Avoiding a Liquidity Crisis
In one of my favorite Warren Zevon tunes, he sings “I was gambling in Havana, I took a little risk. Send lawyers, guns and money…dad, get me out of this!” Warren’s plea to his father for cash is not an uncommon “ask” that many Americans make of their family…even by those who have high incomes. Most people simply do not plan for emergency liquidity needs, whether it is to pay for an unreimbursed medical bill, a loss of income due to sudden unemployment, to fight an unexpected lawsuit, or – in Warren’s case - to pay off a gambling debt.
Sources of personal liquidity can take many forms: cash in the bank or an investment account with online bill pay, an untapped line of credit (such as a Home Equity Line of Credit), investments that can quickly and cost-effectively be sold, a long-term disability policy.
How much cash should you keep handy? There is no one right answer, but a good starting point would be enough to meet at least 6 months of typical household expenses. If you are retired and have reliable income sources such as social security and a pension, less cash-on-hand is probably fine. But if you have a highly compensated job and are your family’s only source of income, having more cash-on-hand is definitely warranted. After all, if you suddenly lose your job it could take a while to find your next gig; you don’t want to be forced to sell an investment at a loss or, worse, downsize your home for want of liquidity to make your mortgage payment.
Selling investments to generate cash is an option, but be aware of how long it will actually take to convert them to cash (selling a mutual fund is quick and easy, whereas selling an investment property takes a long time and is complicated), and what the costs (commissions, taxes on realized gains) will be. Also, make sure that the source of capital is appropriate as a substitute for cash. For example, a diversified municipal bond fund is far less volatile than a biotech stock and is a better, though admittedly imperfect, “proxy” for cash deposits in the bank which has daily liquidity and FDIC insurance.
Banks love to lend money…when you don’t need it. So don’t wait to have a pressing liquidity crisis – such as losing a job – to apply for a loan or line of credit. Do it now, while your financial position is stable and strong. With the recent surge in Central Oregon residential home values, this would be a great time to apply for a Home Equity Line of Credit (HELOC) since your loan-to-value ratio is probably strong. Many banks will help you to get a HELOC at no cost, and without a requirement to borrow at closing. The HELOC simply serves as a free liquidity backstop for a rainy day. And, with that line of credit up and running, you have the option of keeping less money in cash.
Suffering a long-term disability, and not being able to work as a result, can result in families being forced to make hard choices, like downsizing their home, due to the lost income. To mitigate this risk, I encourage my clients to evaluate group disability policies when offered by their employer, or obtaining their own individual long-term disability policies. When the premiums are paid post-tax, the benefits are received tax-free.
Financial fitness often involves “paying it forward” in order to have more control and more choices in the future. So take steps now to be prepared for the next liquidity crisis without breaking a sweat. If only Warren Zevon’s fictional character had thought ahead, well, the you-know-what would not have hit the fan.
To learn more about liquidity strategies, contact me at info@bendwealth.com.
Any opinions are those of Stu Malakoff and not necessarily those of Raymond James. Securities offered through Raymond James Financial Services, Inc., member FINRA/SIPC. Investment advisory services are offered through Raymond James Financial Services Advisors, Inc. Bend Wealth Advisors is not a registered broker/dealer and is independent of Raymond James Financial Services.
