By Subir Jha
Any investment has broadly three characteristics : return, safety (risk) and liquidity . The first two factors get a lot of attention and importance. However, the third characteristic does not get the attention it deserves. That is why I call liquidity, the unsung hero in investing.
What is Liquidity ?
Not only liquidity is under-appreciated, but it is also terribly misunderstood. Howard Marks, one of the greatest contemporary investors and chairman of Oaktree Capital, does not think liquidity as whether or not you can sell an asset; true liquidity is how easily you can sell an asset- and at what price – when you are forced to.
Now, let us measure each investment in our portfolio by that yardstick and you will realize that most of the instruments do not pass the stress test. Real estate, equity and long-term debt are a definite no in the liquid club. The right instruments for a liquid portfolio are: Cash at bank, Bank FDs, Liquid/Ultra Short-Term Mutual Funds. And although tempting, don’t consider your credit card limit as part of your liquid corpus.
Is your portfolio liquid?
Obviously, the current crisis makes it easy for me to answer this query. Let me list down a few reasons to have liquidity in our portfolio – job losses/pay cuts/medical emergencies/help for family & friends/any other unforeseen circumstances. Most of us will surely bounce back from these challenges in our life, liquidity becomes an important weapon in helping us to do so.
What is an ‘optimal’ liquid corpus?
I use the term ‘optimal’, because believe it or not, there is something called ‘too much’ liquidity. An ‘optimal’ corpus would depend on the predictability of your cash flow (income in plain speak). If you have a highly predictable income, three to four months of your monthly expenses is sufficient. For moderately predictable incomes, five to six months of your monthly expense would be optimal and if you have an erratic income stream or work in high risk (from an income point of view) jobs, it’s good to have 8-12 months of monthly expenses as liquidity . Monthly expenses include all expenses required for you to maintain your current lifestyle, including your loan EMIs.
How do we build it?
If you have not been saving, please cut down your expenses and start a SIP in a liquid fund /recurring short term bank FD (6 -12 month). It’s not a bad idea to have a separate bank account to keep aside some money towards the liquid corpus . Make sure, you don’t use that account for any other purpose. Practical tip: do this transfer within couple of days of your salary credit
In case you have been investing in long term instruments (equity and/or debt/ home Loan EMIs), pause them and direct that towards a liquid fund/recurring bank fixed deposit till you create this corpus. You can pause them completely or partially, but having a liquid corpus should be your priority.
Another idea: if you don’t have any other choice and have a home loan EMI running, go to your bank and negotiate to reduce your EMI (combination of interest rate reduction and tenure extension). Use this difference to fund your liquid corpus. Make sure, you go back to original/higher EMI, once you have the liquid corpus ready.
Parting shot: Don’t stress too much about the returns from the liquid part of the portfolio. Let your other investments take care of that.
Subir Jha is Founder of Buckspeak, a Hyderabad-based wealth management firm.