Liquidity refers to the ability to convert an asset into cash. It’s part of the investment strategy for many wealthy families, which the rest of us often overlook or forget. In the event of an emergency or unexpected financial situation, how quickly would you be able to access cash? The situation could be emergency-based, like a natural disaster or family illness. It could also be opportunity-based, like a major purchase, wedding or cash that is free and available for the next big investment opportunity when it strikes.
These are the types of things that wealthy individuals think about when they work with family office management services.
What is Liquidity Planning?
Liquidity planning is concerned with the process of managing cash, with the purpose of ensuring you have plenty of cash or liquid assets (which we’ll explain next), in case you need it.
Liquidity planning is part of financial planning, which helps families protect themselves against the unexpected and prepared for investment opportunities. Such planning ensures you have adequate resources to achieve your future goals.
Least to Most Liquid Investments
Liquid assets can be ranked from least to most liquid based on how quickly and easily they can be converted into cash without significant loss of value. Here's a breakdown of liquid assets from least to most liquid, along with examples and approximate conversion times:
Least Liquid (Non-Liquid Assets)
Real Estate
- Example: Residential home or commercial property
- Conversion time: Weeks to months, sometimes years
- Real estate is considered illiquid due to the lengthy process of selling a property, which involves listing, finding a buyer, negotiating, and closing the deal.
Fine Art
- Example: Paintings, sculptures, or collectibles
- Conversion time: Weeks to months, potentially years
- Art can be challenging to sell quickly without significant price concessions. The process often involves appraisals, finding the right buyer or auction house, and waiting for the right market conditions.
Somewhat Liquid Assets
Certificates of Deposit (CDs)
- Example: 1-year CD from a bank
- Conversion time: Days to weeks
- While CDs are considered liquid assets, they typically have fixed terms and may incur penalties for early withdrawal.
Bonds
- Example: Corporate bonds
- Conversion time: Usually 1-3 business days
- Bonds can be sold on the secondary market, but the process may take a few days to complete.
Mutual Funds
- Example: Index funds
- Conversion time: Usually 1-3 business days
- Mutual funds are traded at the end of each business day, so it may take a few days to receive the cash.
Stocks
- Example: Shares of Apple or Amazon
- Conversion time: Usually 1-3 business days
- Stocks can be sold quickly, but it typically takes a few days for the transaction to settle and the cash to be available.
Money Market Funds
- Example: Government money market funds
- Conversion time: 1-2 business days
- These funds are highly liquid but may still require a short processing time.
Treasury Bills (T-bills)
- Example: 4-week T-bill
- Conversion time: 1-2 business days
- T-bills are highly liquid and can be sold quickly in the secondary market.
Most Liquid Assets
Checking and Savings Accounts
- Example: Bank checking account, savings account, credit union checking account
- Conversion time: Minutes to hours, depending on access (24-hour ATM versus branch hours)
- Funds can be withdrawn quickly via ATM, online transfer, or at a bank branch[6].
Cash
- Example: Physical currency
- Conversion time: Immediate
- Cash is the most liquid asset, as it's already in its final form and can be used immediately for transactions.
Remember that the actual conversion times may vary depending on market conditions, financial institutions, and specific asset characteristics. Additionally, while some assets like stocks and bonds are generally considered liquid, their liquidity can be affected by market volatility or economic conditions.
How Much Liquidity Should You Plan For?
How much cash you have on hand depends on your individual situation. There is no formula for determining how much of your portfolio should be liquid cash vs liquid assets vs non-liquid assets. USBank says 2% to 10% of total portfolio. The Balance Money suggests that some investors keep as much as 20% to 30% of their total investment portfolio in liquid cash. There are other sources that suggest your liquidity ratio should equal one or two years’ salary — in case of emergency loss of a job, for example.
Your liquidity should depend on:
- Your age (older investors tend to have high cash allocations than younger investors (Yahoo Finance))
- Economic conditions (during economic uncertainty, some people prefer to maintain higher cash reserves (BlueSky Wealth Advisors))
- Anticipated life events (expecting parents might need more cash than, say, empty nesters (USBank)
- Your wealth (HNW investors may hold 15%, while UHNW may hold higher cash reserves at 20% or 30% (Yahoo Finance)
