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.
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. 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.
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?????
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
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”.
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.
How would you deal with instances of mis-perceived liquidity? For example, assets you had counted on to be safe and/or liquid, are suddenly neither. During the financial crisis these were mortgage backed bonds. Maybe now it’s Munis (see Puerto Rico) or bond funds/ETFs that promise liquidity but the underlying assets are most definitely not liquid.
I like to employ a barbel approach. My risk free assets are TRULY risk free, and my assets that seek return are ALL ABOUT RISK. Not talking about cash here, but Treasuries and CDs I consider risk free. Munis…
Sam I agree with you that many people do not need an emergency fund as such, but they have the equivalent. People who need an emergency fund never have one and vice versa. They are not planners and not good risk assessors in general.
I try to figure out the very worst case scenario and what I would fall back on and in what order. When budgeting or estimating monthly and annual expenses, I break it down quite finely and have categories for car repairs, medical, house repairs, travel costs for funeral, unknown (espcially in the past when it mattered a lot more). If you have a plan then you really never have an emergency. And you don’t make things worse when bad times come. I have weathered bad times and it was tough but I made it through and learned something every time.
Now I can weather any ordinary emergency or major recession without cutting back. I have 90-95% of financial assets invested in stocks and I just sell some as I need money. The portfolio grows every year as I never spend all the income/gains.
The following strategies are ones I use or have used and ones I have seen other people not use before, during and after bad times.
– not paying my mortgage down, but rather keeping payments as low as possible by going with variable rate mortgage and stretching amortization to the maximum (35-40) years (to keep housing and basic expenses as low as possible and instead keep growing my financial assets)
– always having a rental unit or two in my house and/or have ESL student boarders to add certain income if I lose my job or freelance work is slow
– before I had enough financial assets, and relied on freelance jobs for income, keeping about 1-2 years basic expenses in cash, and not going on holiday unless I did
– making sure my rental and pension income covers all housing and vehicle related costs (it now covers income taxes and basic overhead as well)
– keeping basic overhead as low as possible. I spend much more now but can cut back instantly in bad times
– saving and investing all large sums received and most of my earnings until my financial assets were large enough to afford a setback
– risk testing my portfolio. Calculating how much I could lose and how long to recover with or without cutting back, by estimating how deep the recession could be and how quickly the market would recover. Also keeping flexible enough so that cutting back can be done instantly. Doing this keeps me from panicking or spending too much or not enough
– never trying to time the market either housing or stock market and not waiting for the market to pull back
– drawing my pensions (taking discounts or penalties) as soon as I could for certain income
– keeping basic overhead way down. My luxuries can be eliminated in a moment
– not buying cars (drove last one 28 years) or luxury cars (expensive to repair, insure, run, etc.) or toys
– never borrowing money (mortgages excepted) or even taking a HELOC for investment purposes (okay for a standby money)
– never getting into risky investments (with fun or play money I have seen people call it). None of my money is for playing or gambling
– setting up high limits on several credit cards and as large a LOC as I could qualify for when my income was high or steady (never to be used except in “emergency”)
– not paying other people to manage my money, do my taxes, gardening or many other things I can do myself (keeps basic expenses low)
– not moving, buying and selling houses or other assets, going back to school, having babies before getting a house, etc.
– avoiding emergencies by driving carefully and within speed limits, and taking care of property and health
– not buying cottages, RV’s, boats, time-shares, luxury cars, etc. that all have to be sold, not maintained or stored, or sit idle if times are tough
– not funding other people’s emergencies
– trying to have all assets the appreciating kind and buying decent quality things that last and keeping them a long time
– self-insuring on lower risk items (travel, appliances, health) but getting ample insurance on high risk (construction/renovation projects, vehicle, liability, home)
– minimizing taxes by contributing maximum to RRSP and making as many expenses as possible deductible against business, investment or rental income
– eating healthy and exercising, taking good care of eyes, teeth, hearing, knees and hips so I won’t have big medical expenses or have to sell or modify my house or hire people to do things
– not panicking and selling investments in a downturn or when jobless. Believe it or not, when I worked for an investment broker in 2008, I saw people selling their entire portfolios at the bottom but keeping the Mercedes, selling the parent’s house (in Vancouver!) they had inherited for money to live on while looking for the perfect job after being downsized or had businesses fail at age 50 plus. They not only drained their own funds, but their inheritances.
