You want your investment portfolio to be strong and profitable to make gains which can set you up for the future and retirement of your dreams. However, it is also important to remember that these investments have still been made with your funds, and while your money is out there working hard for you, you are going on without it.
So what happens when you hit a financial bump in the road and your emergency savings fund just won?t cover it? Then you need to think out reeling in those investments, and often in a financial emergency, time is of the essence. Therefore, when it comes to your investments, you need to think about how they will be there for you in the future, as well as how easily they can come to your aid now, and that depends on the liquidity of your investments.
What is a liquid investment?
The liquidity of your investments is not only important in an emergency, but can affect how you access your funds in retirement, or when you want to pay for your child?s education. If your investments are not sufficiently liquid or they are too liquid, you can make losses, and even find you don?t have enough funds for your retirement because you have been investing in short term investments to maintain liquidity, but you still had a long term goal.
In a financial sense, liquidity is the accessibility of an investment, that is, how long it would take to arrive in your wallet if you decided you needed the funds today. For example, the funds in your retirement account are not liquid because to redeem the funds you need to complete paperwork, and wait for the money to be transferred to your bank account. However, money market funds are a highly liquid investment because you can often access the funds through a linked cheque book or bank account.
Liquidity can also be defined with regards to the volatility of an investment. For example, an investment can also be referred to as lacking liquidity if the removal of the investment will result in a loss, that is, while it may be fast and easy to convert the cash invested in a stock so it can arrive in your bank account within days, stocks should be invested for the long term, and removing the stocks quickly can result in a loss of value. While the volatility of the stock doesn?t directly affect the liquidity of an investment, it can affect whether it is a good financial decision to liquidate the investment.
Types of Liquid Investments
Each type of investment has a different level of liquidity and volatility when liquidated and it makes for a strong financial strategy to have a mix of high and low liquidity investments, to minimise the volatility of your portfolio. For a mix of liquidity levels, choose from the following types of investments:
- Money market accounts. Investing in the money market is very similar to investing cash in a savings account, but offers a much higher return, without compromising liquidity. There is also very little fluctuation in a money market investment which makes the account safe and reliable, especially if you need to access your funds in a financial emergency.
- Savings account. A savings account is a traditional form of investment and means your funds can be as liquid as if they were in your everyday transaction account. High interest savings accounts are often linked to a transaction account with the same provider, to make for easy regular deposits, and quick withdrawals.
- Annuities. An annuity is when money you have earned on an investment is distributed to you on a set schedule, usually quarterly, six monthly or annually. Annuities are most popular as retirement funds as they are able to maintain a fixed and stable income for you after you have stopped working. As a result, annuities have a significant lack of liquidity and because they are designed to provide an income stream it is very hard, if not impossible to remove the original invested amount. The volatility of annuities will depend on where they are invested as some contain both stock and money market investments.
- Stocks and bonds. Stocks, bonds and mutual funds should be seen to have very little liquidity because even though it is possible to access your invested funds quickly and easily, these types of investments are designed to remain untouched for a certain period of time, for the best returns. Stocks and bonds can be invested for anywhere upwards of one year, the period of time will be relative to how long it will take to recoup the original investment.
How to Achieve Investment Liquidity
We have all become aware of how unpredictable and damaging investment markets can be in recent years, and being able to access funds in an emergency is more important than ever. Therefore, it is important to achieve a balance of long term and short term investments, where your short term investments can be easily liquidated without significant loss, and your long term investments can be left to grow in value over time.
To achieve investment liquidity, you need to look for investment options which have maturity dates in the medium to long term, but can easily and without too much loss, be sold before that date in an emergency. This means you have liquidity if you need it, but you are still making strong returns on your investments in the meantime. These investments should feature:
- Issue in a negotiable format. When investments are issued in a negotiable format they can be sold to a dealer or a bank and delivered for payment. Non-negotiable investments are those which have been issued by local financial institutions and are physically held at the institution, or are held by you as the investor. Also be aware that some investments cannot be sold before their maturity date, and are not negotiable.
- Issued by recognised entities. To make sure your investments can be easily liquidated, make sure they are issued by entities which are recognised, or are traded extensively within the investment community. This will make it easier to complete a sale or trade, if your investments are from a well know institution.
- Low default risk. Make sure your investment has a good credit rating and therefore a low risk of default. Investments with good credit ratings are consistently traded in active markets. However, investments issued by institutions with a bad credit rating can be difficult to sell, and if you do sell them, the price will usually be much lower than the value you originally paid.
When you have investments with these features you can then look for those which offer the highest yields, including longer term investment options. Just remember that if interest rates go up, the market value of an interest bearing security will go down, and the longer the maturity date on that investment, the greater the change will be to the market price.
Therefore, make sure to balance short term maturities which mature in 30 days or less, with long term investments of two or more years. This balance can help you meet emergency cash needs, and if you require additional funds, the entire portfolio is liquid and can be sold.
Alban is a personal finance writer at Home Loan Finder, a home loan comparison website.
Don’t forget about laddered CDs, my favorite liquid investment tool. They work like this:
You have $1000, and you chop it up into 5 CD’s of $200 each.
The first CD expires in a month; the second in 3 months, then 6 months, 9 months, 12 months. When the first CD expires in a month, you hold it until you can “rotate” it into the 12 month position. This way some of your cash stays accessible, and you get the benefit of holding longer-term CDs.
Paula – Excellent strategy. It’s like building and maintaining your own money market fund. Only you know what’s in it! A lot of people don’t completely understand what’s in a money market fund, but it’s a good bet you can get both a better and safer return by laddering, just as you say.
The real key is solid returns and liquidity. That’s the real challenge. Your article helps to keep a focus on liquidity but CDs aren’t paying anything these days. Where’s that short term return going to come from? If you live in a state that permits it, Peer 2 Peer Investing may be another tool to use in this area.
Hi Mike–that’s hard to achieve with todays record low rates. But a CD will give you liquidity to cover expenses or cash to buy into stocks after a decent decline. It’s about “keeping your powder dry” more than return, at least in this distorted environment where fixed asset returns don’t even cover inflation.