Return, risk and liquidity are the three important pillars of all investment plans. And though return and risk are given much importance, liquidity seldom gets the prominence it deserves. Liquidity has always been an underdog in the world of investing, especially with retail investors in India. However, liquidity is gaining prominence now due to the unprecedented challenge that COVID-19 has presented to investment portfolios worldwide.
Let’s understand how liquidity is important; why it’s hogging all the limelight today; and how you can infuse liquidity in your investment plans in these uncertain times.
What is liquidity and why it’s important?
Liquidity, in simple terms, is the ease and speed with which we can convert an asset into cash. Meaning, we can sell it easily whenever we need cash. Liquidity is an important factor because life is unpredictable and job losses, medical emergencies, business failure and economic slowdowns are a fact of life. Now we can also add pandemics to that list with what we have experienced with COVID-19.
The following example will help you understand why liquidity is important.
In 2012, Anil Sharma bought an apartment worth Rs. 80 lakhs in Gurugram, Haryana, and took up a home loan to finance his purchase. Real estate investment was more lucrative than mutual fund investment at that time with lucrative returns in the range of 16-18%. Anil also enjoyed maximum tax benefits with deductions based on interests paid on the home loan.
By 2017, however, the outlook started to look grim for the real estate industry due to demonetization and the ensuing slowdown. Anil had a manufacturing unit that supplied parts to automobile manufacturers. With the automotive sector in a severe slowdown by 2018, orders started to dry up and he had to shut down his factory. Now he was in immediate need of funds to start a new business and pay off his creditors, however selling his apartment was getting difficult.
After much delay, he had to sell his apartment at 70 lakhs in early 2019; taking a hit of 10 lakhs after staying invested in real estate for 7 years. A real estate investment is an example of an asset class with low liquidity. If Anil had diversified his investments in equity, liquid funds, fixed deposits, cash and bonds, he could have easily converted his investment into cash without losing time and money.
Additional Read – Investing Advice by Experts for Investment in Post Pandemic World
How to create liquid investment plans?
Liquidity is important but you shouldn’t go overboard with liquidity. The right liquidity investment portfolio takes into account the predictability of your income. That depends upon the type of your job and the nature of your business and several other factors.
Experts recommend you to formulate your liquidity strategy based on the following:
- Highly predictable income – Liquid emergency corpus of 3-4 months to meet your expenses.
- Medium predictable income – Liquid emergency corpus of 5-6 months.
- Unpredictable income with erratic cash flow – Liquidity of 8-12 months.
How to build liquidity in your portfolio?
Utilize this lockdown to reduce your expenses and increase your savings. You can start a SIP in liquid funds with a target to save 6-12 months of your monthly expenses in the fund. Liquid funds invest in treasury bills, commercial paper and other short-term fixed-income generating instruments. These funds are short-term investments and come with a maturity period of 91 days, which is the most significant feature of liquid funds.
You can also start a short-term recurring fixed deposit for 6-12 months with a bank and maintain an emergency corpus with high liquidity. It is also a good idea to maintain a separate bank account for the purpose of liquidity. You should only use this bank account to receive money post-maturity of your liquid instruments.
Selecting liquid funds
When you select the liquid funds for your mutual fund investment, make sure that you have carried out proper research and have selected them according to your financial goals, investment horizon and risk appetite.
The ongoing coronavirus pandemic has emphasized the importance of having an emergency fund. Rather than keeping the entire emergency fund in a savings bank account, we can invest them in various highly liquid but safe investment products and get decent returns. To ensure that you have adequate funds at your disposal immediately in times of crisis, you can divide your emergency corpus into cash, FDs and liquid funds.
If you are not sure how to navigate the choppy water in these tough economic conditions, let Tata Capital Wealth help you with bespoke wealth management and investment solutions. With Tata Capital Wealth, you can take advantage of holistic and hand-picked investment opportunities curated according to your investment goal, horizon and risk profile.