If you have been saving money and building equity in your home, then you are accumulating wealth. That is great, but it may not be enough to save you from bankruptcy or other money troubles.
In the corporate world, bankruptcy often results not because a company has debts that exceed its assets, but because it does not have sufficient liquid assets to meet the immediate demand for cash. In personal finance, this type of imbalance may not always lead to bankruptcy, but it can lead to you having to run up credit card debt even though you still have a positive net worth. As paltry as today's savings account rates may seem, if you go from earning money to paying 13% or so on a credit card, you have failed to deploy your assets wisely.
What constitutes a liquid asset?
To help prevent this from happening, you should think of assets as falling into the following categories:
- Illiquid. Things such as equity in a home are very difficult to access in a pinch. Yes, you could borrow against that equity, but paying money on a mortgage loan just to access your equity is not an efficient way to use your assets. Also, any investments in a retirement portfolio that would require you to pay a tax penalty in order to access them should be considered illiquid unless you are of retirement age.
- Semi-liquid. Stocks and bonds can be sold as needed, but not without advance notice, and if you have to sell them under duress, you may lose by selling at an inopportune time. These should be considered semi-liquid assets, which can be used as long as you have plenty of advance notice.
- Liquid. Things like savings and money market accounts can be accessed almost immediately, and thus should be considered liquid. CDs are a gray area -- they do lock your money up, but they could be considered somewhat liquid if the term is not too long, or if the early withdrawal penalty is not too severe.
Deploying your assets appropriately
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Assuming you are living within your means from paycheck to paycheck, what you need to do is deploy your accumulated assets in a way that will leave you enough liquidity to handle large, non-routine expenditures.
To do this, make a life financial calendar. Instead of a normal budget that might show month-to-month expenditures, a life financial calendar would list the years for your expected lifespan. For each year, figure out what major expenditures might be required around that time. Be sure to plan on the unexpected occurring in the current year, and account for when you will need to start drawing on savings in retirement.
Once you have these financial events mapped out, you can deploy your assets accordingly. Illiquid assets, such as the equity you accumulate in your home, should not be counted on to meet those events. Money needed more than five years in the future can be invested in semi-liquid assets, so it can earn a decent return in the meantime. Once an event moves within five years though, you should start transitioning sufficient funds into liquid assets to be prepared.
With the right kind of planning, you can have both wealth and liquidity, or to put it differently, you can have money that is there when you need it.
The original article can be found at Money-Rates.com:
Liquidity planning: a straightforward guide