Part 2 of 2-Part Series
The higher the LR, the more liquidity you have, and it is easily calculated as well as managed. While it might not be easy to increase your liquid assets, managing your personal spending can increase your LR you are not liquid enough. That isn’t to say this ratio is used to determine whether your lifestyle needs be altered, but it is important to know what flexibilities you have.
Let’s use an example to more clearly illustrate the value of using the LR. If you have an annual spend of $60,000, and assets of $10,000 in your savings account, a house worth $1.1 million, $100,000 on the stock exchange, $50,000 in a small company stock which isn’t traded and $100,000 in bonds which are maturing in 10 years, what is your liquidity ratio? First off, we determine what are liquid assets and they are your cash and highly traded stock. This is because highly traded stocks on the exchange are easily sold for cash, while your stock in the small company cannot be sold easily since it is not on the exchange, nor highly traded. Real estate and bonds not maturing for some time are also illiquid assets. That means you have liquid assets of $110,000 and a yearly spend of $60,000, putting your LR at 1.83. In easier words, it means you would be able to maintain your current lifestyle for about 1.83 years or 1 year and 10 months with only your liquid assets.
Seems simple enough and it is quite easy to calculate for yourself. An LR of 1.83 is excellent as most experts suggest being liquid enough to support yourself for 3 months or a 0.25 LR. However, what we didn’t take into consideration is how much of those assets we listed are part of your retirement savings and investments. If we don’t take that into consideration and use it all in your LR calculation, it could be devastating to your long-term financial stability. If in this example you needed to use your liquid assets to sustain your life for a year, you may well have burned through a very large percentage of your retirement savings and will lead to serious problems in your retirement when you run out of money.
So perhaps we don’t take your stocks into consideration for your LR? That would leave your adjusted liquidity ratio at a not so healthy .16 or 2 months. You’re now below the recommended minimum and at possible financial risk. These are all considerations which need to be made, and perhaps isn’t as simple as at first glance. But it’s the reason why managing your wealth requires much more than most think and the reason why we’ve got you covered!