You’ve heard the recommendations of always having an emergency fund equal to 3-12 months of expenses. Just in case something comes up, your emergency fund will be there to bail you out. However, perhaps the need for liquidity is overrated.
Not only may we not need as much cash as we think, we may also not need our investments to be highly liquid as well. After all, the last thing we want to do is constantly go in and out of our investments. It’s usually better to invest for the long term for compounding and tax minimization.
If you are financially competent, there will rarely be a case where you’ll ever run out of money in an emergency. Further, there are plenty of instances where the lack of liquidity has saved many real estate investors in the past.
Having six months of living expenses in cash is good enough for most people. In this ultra-low interest rate environment, unless you’re trying to buy a house, having too much cash becomes a drag on returns.
The Need For Liquidity Is Overrated
As someone who believes it’s best to invest in stocks and real estate for as long as possible, having an investment that can be easily sold could be very detrimental.
Think about all the folks who wigged out between 2008-2012 and sold equities or real estate back then. Or more recently, what about the people who sold anything around March 2020? They’re all kicking themselves now!
In 2012, I tried to sell my old rental house for $1,700,000. The worst of the downturn was behind us. I had recently engineered my layoff. And I figured it was better to downsize rather than hold a ~$1,100,000 mortgage.
As a result, I signed a 30-day exclusive listing contract with a real estate agent friend. He and his wife came over to stage our house.
We got a standard inspection done and pulled a 3R report for our disclosure statement for about $500. My agent ended up hosting three open houses and around 10 private showings.
Our best offer was a verbal offer with no number, just an indication they were willing to offer “much less than asking.” I told them to bugger off and pulled the listing after 29 days.
Thank Goodness For Illiquidity
In retrospect, if I could have just pressed a button to sell for $1,700,000, I probably would have. Thankfully, the real estate market was so illiquid that I saved myself from myself.
Instead, I sold the property for over a lot more five years later. At the time, I felt selling the property for ~30X annual rent was too good to pass up. Further, I no longer wanted to deal with tenants and maintenance issues as a fist-time father. Thank goodness real estate was so illiquid!
I then reinvested $550,000 of the proceeds into real estate crowdfunding, $500,000 into various stocks, and $500,000 into various municipal bonds. It was great to earn income 100% passively.
Why You’ll Likely Never Face A Serious Liquidity Crunch
Just like the fears of running out of money in retirement are overblown, the fear of illiquidity is overblown. If you lose your job, lose money in an investment, or find yourself in an emergency, you will find a way to come up with the necessary cash.
Just reading this post makes me confident you will be able to withstand a future liquidity crunch. Let me share some reasons why you likely won’t be forced to sell all your assets and live down by the river.
1) You have multiple types of insurance.
With health insurance, homeowner’s insurance, rental insurance, auto insurance, short-term disability, long-term disability, life insurance, and an umbrella policy, it’s hard to succumb to a financial disaster unless you are not insured.
Sadly, medical debt is the #1 reason for bankruptcy in America, not poor spending habits. To counteract egregious medical debt, make sure you thoroughly understand what type of health insurance benefits you are getting for the monthly premiums you are paying.
2) You have risk-free investments.
Everybody knows that it’s important to save for an unknown future. Therefore, every financially competent person saves and invests as much as possible to protect against uncertain future expenses.
For proof, just look how the U.S. national saving rate shot up to 32% in April 2020 when the pandemic was at its worst. We can save more if we want to.
My recommendation is to have around 5% your net worth in low-risk assets such as CDs, municipal bonds, US treasuries, and cash. This way, you’ll be able to survive long enough until the good times return.
The only people who don’t save are those who believe they have a bright future. They have either built a business with massive profit upside or they’re on the fast track towards superstardom at their respective companies. In such cases, they’ll never need any savings.
Unfortunately, unpredictable bad things happen all the time the longer you live. Saving aggressively is a must.
3) You’re well diversified.
I don’t know any financially competent person who has 100% of their net worth in a single asset class. Financially competent people are well diversified in stocks, real estate, farmland, art, wine, commodities, crypto, collectibles and more.
Even if you did tie up 80% of your net worth in your primary residence, like the average American does, that still means you have a 20% buffer to sell before you need to tap your savings or take out a home equity line of credit.
