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Liquidity is one of the most important factors in building a strong investment portfolio, yet it often gets overlooked.
Investors will often focus on getting strong returns, stock market movement, asset selection or which fund managers to work with. But overlooking the liquidity of your portfolio is a mistake.
What is liquidity and why does it matter?
Liquidity is a fundamental part of building a resilient portfolio. The liquidity of your assets refers to how quickly and easily you can convert your investments to cash when you need it.
There is truth to the saying that “cash is king.”
When you face an unexpected cost, like a dental bill or replacing the family car, you will need to access cash quickly to cover that expense. In other words, liquidity acts as your portfolio’s shock absorber.
Whether you’re investing for growth, income or a specific goal, you should be clear on if, or when you’ll need cash, and which parts of your portfolio can provide it quickly and without punitive costs.
Australia and the liquidity challenges of property investment
In Australia, liquidity deserves special attention given our proclivity for investing in residential property. In terms of building long-term wealth and effective tax management, investing in direct property has merits. However, the asset itself is inherently illiquid.
If your investments are heavily concentrated in property, you run the risk of becoming ‘asset rich but cash poor.’ If you run into an unforeseen expenditure, you may have to refinance or even sell the property to cover the expense. This can be time-consuming, carries additional costs and can even lead to a financial loss depending on market conditions.
Another challenge with property investment is valuation transparency. Property values are typically assessed infrequently and are based on estimates rather than daily market pricing. This can create a disconnect between perceived and actual value, with the true price of an asset only realised when it is sold. In contrast, liquid assets such as listed shares and exchange‑traded funds are priced daily, providing greater visibility and flexibility.
The liquidity premium
Illiquid investments such as property or private equity often offer higher rates of return because they include a ‘liquidity premium.’ The higher return is compensation for holding an asset that cannot be converted to cash quickly or easily. This can be problematic if your overall portfolio has an insufficient allocation to liquid assets. Without adequate liquidity, you may be forced to sell assets at unfavourable times or take on additional debt to meet short‑term needs.
The right amount of liquidity depends on your risk profile, cashflow needs and investment horizon.
Liquidity and accessibility: How quickly can you get your cash?
The liquidity of your portfolio is a practical consideration of how quickly you can access cash, at what cost and under what conditions. As noted, for those invested in direct property, selling a spare bedroom to access cash is not a viable option. However, many liquid investments do offer the ability to sell a parcel of shares or individual units to access cash fast.
For example, Australian shares and exchange traded funds (ETFs) are considered highly liquid, with proceeds typically available after a two-business day settlement period (commonly referred to as T+2 Settlement.)
Other investments can appear liquid but carry hidden access constraints. Although term deposits are sometimes treated as a cash investment, they can take 31 days to be ‘broken’ and can result in forfeited interest. Managed funds can also vary significantly, with some offering daily withdrawals and others restricting redemptions to weekly, monthly or even quarterly windows. In stressed market conditions, these timeframes can be extended further.
If you foresee liquidity being an issue in future, it is wise to discuss redemption periods with your adviser to ensure your investments are right for you.
Generally, it is important to maintain an emergency fund, separate to your personal portfolio; preferably these funds would be held in an at-call high interest savings account. As the name suggests, your emergency fund is a safety net to cover both your cashflow and portfolio. For instance, if you were to lose your job and investment markets dip simultaneously, your emergency fund should prevent your investments from being sold for a loss, covering your living expenses and preserving your future performance.
Find the right liquidity balance for your portfolio
Key to an effective investment portfolio is aligning the underlying holdings with your goals and objectives. Whilst illiquid investments can be enticing with their promises of higher returns, it is important to ensure your investments align with other aspects of your goals such as time frame, cash flow and access to capital.
As with any investment decision, it is always wise to have a discussion with a licensed financial adviser before proceeding. Taking time to sit down, take stock of your financial position and review your current goals and objectives reduces risk, but more importantly gives you peace of mind.
FOR MORE INFORMATION
If you would like to discuss your personal investment portfolio, please contact local RSM Financial Adviser.
The information provided on this website is general in nature and does not constitute financial advice. It has been prepared without taking into account your personal circumstances, objectives, financial situation, or needs. It is important that you seek financial advice before implementing any financial strategy.
Where a financial product is referred to, you should read the Product Disclosure Statement and Target Market Determination and seek financial advice. RSM Financial Services Australia Pty Ltd ABN 22 009 176 354 holds Australian Financial Services Licence No. 238282.