Man… 2008 permanently scarred me. Besides a paid off home (high COL area) and angel/vc/crypto (less than 5% of total net worth) I am 100% liquid. I won’t even do index funds… ETF equivalents only.
The only way I will run into a liquidity crunch is if the economy collapses, and who knows – it can happen. Now my kids, that’s another issue. I have 1/3 rd of my portfolio outside of IRAs and 401K. and I want to ladder about 6 yrs worth of expenses into CDs. That should give me the cushion I need.
Are you hedging for currency risk? When I look at central bank & government liabilities, I can’t help but worry they will bail themselves out as a political decision.
I have to agree with the comments made in #7 about unemployment. I knew a guy who got fired and his former employer denied his unemployment. However, the reason for the firing was trivial. So he fought it. He had witness testimony of his exact actions. Once the unemployment agency heard this they reversed the employers decision and allowed the unemployment benefits. But like Sam says, you may not get it if you quit or get fired. This is why I advocate for an emergency fund of 3-9 months. I say cover all your bases just in case. This money will at least give you time to find another job or start a side gig. Just my two cents.
Thanks, Miriam
Sam, we may be facing something much worse than a garden variety recession. So many agents in the system are geared to collateral values. It’s hard to imagine markets dropping from overvalued to below fair value, but it happens. It’s the leverage as it forces liquidation that drives prices to crazy depths. There are predictions of Dow 5000 out there and most gotta wonder how the hell would we get there? It can happen. That pendulum tends to swing from one extreme to another. Like most can’t imagine a Dow:gold ratio ever getting back to unity, it ‘s when everybody thinks it’s out of the cards that the move begins.
In the end, this is really just a discussion on risk tolerance and there is no right answer. It all depends on the individual person. Right now outside of retirement plans I have about 30% in cash. I feel very comfortable with that so I have another 20% in illiquid investments that could pay off very well. Then, I have stocks, mutuals and I write options as well. In my retirement, I do have a very large position in a stable value fund but that is only because I believe the equity markets are overvalued. That is not so much for liquidity as it is about waiting for an opportunity. I still have 55% of my net worth (not counting personal residence) in the stock market. I don’t feel as though I am missing out. Most people chase the illiquid investments and go too far. Then they get stuck and have to sell things they should hold onto. It is a balancing act.
I would say 30% of your net worth in cash is very conservative. What are some of the things you are guarding against in retirement? And what are the income streams you are living off in retirement? Thx
If you’re a two income household, you don’t need that much liquidity. If you have assets other than real estate, you also don’t need that much liquidity. If you are a person with a highly desirable skill set, you don’t need that much liquidity. It took me a long time to get comfortable with deploying cash and not letting it sit idly for a rainy day. The more we understand risk, the better we are in a position to understand how much liquidity our personal financial situation warrants.
Good post Sam. Howeve, you’re either more aggressive than you think or I’m too risk-averse. I believe liquidity is very important and I keep a high level of cash at all times. In my personal savings I have 12 months living expenses set aside PLUS the a,punt equal to my mortgage balance pay-off. If I were to get laid off I’d immeidately pay off my mortgage and live off my passive income while I try to sort things out. For me, liquidity is underrated, not overrated.
Liquidity is overrated if you’re financially competent AND you have a big safety net.
I am currently struggling with liquidity issues despite being at least somewhat competent. After another strong trading year in 2015 I decided that rather than investing all of my savings that year in liquid assets that I would aggressively pay down my home mortgage. I wanted to own my home outright and lower my COL as a purely commission based earner that had enough leverage on his money already.
