Personal Liquidity

"If you want a rainbow, you gotta put up with the rain." Dolly Parton

Liquidity

Intro

To cut to the thick of it, Liquidity refers to how easily can assets be converted into cash. In essence the more liquid the asset the easier this process will be.

Cash is considered the most liquid asset. Closely following this though are stocks and bonds which both can be converted to cash with relative ease. These are therefore considered liquid assets.

On the other side of the spectrum we have assets that would be considered the least liquid, the most commonly known being real estate, land or property. These are seen to be less liquid due to the time taken to convert the asset into cash and that it isn’t the easiest process either.

Consequences

Holding liquid assets allows the holder to easily and more efficiently allocate cash when needed for example pursuing another investment or taking that dream holiday. Whereas, holding less liquid assets in your portfolio will decrease how quickly and efficiently cash can be allocated when needed.

Staying on Top

A great way to ascertain what kind of position you are currently in, is to look at your personal Liquidity Ratio. This ratio gives a good indication to an individual or a family can continue to cover their outgoings by utilising their cash assets.

 This ratio is calculated by cash assets by monthly expenses. For example, if an individual or family has ￡10,000.00 in cash assets and monthly expenses of ￡2,500.00 their Liquidity Ratio is 4.

Liquidity Ratio: ￡10,000.00 / ￡2,500.00 = 4.0

The higher the number the more months that can be covered by the individuals or family’s cash reserve.

Things to Note

It is always good to have a cash reserve that can be relied upon at times. However, it must also be noted that holding too much cash can also work against you given that there is a significant opportunity cost associated. This is where inflation will be slowly eating away at the pot of money where as it could be used to invest in the markets to seek potential growth.

Should you wish to gain a further insight, please do not hesitate to contact me…

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