What you need to know:
Wealth management. Managing liquidity is an essential component of wealth management as it allows you to fund unexpected needs whilst limiting the rush to sell assets at unfavourable prices.
Have you found yourself depositing a cheque into your savings account and later withdrawing the cash after barely a month or two? Or sometimes buying shares in the stock market and cashing out barely three months later?
If this is the case, then your problem is not about taking control of your expenditure but it is simply managing your personal financial liquidity.
Liquidity is the measure of ease of access to cash whenever you need it, without incurring a significant penalty or loss.
While majority of income earners often emphasise the use of a budget as a tool to balance their expenditure with their income, many of them have never recognised liquidity management as a crucial component of wealth management.
Managing liquidity is an essential component of wealth management as it allows you to fund unexpected needs whilst limiting the rush to sell assets at unfavourable prices.
This was evident during the recent liquidity crunch that greeted the local bourse when banks raised interest rates and inflation increased, many investors rushed to sell their assets at unfavourable prices to meet their basic needs. This led to loss of personal wealth or income through price devaluation.
This underscores the need to manage one’s personal financial liquidity. Managing liquidity is a tricky puzzle that involves balancing the need to meet unexpected spending and investing in ventures that would generate optimal returns.
Balancing the risk of lower returns with the need for ease of liquidity often involves trade-offs. First, focusing only on achieving higher liquidity would imply investing in liquid assets such as cash in the bank that would generate lower returns.
Secondly, emphasis on higher returns would mean investing in illiquid assets such as insurance savings plans or equity funds that would attract financial penalties or loss of capital through price devaluation in case of premature withdrawal.
A proper liquidity management strategy should also allow you to take advantage of investment opportunities as they arise without rushing to the bank for a loan.
To manage your liquidity, you need to identify your needs. What are those liquidity needs that would require you to have cash? Is it that nice car that your neighbour is selling at a throw-away price or is it groceries?
Regardless of the reason, personal liquidity needs usually fall in three categories. First are everyday living expenses such as buying food, paying rent, paying for transport and loan re-payments. It beats logic to stash cash meant for such expenses in a fixed deposit account or in stocks.
Next, are precautionary liquidity needs which include unanticipated events or emergencies.
Although precautionary needs are never anticipated, they should be catered for and therefore you should ensure that you have sufficient funds in the form of an emergency fund.
This explains why you should have an emergency fund that is equivalent to six to nine months of your monthly expenses.
An emergency fund or scheme is quite important. However, where you keep the funds dictates whether or not you manage your liquidity needs with ease should an emergency strike.
Given that the nature of the liquidity needs is unexpected, you should keep the cash in a safe haven such as money market fund or savings account where you can easily access the money as you generate some incremental returns on it.
Should the unexpected strike, you would easily access your cash without selling assets at unfavourable prices.
Third are the discretionary liquidity needs which require you to have cash to take advantage of lucrative opportunities, for instance buying a cheap piece of land or investing in a rights issue.
Since the liquidity needs are discretionary in nature, you can allocate the cash meant for the needs in assets such as equities and mutual funds where you can earn significant returns.
Conversely, given that these assets can become illiquid, it is advisable to have credit solutions such as bank loans that you can rely on should you wish to meet discretionary liquidity needs.
It is advisable that you consult your personal financial advisor to assist you prioritise your liquidity needs and meet your financial situation, risk tolerance, and lifestyle.