Well, I got 85% of the way there before my trading took a massive hit mid-2016 that has not recovered. When it started to go bad I scrambled to refinance to either cash out some more safety or at least lower my payment. However, with negative income for the year not only could I not refinance, I could not even get a home equity line despite perfect credit. And I used every connection I had with several banks that I have relationships with.
Luckily, I was able to cut my living expenses in half, take on side gigs, and I kept a large emergency fund. I’m still grinding. After this year though I will have my retirement accounts, futures business margin money, and home that is 90% paid off. Basically things need to turn around or it’s restart at 34 in a new career, liquidate retirement with penalty, or sell my home. I fit in your 1% net worth by age, have kept my lifestyle below your ratios, but I am still stuck in a liquidity crunch.
The crunch definitely forced ingenuity in cutting lifestyle and side hustling. However, it has added a stress burden that has been crushing at times. In hindsight I would have invested in liquid assets, built up my business margin more, and waited until I had the full amount to close out the mortgage comfortably. At the time though I had an 8 year solid track record of income, fully funded SEP IRA contributions for years, and over 12 month emergency fund. I figured with the S&P historically overvalued at a 25+ CAPE why not lock in 4% with some of the money and reduce leverage?
I think that anyone that loses a job or income for an extended period or suffers a downturn in the business they own can easily end up in this situation if they are in illiquid assets. Especially because it dries up your access to credit. I’d love me some liquidity right about now.
Thanks for sharing your story. Can you clarify what Trading income entails?
Sounds like you locked in some profits on the S&P 500 and pay down some debt, both of which sound like great moves.
And you’re even closer to paying off your house. You’ve cut expenses and have made things work. Just confused on the trading income. What Is it that you exactly do? Thanks
Self-employed commodity futures trader. That has been my only income over the last 11 years other than side gigs. So purely performance commission-based income. With the lack of volatility, under-performance of momentum and correlation strategies, and my main grain market strategies becoming obsolete it has been a huge struggle for me the last 2.5 years. As you know, everything moves in cycles though. I still believe I can make a living this way or I’d go work for someone. I need to be able to ride out less volatile markets though (Equities have had more volatility lately, but that has not really translated to most other markets, like my highest volume grain sector. I’d argue that this rangy trade in equities has been pretty inconsistent day to day as well).
It’s an extremely risky gig, so that’s why paying off the house seemed prudent when I could. It ended up being a liquidity trap though that has handcuffed me. I cannot access it unless I sell my home, losing commissions in the process, and go rent, because I have no access to credit without income. That mortgage pre-payment would buy me 4 more years of living currently.
A lot of things that I could have done different, like set up a HELOC when times were good, or put that money into my business margin account. However, I would not say what I did or my lifestyle was financially incompetent. When income and credit dry up liquidity is not underrated. I think that the next time we see a recession and/or a 30%+ correction in asset prices that a lot of financially competent people get caught like me.
11 years as a self-employed trader is very impressive. Seriously, I don’t think most people can last beyond 12 months.
And I think you’re right, a lot of people will be caught swimming naked in a 30% correction, but I don’t think a lot of people reading Financial Samurai or focused on financial independence will hurt nearly as bad.
We are resourceful and we will plan accordingly for different types of scenarios. Now the under 35-year-old who thinks he is warren buffet because he hasn’t seen a loss yet might be screwed.
Thank you. I still think I’m making my way out of this with a good lesson.
Agreed. People that spend their time here are better prepared and more likely to survive a downturn.
I know plenty of e-commerce buffets and I just hope they have liquidity when things turn
Update**- I made it through ok. I was forced to switch careers to something that’s still speculative, but more stable. And that I luckily love.
It was never a complete financial wipeout at risk, but I never want to feel that financial stress again. I cant imagine what others are going through now in impacted small businesses.
