You’ve heard the recommendations of always having an emergency fund. Just in case something comes up, your emergency fund will be there to bail you out. Personally, I’ve always got at least six months worth of living expenses in cash. However, what if 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.
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.
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 a 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 in March, April, and May of 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 million 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.
However, I did end up selling a municipal bond fund after it recovered about 80% of its losses in June 2020. If I had held on, I would be up for the year. Oh yeah, and I sold about $50,000 in Tesla stock during the summer as well. If I held on, it would be worth over $150,000! Damn the liquidity!
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 have the wherewithal to protect yourself from any 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 and not poor spending habits. The New York Times reported that 20% of Americans under 65 with health insurance had trouble paying their medical bills over the past year. Of those, 63% claim to have used up all or most of their savings to tackle their healthcare expenses.
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. And to further protect yourself, let’s talk about point #2.
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.
My recommendation is to save between 5% – 10% of your net worth in low-risk assets such as CDs, AA-rated 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.
3) You’re well diversified.
I don’t know any financially competent people who have 100% of their net worth in stocks or 100% of their net worth in real estate. The same goes for having 100% of their net worth in any other asset class.
Even if you did tie up 80% of your net worth in your primary residence, 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.
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 TaskRabbit 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 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 in passive income generating investments 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.
What’s awesome after you receive or negotiate a severance is that you’re 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 many 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, the federal government offered enhanced unemployment benefits for several months.
Below is a sample of the states with the highest unemployment benefits. In some cases, one could make more off unemployment benefits than from a full-time job.
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.
Not only will you reduce food costs, you will completely eliminate all vacations. All entertainment, all new clothing, and all non-essential items will be nixed. You’ll sell everything you haven’t used in a month on Craigslist.
If you own a home, you will either rent it out and downsize into a studio apartment. Or, you will start renting out rooms for extra cash. A home’s value, after all, is based on a multiple of its cash flow. Finally, you can establish a home equity line of credit before the market tanks for extra reserves.
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. 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. 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.
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.
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.
The government launched a multi-trillion dollar stimulus package that provided $1,200 stimulus checks and enhanced unemployment benefits at the start of the pandemic. Now we have another $900 billion stimulus package that provides $600 stimulus checks per adult making under $75,000. Families get a $600 stimulus check per kid as well.
Besides these stimulus packages, we’ve seen 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.
If You Are Financially Incompetent
I realize it’s easier 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.
I thought I was rock steady financially until I got obliterated in 2008-2009. However, even back then, liquidity wasn’t much of an issue. If I lost my job, I would have received a severance package to last me through the recession. Further, I could apply for unemployment benefits.
If needed, I could have sold my house and moved back home with my parents. And of course, I would have proudly returned to my minimum wage job flipping burgers at McDonald’s!
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 for free.
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.
Who knows. Maybe after 11+ 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.
The more you can help others today, the more help you will get tomorrow when you may really need it.
Readers, do you think the need for liquidity is overrated? What are some things you will do before being forced to sell your primary home or investment? Share a situation where you faced a liquidity crunch and were forced to sell something you didn’t really want to.