100,000 back and invest it, and use the rest for a down payment.
They went ahead and followed my advice and today have over $150,000 in their brokerage account and own a home. Then they said that their daughter got married about a year ago and they had no problem paying for the wedding because they had plenty of money in the bank. Had they blown out their savings for their home, they would’ve had to scramble to find the money to pay for the wedding.
This meeting made my day. First, it’s not very often that I get thanked! More importantly is that this couple listened to me about not tying up their entire net worth in an apartment.
When we are in the “wealth accumulation” phase, and we have a long time until retirement, the thought of keeping money liquid doesn’t tend to factor into the equation. This means that whenever a sizeable amount of money is saved or inherited, the only thought is to buy property. I have met so many people over the years who have invested everything they have in their apartment, or in their dwelling plus an apartment or two for investment. It’s true that I have spent many columns writing about the importance of saving 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.
Cash is king
What is liquidity? It’s 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. Don’t believe me? Well I have a good friend that bought an apartment a few years ago, just around the corner from where I live, for more than 25% off market value because the divorcing couple had to sell.
Many of my clients are at the stage of life where they are starting to marry off children. When we start to plan they tell me how much their home is worth and how much it has appreciated. That’s amazing, and it’s surely been a great investment over the years, but... as I have written numerous times, they ended up putting every last cent they have into their home. While they may have very respectable net worth, 95% of their money is tied up in a property. How will they pay for the wedding, or some other large expense? 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.
Emergency fund