If you’re going to go low liquidity make sure you have ample excess to credit. It’s impossible to find it when you need it if your income slows down or disappears. I’m not taking that risk again personally. It takes too much of a toll when it almost doesnt work out, let alone if you are forced to liquidate and change everything.
Good job making it through! It was dicey at the end of 2018 and in 2Q2020.
This is a tough one. You decided in 2015 that the S&P was overvalued at 25+ CAPE therefore took money out of stocks and paid off 90% of your home up until now. It’s now 2018 and you left a lot of returns on the table. Anyway, if you can get the last 10% of your home paid off then you are golden. Good luck.
Good post. I used to be a spender. Illiquidity in my current investments keep me disciplined in two major ways:
1) It forces me into a buy and hold type position. Most of the RE deals we’ve done don’t make any sense if we don’t hold for a few years at minimum, but preferably closer to 10yrs. This forces me to start building long term wealth without the temptation to spend.
2) It makes me feel broke. Anytime we start to get too much in liquid assets, I inherently “feel rich”. It’s weird how that happens, but there is a comfort (read, complacency) in seeing a few extra zeros in the account. So when that cash (or cash equivalent) gets too comfy, we buy a property. All of a sudden we’ve tied up a bunch of money and those zeros go away. Things become less comfy and I put my nose back to the grindstone. It is all mind games with myself, but if it works it works. Thanks again for the great post. – FS
wonderful second point about feeling rich and losing motivation. That was a huge motivator to continue to work hard after making some lucky investments in my 20s.
Related: https://www.financialsamurai.com/the-biggest-downside-to-paying-off-your-mortgage/
I do not think keeping some liquidity is overrated and the idea of 10% in assets with liquidity sounds good.
What many people don’t realize is how emergencies don’t always take turns and some safety nets are interrelated. In 2008 my husband was downsized taking his and my Health insurance, along with his short and long term disability and some life insurance. When I landed in the ER a few days later we realized what a disaster it would be without disability or health insurance to defray medical costs and even more if it was him in the hospital from a biking or home improvement accident instead of me. An injury could prevent hustling and because you aren’t able to look for a job you can’t claim unemployment. Downsizing isn’t easy when you are medically unable to pack and cutting back on expenses is tough when your doctor strongly recommends expensive medications or therapy. Accepting charity from others is emotionally tough after the ego blow of losing a job but is a option. Actual cash from Unemployment took 12 weeks from layoff notice because the former employer refused to complete paperwork timely and was a fraction of the former paycheck so I wouldn’t recommend counting on it to solve a short term liquidity problem.
Available credit on a credit card would be a #11 option and paying the penalty to access illiquid accounts is a viable alternative to moms basement especially if that basement comes with never ending I told you so. The best option is a can-do attitude that you will do what it takes and figure it out.
Thank you for sharing. That was the feeling I had when reading this post. What Sam preaches makes sense but only to a certain group of people (myself included, hopefully) who have made the right choices all along. For majority of households the need for a safety net is real and Sam can be more responsible by stating that up front….and not from the standpoint of “only stupid people are dumb enough to hold too much liquidity” – many times it’s not a choice but rather a forced circumstance.
Why do you think only stupid people are dumb enough to hold too much liquidity? I don’t think that’s kind of insulting to them? Every circumstance is different.
A can do attitude is right. When you’re down, you find a way to get back up. And the people who are kind to others after all these years will most certainly be able to find a helping hand.
How are you guys doing now? Did you have to liquidate anything available during this downtime?
I was in the ER with 1st trimester pregnancy complications and sent home on bed rest unable to work. My small business employer didn’t offer disability insurance so we went from healthy two income household with health insurance to no income household with no health insurance and one unable to work in less than a month. I naively didn’t realize life can turn so fast. Since my husband was employed when I got the job we thought we could just live on his salary if anything happened to me so I only paid for long term disability insurance on our own. A week after I got home we finally got the COBRA paperwork in the mail to continue his health insurance for $1200 per month back to the date of separation which would include my ER visit. We didn’t think to include health insurance in our expenses when calculating our emergency fund since it wasn’t a normal monthly expense and we naively figured one of us would be working and eligible for employer subsidized insurance. I will never forget the feeling of walking in the hospital registration and crying when they asked for my insurance cards and having to say I didn’t have any because it ended a week earlier. I didn’t fully understand that we were in the Cobra waiting window. They were understanding but I was terrified.