Below is one of my recommend net worth allocation frameworks for self-starters who are willing to work on their X Factor. I may have to update this asset allocation for post pandemic life.
4) You’re not too proud to hustle.
The invention of Upwork, Uber, Lyft, TaskRabbit, Thumbtack, Craigslist, Etsy, eBay, Amazon, and WordPress make it possible for you to make extra side-hustle money if you find yourself in financial despair.
The other day we hired a person from Craigslist to install a wireless doorbell and several fire alarm systems in hard to reach places. He made $85 gross in one hour and had four jobs to do that day.
Several years ago I gave over 500 Uber rides that made me roughly $30/hour gross on average and sometimes $100/hour net due to driver sign-up income.
There’s probably thousands of dollars worth of clutter in your house you can sell on Craigslist. And if you’re really gung-ho, you can try to sell your craft on Etsy, buy and re-sell products on eBay or Amazon.
Or you can start a website like this one. It’s so cheap and easy to start today compared to when I did in 2009.
5) You’ve developed multiple streams of income.
There are an endless number of investments that provide passive income in case you lose your job or your business blows up. Given you’ve been diligently saving and investing for years, you should have some passive income to hold you over until you can find a new main source of income.
It took about 12 years after college for me to generate a livable passive income stream. After 20 years, the passive income was finally enough to provide for a family of four in expensive San Francisco.
Therefore, it’s highly feasible that if you start generating passive income early, by the time your company decides to age discriminate by laying off 40+ year old workers, you’ll be just fine.
6) You negotiated a severance or received a severance.
Even if you didn’t have the foresight to start investing early on, you should at least be able to negotiate a severance.
Standard severance packages range from 1-3 weeks per year you’ve worked plus 2-3 months of base salary according to the WARN Act for employees at larger companies.
If you work at a company with deferred stock and cash compensation, a good severance negotiation will allow you to keep your unvested compensation.
In other words, you have the potential to earn WARN Act pay, a severance payment, and deferred compensation to hold you over until a recovery.
7) You’re eligible for unemployment.
In most states, after you negotiate a severance you’re also eligible for unemployment benefits. Conversely, folks who get fired or quit are often times not eligible for unemployment benefits.
The logic goes that they left due to cause or voluntarily. There are cases when you can receive unemployment benefits if you get fired for cause. However, it is an uphill legal battle that takes effort.
In almost all states, you get to receive unemployment for up to 26 weeks. In addition to unemployment pay, your unemployment agency will provide job search help and career training.
During severe economic times, unemployment benefits may get extended due to federal government assistance. For example, back in 2009, the federal government extended unemployment benefits up to 99 weeks. In 2020 and 2021, the federal government offered enhanced unemployment benefits for several months.
Below is a sample of the states with the highest unemployment benefits when we had maximum benefits of an extra $600 a week. In some cases, one could make more off unemployment benefits than from a full-time job.
The current enhanced unemployment benefits of $300/week run out Sept 6, 2021. If you’re thinking of negotiating a severance, now is the time. The value of a severance has gone way up due to higher unemployment benefits.
8) You can slash costs and downsize.
No rational person facing a liquidity crunch will keep spending and living like they once did. Instead, you will easily slash all extraneous costs. You will subsist on ramen noodles and water for as long as it takes.
Other expenses that will be reduced or eliminated include vacations, entertainment, and clothing. You’ll even sell things you haven’t used in months on Craigslist or eBay.
If you own a home, you can either rent it out and downsize into a studio apartment. Or, you can rent out rooms for extra cash. A home’s value, after all, is based on a multiple of its cash flow.
Finally, you can open a home equity line of credit to boost your liquidity.
Related: Housing Expense Guideline For Achieving Financial Freedom
9) You’ve got a vast support network.
Let’s say worst comes to worst and you’ve completely run out of money. Since you’re always focused on helping others, people will gladly line up to help you out.
Maybe they’ll give you an interest-free loan or hook you up with a job at their company. Maybe a friend will give you some freelance work.
People absolutely love to help those they like, especially those that have brought some type of joy into their lives. Any emotionally competent person who is kind and helpful will have a good support network of helpers.
