What is the importance of liquidity planning in my investment portfolio?
Let’s talk about how you calculate your liquidity ratio.
Liquidity management is a concept, a lot of people don’t understand. The definition of investment liquidity means the availability of converting or having an asset class that is convertible to cash or to cash like instruments that you can spend and use in your day to day life.
Think of an investor, an individual who’s got all his assets in one single investment. It’s a high rise in a remote city somewhere in Canada and it’s a really tough area to sell.
That would be a very illiquid asset.
The only way he can get his cash, is he needs to sell that entire asset to one specific buyer. The other end of that spectrum would be actual cash sitting in a bank account. That is a fully liquid portfolio. In between that, you have all sorts of different portfolios or net worth statements.
What are your liquidity needs?
Let’s chat about individuals who don’t have enough in liquid assets.
It could either be that all your assets are in an RRSP, a registered account or a locked in retirement account. Essentially, an account that you’re not able to pull the money out means the funds in that specific account are not liquid.
Let’s go through a scenario where all of your assets are in an RRSP, you have no tax-free savings account, you maybe have some registered education savings plan money and then all of your other net worth is in either homes, cottages, real estate and other illiquid assets.
You’d be a very illiquid investor and that could be a concern for you.
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When we sit down to do our investment planning with clients and chat about investment liquidity, we want to make sure that you have some of your assets in an account that is liquid.
A tax-free savings account (TFSA) is an example of a liquid account.
Having a non-registered account holding assets that are liquid is another alternative to liquidity management.
The Importance Of Liquidity Management & Liquidity Ratio
What kind of assets are liquid and can be included in my investment portfolio?
Stocks are extremely liquid for the most part and with bonds, there’s historically been a little less liquidity.
Preferred shares and debentures are not as liquid as the former mentioned above.
You should definitely consider having a portion that is liquid. The most liquid stocks are the most highly traded stocks.
Think of your Canadian and US large cap companies. These are highly traded.
There’s a ton of volume every day on the market for these large cap companies. Essentially, that means they get traded a ton which leads to their respective stocks being highly liquid.
Sometimes you get to a situation where you have a stock, a preferred share, a debenture or a penny stock that has no bid and that has very little liquidity. You could not even sell your share if you wanted to. That’s the opposite of liquidity.
Generally, as a company gets more mature, as it appreciates over time and as it has a stronger balance sheet, it commonly graduates from one exchange to another.
If all goes well, eventually it gets on the TSX and then it starts to be trading volume. Once there’s trading volume, that means there’s liquidity and we’ll generally see what’s called a liquidity bump on the value of the stock.
We believe in building very custom and tailored investment portfolios with a balanced calculated liquidity ratio. We want to be assured the client has their liquidity needs looked after.
I think it’s extremely important and I believe people should have exceptional liquidity management not only in their accounts but also in their net worth, on their balance sheet and in their personal net worth statement.
At the end of the day, when you’re looking at that and you’ve got a bit of everything and if you’re not sure of your current liquidity ratio, obviously you want to consult your tax professional or your portfolio manager.
It’s a really important concept and if you get caught on the wrong side of liquidity, you can really get crushed and devastated through having to sell an asset at a depreciated value.
You want to be able to control when you sell your assets.
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