Ultimately I miscarried right at 12 weeks and will always wonder if the stress of everything had something to do with it. I was able to return to work and a few months later my husband found a new job but with a big pay cut because employers have no reason in a recession to offer higher salaries. But…last one in meant first one downsized as the Recession deepened and his next round of unemployment was longer and next job was an even bigger pay cut to start followed by his employer forcing employees to takey more pay cuts during. We discovered my small business employer health insurance was $1600 per month in 2010, had very high co-pay and deductibles and there is no cobra option to continue if I am no longer employed. That law and FMLA to protect your job during a health crisis do not apply to companies of 20 or less employees. Small employers can’t get reasonably priced insurance like big corporations can. We learned unemployment isn’t an option if you are self employed. We ended up liquidating everything we had in taxable mutual fund investments, the cds and 75% of our cash during the ups and downs of the Great Recession. He finally found a job in 2013 making what he was in 2008 and we are doing great now. You don’t know how you will handle a crisis until you get there. we were lucky and blessed and raised right to be able to stay strong through it. I could easily see temptation to just give up when life got too hard and too overwhelming. Especially for someone without a strong emotional support network of people who love them or someone that relies on status symbols or their job for their identity and self worth and can’t deal with that loss plus the liquidity crisis at the same time.
When I saw the title I first thought you were suggesting no liquidity but then read #2 savings buffer and saw you do agree that something available is prudent and suggest 5-10%. I agree! It’s like an umbrella policy you hope to never use but still have. But I also agree that not everything needs to stay liquid especially as your net worth grows.
Well I got #10 down that’s for sure! Moms basement is as good as home!! I think #5, income streams, is probably the most important thing when you want to bet harder on one pony. We were heavily weighted in Amazon and other tech stocks and some people said to never let go of Amazon. It was up to us, I wouldn’t let go either but I don’t feel like we have enough income streams. We have 6 streams but that other 5 can’t measure up to the holy paycheck yet.
I stay illiquid to an extent because I keep very little cash with the exception of emergency cash. Emergency cash I don’t count as cash. Emergency cash is not investable therefore it’s not counted or even linked on PC though I know it’s there.
Real estate is problematic if one has to sell really quickly. The home owner that we bought from got a new job on a totally different coast in a different state (SF, Cali) therefore they were motivated to sell. IMHO it’s one of the reasons we got a fairly good deal. We paid the same amount they paid 10 years earlier. Every year we stay in it, that’s basically an additional 3 percent. They also put a great deal of updates into the home. I’d rather the liquidity of stocks and the better returns. Because, I keep so little cash if I decide to buy that second home before the 2020 election, I would need to sell stock. It’s basically a rebalance or redistribution from one asset class to another.
Sorry it’s been tough for you with stocks in 2020. Real estate does significant outperform in a bear market if real estate is not the cause. You just have to keep the faith and ride out the stock market volatility.
So true, especially about the emergency fund. I definitely have a plan – although it’s not well-developed – if by chance I lose my job. While most of my money is somewhat illiquid (mostly because it’s in tax-advantaged retirement accounts, although is that a factor in liquidity?) my emergency fund would hold me over while a ramp-up my “side hustles” (which I guess would become front hustles? main hustles?)
Love this post, Sam. I’ve been saying this to friends for awhile, and my wife and I are on the same page. In fact, we don’t have a “traditional” X months of savings “emergency fund”. We use YNAB religiously to budget each month, and save for what most people would consider financial emergencies (medical expenses, car maintenance, braces for our kids — our oldest is not even 2 yet).
