Champagne isn’t the only thing we love that is liquid. Some of our investments should be liquid as well. In this case, “liquid” just means that you can quickly turn your investment into cash. If I invest my money, can I still access it? It depends. There are a variety of ways you can invest your money. If you stick with stocks, bonds, and mutual funds, your investment is relatively liquid. For example; sell the stocks you own and cash is then made available in your account, which you can then withdraw or transfer to your bank account for spending. The tricky part is if you happen to need or want cash when your stock values are down.
Let’s say you invest $50,000 in various stocks at the beginning of the year. At any time you can sell those stocks and walk away with cash. The amount of cash is to be determined. If the value grew to $60,000 at the time you want to sell, you just made yourself $10,000 (less taxes owed) which is another topic for another day. But what if you invest the same $50,000 and at the time when you suddenly need the cash, the value is only $30,000? If you absolutely need this money today, you’re out 20 grand. Bummer. So if you were banking on this $50,000 for a down payment or college tuition, you’re going to be pretty disappointed when your money is now worth a great deal less. Now the house you’re ready to purchase is out of reach and your kids can’t go to college. Sorry kids. Of course, we’re being dramatic here, but it’s necessary to get our point across. These examples are exactly why it’s important to be aware of the fact that just because stocks and mutual funds are “liquid” doesn’t always mean their value will be there in a time of need, despite the fact that you can sell and walk away at any time.
It’s crucial to keep a cash reserve uninvested so that you’ll hopefully never have to sell your stocks in a down-market, which ultimately means taking a loss. The only potential pro to taking a loss is that you can offset any gains you’ve acquired on another stock or in another account. This can help reduce taxes owed on your investments at the end of the year. To be honest, if you’re in a place where a loss in your portfolio is seen as a good thing, you’re doing okay for yourself. For more on this, look out for our blog post “Capital Gains versus Losses and How They Impact My Taxes”.
To paint a bigger picture, let’s look at what happened in 2008 and 2009. Young kids in their 20s or 30s with a long, long time until retirement were not affected the same way as people in their 60s planning to retire in 1-5 years. The people that wanted to retire in 2010 or shortly thereafter (if not in a fixed account or cash) lost a lot of money and had virtually no time to earn it back. Waiting for stock prices (your account value) to comeback can take years. These folks may have panicked and pulled their money out, essentially locking in that loss. So although their money was “liquid” and available to be converted to cash, the amount of cash was substantially lower. Timing is everything. The young adults who went through 08/09 would have made back all their money since then and probably doubled it if they stayed invested straight through. Lucky for them, they didn’t need the money in 2010 so liquidity was quite irrelevant.
The moral of the story is just because your investments can be quickly converted to cash if you happen to need it, the amount of cash cannot be determined until the moment you sell. If you are a few years away from retirement, scale back and minimize your exposure to this type of risk.
This is just one aspect of liquidity. Other investment vehicles such as mutual funds, bonds, CD’s, and annuities will sometimes carry back-end loads (a fee for surrendering or selling before a specified period of time has elapsed). We will talk more about this in another post. Again, you can still convert these investments to cash, but you may experience a loss/fee if you have not held it as long as the fund and its respective contract calls for.
Different investments are intended for different time-horizons. You would invest more conservatively for money you plan on using in a short time. You can take on more risk or longer contract terms for money you don’t plan on using for 5-10 years. Each has it’s own set of pros and cons. This is why it is so important to be realistic and honest with your advisor so that the two of you can choose the appropriate investments for your needs.
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Investing involves risk including the potential loss of principal. No investment strategy can guarantee a profit or protect against loss in periods of declining values. Please note that individual situations can vary. Therefore, the information presented here should only be relied upon when coordinated with individual professional advice