10) You’re not too proud to live in mom’s basement.
If for some reason you were completely selfish all these years, surely your parents will help. They will unconditionally take you into their home and provide for you and your family until you can get back up on your feet.
The stigma of living with your parents as an adult child has subsided, especially post-pandemic.
As a parent, if my son or daughter is down on his luck, you bet your buns of steel I’d gladly accept him back. This way, he can at least save on rent and build back his savings. I’d love to use this time to reconnect with him.
In addition to living off your parents, you’ve learned how to properly ask your parents for money as an adult child. So many adult children have been able to extract from their parents money for a car and a down payment. Surely, it’s much easier to ask for money if you’re facing homelessness.
If you’ve never asked for help before, now is the time. Don’t let honor and pride make your life more difficult than it already is. People are more than happy to help others who are down on their luck
11) You track your money like a hawk.
If you are regularly checking your net worth composition at least once a month with the help of a free online wealth management tool, then you’re always going to know how your money is being allocated.
As a result, there will seldom be a surprise expense you cannot cover. You are fully aware of your monthly cash flow and liquidity. The people who have money issues tend to wing it and not stay on top of their finances.
The more you can track your finances, the better you can optimize your finances.
12) The government may bail you out.
Whenever there is extreme hardship, the government tends to bail its citizens out. Just look at what has happened during the coronavirus pandemic.
In addition to enhanced unemployment benefits, the government launched multi-trillion dollar stimulus packages that provided stimulus checks for millions of Americans who made below a certain threshold. Some people got $1,200 checks. Some families got much more.
Besides these stimulus packages, we’ve had bank bailouts, housing bailouts, natural disaster relief, and more. It’s good not to depend on the government for bailouts. However, feel better knowing that the government has a history of bailing us out.
Related: Earn Higher Returns With An Illiquidity Premium
Reviewing My Liquidity During The Global Financial Crisis
I realize it’s easy to say “liquidity is overrated” during a bull market. Bad things happen all the time, no matter how much we plan ahead for the future.
Financially, I thought I was rock steady until I got obliterated in 2008-2009. My net worth declined by ~35%.
However, even back then, liquidity wasn’t much of an issue. If I had lost my job, I would have received a severance package to last me through the recession. Further, I could have applied for unemployment benefits that would have lasted for an incredible 99 weeks back then.
If needed, I could have sold my house and moved back home with my parents. But before I did that, I could have sold stocks or bonds. And of course, if absolutely necessary, I would have proudly returned to my minimum wage job flipping burgers at McDonald’s!
By 2009, the S&P 500 had stopped going down. And by 2012, the S&P 500 recovered all of its losses. The key is survive until the good times inevitably return.
However, I will say that the more cash you have the more liquid courage you have. Investment opportunities arise all the time. You need cash to take advantage. But you need lots of cash to have the courage to invest during bad times.
More Insurance For Your Finances
If you are worried about your future, the one thing you must do is start treating people right ASAP.
Get involved in your community through your local church or school. Volunteer at organizations whose mission it is to help the less fortunate. Become a mentor to others.
Ask your bosses or colleagues whether there’s anything you can do to help without expecting anything in return. Connect with people on LinkedIn before you find yourself unemployed and in a liquidity crunch.
Your goal is to build up as many “credits” as possible just in case the worst happens.
Who knows. Maybe after 12+ years of writing for free on Financial Samurai, perhaps some readers may lend a helping hand the next time I’m down on my luck.
We’ve got doctors, lawyers, physical therapists, real estate agents, venture capitalists, money managers, child psychologists, parents, and so many more reading this site. There’s a great community who can help each other.
The more you can help others today, the more help you will get tomorrow when you may really need it.
Liquidity is always good to have. However, unless you’re saving up for a big ticket item, having more than six months of living expenses in cash is probably unnecessary.
Invest In Real Estate To Build More Wealth
Given you agree the need for liquidity is overrated, consider investing in real estate. Real estate is my favorite way to achieving financial freedom because it is a tangible asset that is less volatile, provides utility, and generates income.
Real estate now generates over $150,000 a year in passive income and accounts for roughly 40% of my net worth. Being able to take advantage of rising rents and rising home prices can really build lots of wealth over time.