My wife started an Etsy business a couple years ago to bridge the gap between quitting a job she hated and becoming a full-time mom. By her second year she was making $75,000/year. She shut it down when we had our son, and I’m the primary income earner, owning my own business. If for some reason my business went down the tubes, she could fire Etsy up again literally overnight and generate income.
I also played poker professionally when I left collage. I can literally walk into any card room and generate, at a minimum, $50/hour. Nobody can take my wife’s ability to get on Etsy away from her, and nobody can take my ability to play poker away from me.
So we consider these our “emergency funds”. Of course, we’re also building our investment portfolio, mostly maxing out our 401k and planning to purchase rental properties in the next two years.
I guess my point is that smart, talented people really don’t need to worry about financial emergencies (as you’ve pointed out), and I think this needs to be better communicated by society.
Re people who are fired (and I’m sure all but the most evil Employers would always assert the firing was for some kind of cause anyway) still do generally collect unemployment benefits. Here, the Employer has to show up at a 1-hour hearing and convince the Examiner that the firing was for gross/deliberate/knowing misconduct rather than just poor performance, tardiness, unpleasantness, unprofessionalism, etc. It’s a high standard for the Employer to meet and in some instances they don’t even bother contesting the unemployment benefit application unless they’ve got a smoking gun (or really want to try and stick it to the terminated employee even if they don’t).
Re laid off – yes, you will always (as certain/always as anything can be in this life) get your unemployment benefits.
Hi Sam,
Good post. I’d like to point out one small inaccuracy though. You wrote ” Conversely, folks who get fired or quit are NOT eligible for unemployment benefits because they left due to cause or voluntarily.”
That’s not entirely true. That can be a gray area. I was terminated after over 30 years with my employer last fall. It was for unprofessional conduct. (ruling in court that is being appealed later this year). When I went to apply for unemployment benefits my employer said it was misconduct. (of course). They give you a 5 minute phone interview and write up a decision based on each side’s phone interview. The written decision was so poorly and grammatically written I wondered how some of these people make decisions affecting other peoples lives.
Anyway, I decided to appeal it. I went before an administrative judge. My employer had an attorney and an assistant HR person. I represented myself. I’ll spare you all the details but the judge ruled it wasn’t misconduct and overturned the decision. They had 30 days to appeal it to an appeals board but didn’t do so the decision stands in my favor. I’m in California so the few hours of preparation and another 2-3 hours going to court was worth the approximate $11,500 I will get from unemployment this year.
What an ordeal. Glad you were found not guilty of misconduct.
But if the judge found you guilty of misconduct, you wouldn’t get unemployment benefits right? Therefore, you got unemployment benefits because you were laid off instead of fired. Were you able to get some severance from them?
But if the judge found you guilty of misconduct, you wouldn’t get unemployment benefits right? Therefore, you got unemployment benefits because you were laid off instead of fired. Were you able to get some severance from them?
Also, after 30 years of work, what would you say that you are financially OK given all those years of saving and investing? If not, pls share why. Tx
Related: https://www.financialsamurai.com/median401k-retirement-balance-by-age-is-dangerously-low/
Sam – Labor & Employment attorney here. He was fired, not laid off.
A layoff is a separation for financial, downsizing or re-organization purposes. A termination (firing) is because the Employer does not want you, personally, to remain in their employ.
The logical snag here I think is that most Americans are completely unaware that they are employees at will, i.e. they can be terminated at any time and for any reason or no reason at all (with a handful of exceptions including they can’t be fired for discriminatory reasons, or in retaliation for taking FMLA leave, certain whistle-blowing activity, and other very specific, statutory protections). Unionized employees protected by just cause provisions in their collective bargaining agreements, and the small amount of high-level employees/execs who have similar just cause protection in an individual employment contract being the notable exceptions to the employment at will doctrine.
