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HOW LIQUID ARE YOU?

Photo of water tap running US dollar billsLiquidity is the measure of how quickly you can access cash when you need it without incurring a significant penalty.  Note well that the issue is not about zero cost but rather a significant cost. Every decision has a cost even if that cost is the potential income lost if you were to drawdown on your savings i.e. (opportunity cost).
In the region there are many sayings that we would use to indicate a liquidity problem.  These include:

Or, you may refer to an individual as being asset rich, but cash poor.  This underscores the point that liquidity is not a measure of one’s net worth but rather of one’s cash flow.  You can have valuable assets but still be cash broke.  Hence, if you are not liquid you are not financially free.
Let us classify liquid assets into two categories; those that are tangible and those that are intangible.  Tangible assets include i.e. cash assets such as money in one’s wallet, savings and chequing accounts as well as near-cash assets which will include short term investments such as Treasury bills.
The general rule of thumb for personal liquidity is that you should have three to six months of living expenses including mortgage payments in tangible liquid assets

Tangible Liquid Assets
Six months living expenses including mortgage

Then there is the Intangible asset, the one that you seldom hear about but is so critical – Your relationship with your bank. This impacts the options available to you to access ‘fast” credit (cash) and the price of the credit (cash).  This relationship is in turn impacted by the nine C’s of credit. 
Capital Adequacy Credit History Character
Capacity to Repay Collateral;Commitment (equity)
Cash Flow Conditions (job security)Communications (with your bank)
When you consider what is assessed in relation to capital adequacy, cash flow, capacity to repay, collateral, etc - The message is clear “you need money to obtain money from a bank.”
This is the reason why Cash is King.  We all know that we need oxygen to breathe and water to live.  I saw this quote on the WWW in the aftermath of the financial crisis - “Liquidity Is the New Oxygen”. 

WHY CASH IS KING?  THE IMPORTANCE OF HAVING A CASH CUSHION


You need to have adequate cash reserves which you can tap into quickly and easily to tide you through a difficult period or emergency that may arise along this life’s journey - loss of job, medical emergencies, unforeseen expenses related to the law.  Some refer to this as an emergency fund or a rainy day liquidity fund.  Cash reserves in your “rainy day liquidity fund” should be adequate to cover three to six months of expenses so that you won’t have to tap into long term investments to meet short-term cash needs. Considering the ‘What Ifs of Life’, are you financially confident and secure?
Cash is also important as collateral for loans.  The best collateral for loans is one that is easily liquidated.  No wonder banks prefer cash over all other collateral options.
Access to cash also allows you to take advantage of cost saving opportunities.  For example the local cable television company in St. Kitts drops off two months payments if you pay your cable bill for the entire year in January.   However, if January is the month when your song is “things tight’, then you not only prevent yourself from saving, but you also prevent yourself from earning… Remember a penny saved is a penny earned. 
Additionally, if you are very liquid you can take advantage of investment deals.  Imagine someone approaches you to purchase land in a highly marketable area at 40% less than the market price but you are unable to take advantage of this opportunity because you do not have adequate cash to meet the required down payment for the loan as well as the associated legal fees.
Finally having adequate cash reserves also affords you peace of mind.  And that is priceless!

HOW DO LIQUIDITY PROBLEMS ARISE?
Consider this scenario.
John Brown is a single father with two minor children. He earns a monthly salary of $4,000.  His living expenses are approximately $3,600 which include monthly loan payments of $1,600.  The balance on his 8.5% loan is $30,000. At the end of April he received a lump sum of $5,000.   He has to choose from among the following options before him:

How would you advise John to ensure his own financial success and confidence?
If John uses his lump sum to make additional payments to his loan principal (assuming there is no penalty and the loan is a reducing balance loan) he may save a significant amount in interest payments.  If he uses the money to purchase stocks he may be making an investment in an asset that can potentially generate significant returns.  While options I and II in isolation sound attractive based on the potential savings or gains that can accrue to John.  The reality is that John is not in a secure financial position to choose options I or II because John is just a dollar away from a financial crisis.  He has hardly any cash assets, and given the fact that he is a single father of two minor children he is vulnerable to an umpteenth number of what ifs.  What if a child or both become ill for example with appendicitis and require surgery?  What if he loses his job? What if he becomes ill?  What if …what if…what if… 
Generally personal liquidity problems arise because of the following:

Here is a test you can take to determine your confidence in your personal liquidity situation.


Rate your confidence in your ...

Low

Below
Average

Average

Above
Average

High
  1. Job security (take into consideration your job flexibility and the current economic situation)

1

2

3

4

5
  1. Ability to access credit on short notice

1

2

3

4

5
  1. Ability to carry your debts without strain

1

2

3

4

5

 

Rate your progress and confidence in....

Low

Below
Average

Average

Above
Average

High
  1. The size of your savings

1

2

3

4

5
  1. The size of your “rainy-day  liquidity fund (emergency fund)

1

2

3

4

5

Take action to address the situation if your score is below average.  And even if your rating is average try to be above so that you are more financially secure and confident.

 LIQUIDITY TRADE –OFFS
Certainly there are trade offs to maintaining cash reserves. Well! That’s Life….

 ...BECAUSE LIFE HAPPENS ... NO MATTER HOW MUCH YOU MAY PLAN.

So, until you disembark from life’s boat ride you have to practise this balancing act between how much cash to have as reserves and how much to spend and invest for the long term.   This brings us to the discussion of the need for a personal liquidity management strategy.
WHY HAVE A PERSONAL LIQUIDTY MANAGEMENT STRATEGY?

SUMMARY
Personal liquidity management is a PROCESS not a one-off event. It is about managing your CASH FLOW through proper planning and it requires realistic forecasts of current and expected income and expenses. It should be part of the Financial Life Plan for you and your family.  Of course the plan will need to be revised as circumstances change. It requires establishing systems and controls for your finances:

The end result - Greater Financial Freedom… When you reach this stage you can then borrow from the late great Dr. Martin Luther King Jr. and shout “Free at last...Free at last.  Thank God Almighty, I am (financially) free at last!”