In 2016, I started diversifying into heartland real estate to take advantage of lower valuations and higher cap rates. I did so by investing $810,000 with real estate crowdfunding platforms. With interest rates down, the value of cash flow is up. Further, the spreading out of America is permanently here post-pandemic.
Take a look at my two favorite real estate crowdfunding platforms. Both are free to sign up and explore.
Fundrise: A way for accredited and non-accredited investors to diversify into real estate through private eFunds. Fundrise has been around since 2012 and has consistently generated steady returns, no matter what the stock market is doing. For most people, investing in a diversified eREIT is the way to go.
CrowdStreet: A way for accredited investors to invest in individual real estate opportunities mostly in 18-hour cities. 18-hour cities are secondary cities with lower valuations, higher rental yields, and potentially higher growth due to job growth and demographic trends. If you have a lot more capital, you can build you own diversified real estate portfolio.
For more nuanced content, sign up for my free newsletter here. Although the need for liquidity may be overrated, the need for good financial knowledge is not! The stock market is volatile again as the Fed raises rates. Just make sure your net worth is properly allocated and you should be fine.
Nice job here Sam! A great post like always!
I like having 3 months of emergency funds available, and will continue to decrease that number as my passive income increases.
When first starting the journey towards financial stability or freedom, having a six-month emergency buffer is essential; for many, a year will bring a piece of mind. Once you hit a certain threshold of savings, though, the need for such large cash reserves becomes moot and instead becomes a cap on your portfolio’s ability to grow. For me, once I reached a sizeable portfolio of investments, I ran an analysis and saw that the opportunity cost of holding more than three months in cash was too great. With my side hustles and three-month buffer, the chances are small that I would not have the funds to cover a significant expense. If I do, I am willing to sell assets as needed to cover the cost. For me, the most likely asset I would reach for is my HSA, as I have years worth of medical expenses that I have yet to reimburse myself (surgeries add up fast). In the interim, I will continue to let these funds grow and use them as a supplement when needed.
I’m in the boat of having about three to six months of expenses in liquid cash. And then I have highly liquid assets to tap into if needed if something unexpected happens and I need to access more.
Everyone has a different comfort zone and a different amount of expenses, so some people may feel they need to have a higher amount in cash. But for me, I like my cash to work for me so I don’t let too much stockpile.
Great reference list by the way. Lots of ways to avoid a liquidity crunch!
Liquidity is not just about access to resources. It is about *low-stress* access to resources. Many of the alternatives discussed in this article would be accompanied by high levels of stress and anxiety.
You make an important point. It all comes back to risk and reward. While many of these alternatives may be accompanied by high levels of stress and anxiety, they are backup options that allow you to maximize the amount of money you have an illiquid assets. Often illiquid assets have the highest returns, because they need to compensate you for the illiquidity. If an individual more adverse to high stress and anxiety, that individual should keep their money in more liquid investments, and therefore accept lower returns.
Everything is relative – blanket statements are tough. This article may work for him but I say as a banking veteran who has financed over a hundreds of million of loans, fools, whether with debt or without it, generally give short shrift to the fundamental of liquidity.
Cash is and always will be king in times of pure survival.
A word about that: I was at ‘ground zero’ during the 08 crisis as a Lehman Brothers employee: nobody really has a good idea at how close we were to returning to the economic stone age. Seriously. Seriously, perilously close.
If you really knew – most of the folks commenting here or writing articles like this would have no confidence in their personal financial strategies which assume that the music (the economic rules, mechanisms and institutions that make modern civilization work) is still playing or will always play.
Long haul – it will – but it can also go very silent for what can be a punishingly long time, the silence can easily outlast your confidence.
Very thoughtful post, well said. Veterans of the cycles can see more and acknowledge they know less.
Further, I might add for the “long haul” – it “may” – not “will”. No one knows if it “will”.
For example, if you took a poll of the 10’s of thousands of small business people being decimated and put on the verge of or over bankruptcy in Canada right now given near-martial law conditions you would get a great many very depressed and desperate people responding “it won’t”.
I was right there with you working in finance during the 2008 global financial crisis. My best friend at the time got laid off from Lehman.
It was definitely a difficult period, and it was really hard to keep on investing during that time.