In this regard, as I like to tell people here in MA, if you show up to work in a Yankees hat and the boss is a big Sox fan he can fire you on the spot because he does not like the hat. That is not a lay off – your ass was fired. In that context, you will still get unemployment benefits because the firing was not for deliberate misconduct (a very high standard for the Employer to meet, and it does not include run of the mill poor performance, tardiness, small ball misconduct, etc.)
Sounds like here JK was probably falsely accused of gross or deliberate misconduct, but the admin judge ultimately did not credit the Employer’s version of events, hence he was given unemployment benefits.
Thanks for sharing your thoughts!
Definitely a gray area and a lot of confusion between fired and laid off. Don’t you think in general the people who are fired or fired because of cause, and therefore have a harder time to claim unemployment benefits?
I have yet to meet someone who was laid off for no cause and who was denied unemployment benefits. Have you?
Le Lawyer, you’re correct. I was fired , not laid off. While I live in CA and it is an at will state I work in education and was able to appeal this firing. I originally won the case but the district continued to appeal it. It led to several years on paid leave and they were finally able to spend enough money to get it overturned. I’ve learned a lot of things through this process. For one, it isn’t really about right or wrong sometimes but more about the legal process. I don’t want to elaborate since the case is ongoing and we’re appealing that decision now.
I’m not worried about my financial situation Sam as I have a pension coming and a sizable nest egg. My home is all paid for also. Interestingly, if I had taken my pension I wouldn’t have been eligible for unemployment. My pension will grow during this time while this works out.
Surprisingly there are a lot of people that have to fight for benefits from those I’ve talked to. They may say they were laid off or that their employer “found” a reason to fire them so they could deny benefits, etc.. Each person’s case is different.
What helped me is that I went into this much more prepared than my school district. I just want to let people know that you can fight the ruling if it is against you. Do your research. Look at case law, etc.
As a side note, it’s turned out to be a blessing in many ways. I’m an older dad and I’ve had the last several years, with pay, to be able to spend time with my two kids full time, go to all their activities, etc. You can’t put a price on that.
PS LE Lawyer- I’m originally from New England and a big Sox fan. I would fire the guy wearing a Yankees hat also. ;-)
You need some liquidity. Not just to cover an episode of unemployment but also to take advantage of future Investment opportunities that come your way or other unexpected things that might occur. I believe liquidity gives you flexibility.
Clearly long term unlocks our good friend, the compounder, so it must be paid due respect, but don’t discount the power of a proper level of liquidity.
I agree completely, and would even take it a step further and argue that illiquidity has been good for me, personally. By investing in commercial real estate for the long-term, I now have enough cash flow where if I lose my real job, I have enough income in perpetuity to get by pretty well, not at my current standard of living, but at an above average existence. By locking up money in my child’s 529 plan from birth, my young child can attend our state university tomorrow with no student loans for tuition or living expenses, even if a catastrophic event happens and I can’t make any more contributions. By always maxing out a 401k instead of a taxable account, I could stop contributing today and still be able to cover the costs of old age when that time comes. I know myself and my situation well enough to understand that if I had invested the same amount of money in a taxable brokerage account with more liquidity, I would have spent plenty of it on creature comforts that I don’t need, and I would be worse off today for it.
So many spot on reasons in this article! Thank goodness for insurance. It isn’t cheap but it’s much cheaper than paying fully out of pocket and has saved me tens of thousands. I agree with everything on your list. Diversification is an important one and so is savings.
Thanks for the article Sam. I am in my early 30’s and have managed to save $2Mish through grinding in finance/disciplined savings. Regarding your comment about asset allocation, I have little to no divserisfication regarding the $2M. Other than a chunk of cash (dry powder) all of my NW is in equities, primarily individual companies, albeit spread btwn various sectors etc. I guess I would benefit from owning some alts and/or RE, but have to imagine there is gonna be a healthy correlation esp w the RE. I live in NYC and am not getting long physical property so would have to do crowdfunding to plug the RE bucket and have to imagine those investments will be under meaningful pressure assuming the market/economy gets crushed. So not really sure I would get a massive benifit regarding diversification if I went that route.
