In the debate between stocks versus real estate as a better investment, a common issue that comes up is real estate’s lack of liquidity, and therefore inferiority.
For example, reader Nate writes, “I prefer equities because real estate doesn’t provide a sufficient illiquidity premium to merit the leveraged risk and transaction cost. If stocks provide a better return with better liquidity and bonds provide a similar yield with better liquidity (and collateral), why take on the illiquidity at all?”
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 detriment to one’s journey to financial freedom. Think about all the folks who wigged out between 2008-2012 and sold equities or real estate back then. They’re 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 and I felt I had dodged a bullet. I had recently engineered my layoff and figured it was better to downsize rather than to continue holding a ~$1,100,000 mortgage.
I signed a 30-day exclusive listing contract with a real estate agent friend. I agreed to pay him a 5% commission. 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 30 days.
If I could have just pressed a button to sell for $1,700,000 for a reasonable flat fee, I probably would have. But praise all that’s good in the world the real estate market was so illiquid that I saved myself from myself. Even though I’m sure I sold the property too early in 2017, I take solace in the fact that at least I got an extra million bucks five years later.
Why You’ll Likely Never Face A Serious Liquidity Crunch
Just like the fear of running out of money in retirement is overblown, the fear of being illiquid in case you lose your job or lose a significant amount of your assets is overblown.
Just reading this post makes me confident that you have the wherewithal to protect yourself from any liquidity crunch. Let me share 10 reasons why Financial Samurai readers 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 a savings buffer. 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.
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 17 years, the passive income was finally enough to provide for a family of three 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 because they left due to cause or voluntarily. There are cases when you can receive unemployment benefits if you get fired for cause, but it is an uphill legal battle that takes effort.
In many states, you get to receive unemployment for up to 26 weeks. In California, maximum unemployment pay is currently $450 a week. 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 e.g. 99 weeks during the economic crisis.
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 and 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. 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 a good person who has 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.
10) You’re not too proud to live in mom’s basement. If for some reason you were a completely selfish ass all these years, surely your parents 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 is down on his luck, you bet your buns of steel I’d gladly accept him back so he can at least save on rent and build back his savings. I’d love to use this time to reconnect with him.
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. There will never be a surprise expense you cannot cover because 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.
If You Are Financially Incompetent
I realize it’s easier to say “liquidity is overrated” during a bull market or if you’ve got your finances in order. Bad things happen all the time, no matter how much we plan ahead for the future. I thought I was rock steady until I got obliterated in 2008-2009, hence the start of Financial Samurai.
If you feel you can’t afford to get your finances together or you simply don’t have enough time before doom comes knocking on your door, 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. 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.
I will gladly help anybody who was kind to me in the past. My closest friends will never starve because I will never let them starve. We’ve built a support network where if one of us stumbles, we will all do our part to lift that person up. That’s simply the way the world works.
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.