However, in the history of bear markets, the average length of time there’s about two years I believe. So if you want to be really conservative, you can have two years of living expenses in cash.
See: https://www.financialsamurai.com/personal-lessons-learned-since-the-2008-financial-crisis/
I used to feel I needed so much liquidity. Over time I’ve gotten more comfortable holding illiquid assets as I began to diversify my net worth. I still like having enough easy access liquidity to cover a couple months of expenses but try to avoid holding too much cash for too long.
I want to agree! However, my dual income tenants (one of whom is a doctor) missed three months of rent during COVID, claiming they didn’t have any savings at all, or any other means to pay rent, and weren’t eligible for unemployment. Evidently they needed an emergency fund, as none of the above-listed factors were enough for them to be able to cover rent, utilities and groceries (until no. 9 purportedly came through for them once I finally got a lawyer involved and the lawyer posted an eviction notice).
That is surprising that your doctor tenant decided not to pay rent for three months.
I guess from your perspective, will you be OK with the doctor not paying rent… for now? I’m assuming s/he will eventually pay you back, otherwise his/her reputation will be hurt and could really negatively affect his long-term income going forward.
Computers and selling. This is dangerous business. I have hit a button and sold a stock. The next day I realized I panicked and bought the stock back.
A computer and free trading makes it too easy to jump in just to jump out. I learned and no longer do that. I think every mistake I have made is selling a stock.
I wasn’t okay with the doctor and spouse (who was still working and receiving an income) not paying rent for 3 months, because it came after I already gave them a free month of rent (so at this point it was 4 months in total, and $10,000, which is a lot of money to me), and when I asked them to make at least partial payments, their response was something like, ‘sorry, times are hard and after paying all our other bills, we had nothing leftover for rent.’ It was clear from their communication that they viewed me as their lowest priority, and they made no effort or offer to at least partially pay their rent, and I couldn’t afford to carry them indefinitely as I have a mortgage on the property, and a family of my own. In the end, it became clear that I needed to get a third party involved, and within hours of the third party posting eviction notice, all the past due rent showed up. Hard to say if the issue was a lack of emergency fund (probably), or if I was just getting taken advantage because I was initially overly sympathetic. Not a fun situation to deal with, and it has left me thinking hard about turning over my rental units to a property manager, which I’ve successfully avoided for 10 years.
It’s strange. Food and shelter or necessary to survive. You wouldn’t not feed your family for a day. How could you not pay for housing for a month?
Sounds like you’re a six-figure doctor was taking advantage of you.
you’ll never get 1st generation Asians to agree with you. They have to have cash in the bank, I’m fighting that battle with hubby.
With so much help from the parents, is having so much cash really necessary? I know so many first generation immigrant parents who pay 100% for their child’s education, car, and down payments on a home.
Financial support continues for years into adulthood.
It’s the parents who still wanna hoard the cash and yes, our kids are debt free.
Why do you think that is though?
Because the parents don’t know how compound interest works. Or they come from a country where maybe the government was corrupt so they have trust issues.
Because in India, there was no credit, you bought things with cash in hand, whether a house or a car. By the 2nd generation though, it’s debt all the way
Indeed! Cash, property value and gold/silver jewelry was what your networh comprised off :)
Also the local stock markets are very inefficient….high trading commissions, listed companies are family conglomerates or soe, no interesting new businesses or growth stocks, high risk of fraud and misappropriation by management and controing shareholders, low liquidity etc, so all assets into cash and property
Sam, I’m going to have to disagree with you here. I was speaking with a financial advisor(male) just to check out what they would advise the other day about my extra cash on hand and I was expecting to hear him say only keep 6-12 months of cash on the side, the typical recommendation. They want a commission and want to use some of my extra cash for emergencies sitting around to invest. It’s a bank after all.
Then I hopped on a call to hear another broker(female) speak at a conference. She had no interest in mind of using my money to invest and she advised 2 years of emergency expenses. I understand what people will say about this. It’s such a waste of money and your cash is becoming losing its value due to inflation and better off selling your investments for cash instead even tax harvesting would be a better bet.