I agree so much with this. We have a number of real estate holdings, insurance, and own our own business. Often the business asset class and side hustles can provide cash in a pinch. Also, in the extreme worst case, short term solutions like a Heloc could suffice. I think the same argument mainly holds for an emergency fund. If you are high net worth, do you really need 10% liquid at any given time?
As a small business owner I’ve never had to worry much about my liquidity because at almost any time I can declare a dividend.
But to cover all bases I keep a few options open:
I have an unused line of credit for the business of $250,000.
I keep a HELOC open with a credit line of $470,000.
When I have a large expense, like the recent birth of our 3rd child, I’ll open a new credit card with 0% intro APR and pay it down over time to smooth out my cashflows.
I keep ~$50,000 of physical gold as my actual emergency fund. Gold values vary wildly so this is considerably less stable than cash, but the long term value won’t eroded to pennies by inflation and I don’t expect I’ll need it anyway. Physical Gold is very liquid and I’ll have access to it even if the government freezes my bank accounts and credit lines.
Thanks for your response to my comment! While I was approaching your question from a pure risk/return perspective, I hadn’t factored in a fight against one’s own willpower. I assumed one would be similarly disciplined irrespective of asset class, though perhaps that’s a stretch.
In thinking more about it, I’m not too concerned with needing liquidity at the bottom. Your points were well made; being well-diversified and willing to hustle gives me confidence. Ironically, I’d be much more upset feeling forced to ride illiquidity over the peak of a good market cycle, when I might have otherwise been able to reallocate.
I have never had a liquidity issue before. However, I don’t believe in emergency funds as I believe in access to funds. All my extra money are either directed to pay off my debt or into my investment account.
I have a few lines of credits and a margin account that allows me access of about three years of my salary. So if I suddenly lose my primary income, I should be able to last at least a year before I get into a liquidity crunch.
If my finance start to deteriorate a couple of months after I lose my primary source of income, all options are open and I will have to do what it takes to keep on going.
Honestly the answer is relative to your situation. If your a highly skilled worker with sought after skills, special compensation, or your highly compensated you are right, the risk is minimal if you play your cards. But what about the janitor sweeping your floors at work? The waiter at your favorite restaurant? These folks have little to none of your list. To them liquidity might be all they have. It’s very situational.
Well stated as always Sam. I do think that praising illiquidity because it can prevent or delay an illl advised decision is like praising poverty because it can prevent you from spending money frivilously. Freedom always has a positive value and restrictions always pose risks and represent a negative, even when things work out serendipitously as they did with your house. Just because someone buys a winning lottery ticket doesn’t make that a wise purchase.
I like the side hustle comment the most. With the way the job landscape is shifting nowadays, the gig economy pays pretty well. People pay $20 for other people to walk their dog for 30 minutes! It’s insane. That’s partially why I think it’ll be hard for people who retire to run out of money. When you go from working 40 hours a week to eventually getting bored and working 10, those 10 hours are probably higher in pay and don’t affect your level of happiness that much.
Have you read margin of safety? I love that book. Though this article argues the opposite, which I think is realistic for people who can generate extra income.
I wonder how the gig economy will do when the real economy crashes. Will people still pay $20 for dog walking when money is tight? Probably not.
It will be a lot harder to make money when we get a recession.
As for liquidity, having 5-10% in low risk assets is the way to go. You don’t need liquidity for your whole portfolio. Just some liquidity in a small part where you might need to access.
Great post Sam. This brought to mind a podcast I heard recently where the guy was arguing against having an emergency fund (in a typical cash-based vehicle as espoused by most). His point was that he considered all of his stock index funds as his emergency fund and the money can be accessed within 2 or 3 days at most if something happens. The downside of course is that if you need it you’re selling shares and paying taxes, but the upside is that your money isn’t being underutilized in a money market fund gaining little interest.