During the bull market, I shared my belief that the need for liquidity is overrated. Now that we’re in a bear market, I thought I’d revisit my thesis to see if it still stands. So far, I think it does.
You’ve heard the recommendations of always having an emergency fund equal to 6-12 months of living expenses. Just in case something comes up, your emergency fund will be there to bail you out.
However, not only may we not need as much liquidity 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 purposes.
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 investors in the past.
Having six months of living expenses in cash is more than good enough for most people. Going down to three months of living expenses is probably enough liquidity as well.
Unless you’re trying to buy a house, having too much cash becomes a drag on returns. Having too much cash may also make you lazy to build more wealth because you feel more safe and comfortable.
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 my old house 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 a lot more five years later in 2017. 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.
Since 2017, the reinvested proceeds have done well with no effort on my part.
Investing In Private Funds Is Illiquid
One of the main reasons why I like to invest in private funds such as venture capital, venture debt, and private equity is precisely because they are illiquid.
Once I commit a certain investment amount, all I have to do is meet the capital calls for the next two-to-four-years. I don’t have to worry about when to buy or sell because I’m not in charge, the general partners are.
Mentally, it also feels good to invest with a 10-year time horizon before there is any type of liquidity event. Over 10 years, we’ll most likely ride out the difficult times.
And hopefully after such a long period of time, our private fund returns will feel like bonus money.
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.
We are all rational beings who will take action to improve a suboptimal situation! You are financially competent because you’re reading this post, subscribed to my weekly newsletter, and tracking your finances like a hawk. You’re financially competent because you care!
I’m confident the vast majority of 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% of 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, fine 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. If you build up a large enough readership, you could earn money.
When I was facing a liquidity crunch due to my private fund capital calls, I decided to lock down a new business development deal and do a couple more personal finance 1X1 consulting sessions. Where there is a will, there is a way!
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 enhanced unemployment benefits of $300/week ran out on Sept 6, 2021. During extraordinary times, the value of a severance goes way up due to higher unemployment benefits.
With big government in charge, you can worry less during the next financial crisis. Although, you need to still be wary of an overly-aggressive Fed focused on crushing the middle class.
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. But we’re currently back to bad times.
Financially, I thought I was rock steady until I got obliterated in 2008-2009. My net worth declined by ~35% in six months. 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 at the bottom 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 July 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.
Ironically, as the Fed continues to raise rates, more people are sitting on more cash due to higher money market rates and Treasury rates. Hence, there should be even less of a concern about people not having enough liquidity to pay their bills or meet emergencies.
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 14 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. The real estate market is going through a retrenchment period due to higher mortgage rates. However, mortgage rates are on the decline again and the interest in owning real assets has grown.
Take a look at my favorite real estate crowdfunding platform, Fundrise. Fundrise offers a way a way for all 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.
For more nuanced content, join 60,000+ others and sign up for my free newsletter here. Although the need for liquidity may be overrated, the need for good financial knowledge is not!