I’m fortunate enough to have 9 income sources but as a female, we tend to be more risk-averse and in fact, it always works in our favor. Men are traditionally known for taking on more debt, investing like its gambling not goal oriented, spend more, save less, take less advantage of retirement plans from their employers and women outperform over 1% with their portfolios than men. If we’ve learned one thing during this pandemic it is that you must prepare for the worst and hope for the best. During a recession, it wouldn’t be uncommon to see a renter go, job loss, etc you name it and in that case, 2 years worth of the cash will allow that cushion for finding a renter again, job, and still be able to spend the same as you are with all of that. Just my thoughts! I’m sure others like to live on the edge but better be safe than sorry.
I wrote an article about this on my personal finance blog(I’m a college student FYI) so I don’t know as much as you but certainly learning my way.
You can check out my thoughts more in-depth on why women are the best fit for personal financial advisors as per the reasons I mentioned above.
Definitely feel free to have as much cash for liquidity purposes as you wish. I enjoy having cash too. However, over the past 21 years and multiple crashes, it seems like we really don’t need as much cash as necessary.
Now with rates so low, the return on cash has shrunk to almost nothing.
Our fears drive us to hold more cash than we need. But that’s rational since nobody wants to permanently feel financially insecure.
Yeah, i agree. maybe it has to do with the financial scars of multiple economic crashes and immigrant parents, hard not break the mindset. Like you are pointing out, have to look at it objectively
Those financial scars have definitely cost me tons of money over the years. 1987, 1990 and 2000 are the more memorable years where afterwards I became much more adverse to buying stocks. Fortunately I have done ok the last few years but I still became so risk adverse with my 401K after those three memorable years, that the balances are far less than they could have been. Those who started investing after 2000 can only assume how they will react if the market suffers major losses like the Nasdaq did in 2000, 2001, and 2002 (-39, -21, -31). It requires nerves of steel to watch a portion of your portfolio fall that much three years in a row. I remember moving my IRA to a technology mutual fund in 2000 – as a reminder of how bad things can get, I have never sold that fund. Of course, it is now up from 16K to 43K, but it took well over ten years for its value to recoup those years of losses.
Mia, if you do not mind me asking, do you have adequate investments outside of your emergency fund that could be liquidated if needed? If you are financially stable, which is a huge if, you should be able to arbitrage low interest rates with higher longterm market gains to make it more worthwhile investing some of these funds and borrowing in the short-term if needed before paying off the balance. If not, maybe 2 years is the amount you need to get you to a place where this feels unneeded to you in the future. Though, when I was an advisor, I met many people who preferred to have a backup for everything, which is fine as well. I would love to hear more on how you invest the remainder of your portfolio and if you take additional risk in other places as a result.
Would someone review my asset allocation. Background 26 years old turning 27 in a couple months. Household family income $170,000 (Wife and my combined income).
Cash – $62,000
Taxable stock account – $5,000
401k, IRA – $101,000
Real Estate (Primary residence and 4 rental properties) – $2,000,000.
Real Estate debt – $1,200,000.
Is it okay to keep buying investment real estate or do I need to allocate more capital to stocks? I buy about $30,000 of stocks each year. I’m always a tad worried about liquidity with such a large amount of real estate debt; however, the tenants pay the mortgages and it produces a small amount of cash flow. What are your thoughts?????
Sam, you always mention allocating cash, stocks, bends, etc as x% of your net worth. Say i have $100k in assets and $50k in debt – if you believe cash should be 10%, are you referring to 10% of the $50k net worth or 0% of $100k?
just want to clarify
I always get bad vibes when people mention that I need at least 3x of my monthly salary somewhere stashed as liquid money. It is all the more frustrating in a country like India where liquid money almost puts you in the same cage as tax defaulters, at least in the eyes of tax officers. All I say is that have some instrument that you can quickly disassemble and get money. For emergencies, you have life and health insurance…
Another factor that I’ve considered is that financially literate people need less liquidity because they are better able to plan a budget.
A financially illiterate person, who doesn’t think much about money, might need to have lots of extra cash on reserve just because they forget to anticipate large expenses.
Me, I know what I’m doing. I plan for taxes, insurance, car maintenance, and plenty of other things. But I know more than a few other people who take those sort of things as a surprise each time, and suddenly need to scramble for the cash whenever they get a big bill in the mail.