The following post is by MPFJ staff writer, Grayson Bell. Grayson, who runs the finance blog Debt Roundup, is a fan of personal finance, brewing beer, and working on cars.
When I was paying off my debt, I was worried about getting it down to zero.
I was focused on my debt-to-income ratio and working to toward the optimal number. What I wasn’t focused on was my net worth. That has since changed since I paid off my last credit card.
I see many people talking about their net worth and how they have grown. They speak about their investments and their properties. All of their assets which go toward their net worth. The one issue I have found with some is they forget about one thing. Liquidity.
What is Liquidity
There are two forms of liquidity. There is what is used in accounting and what is used in economics. I am going to describe both, but for the purpose of this article, I will focus on accounting liquidity as it relates to your personal finances.
- Accounting Liquidity – This is simply the measure of ones ability to pay their debts when they are due. Basically, the ability to pay short-term obligations.
- Market Liquidity – This is a market’s ability to convert an asset to cash quickly. If in the market, it can be dealing with converting an asset to cash without affecting the price.
Based on these definitions, the most liquid asset is cash. It can be used to get goods and services quickly without affecting the value. When you have money socked away in bank accounts or savings accounts, then you have maximum liquidity. You can use that money quickly to get what you need, especially when paying bills.
Liquidity and Your Net Worth
When talking with people about their net worth, I get feedback about having property, cars, investments, and so on. What I don’t hear too often is money in their bank accounts or savings accounts. When you have net worth tied up in real estate, it means you don’t have much liquidity. You can’t convert your property into cash very quickly. If you needed to pay a bill in two days, you couldn’t get cash from your house in that timeframe.
Tangible assets are harder to sell when money is needed. This means they are less liquid. They can’t be easily converted to cash on the go. If you have investments, then you could have some liquidity to work with. Some investments, like retirement accounts, are harder to pull money out. While you can do it, it will cost you fees and sometimes taxes. This is especially true with 401(k), 403(b), and traditional IRA accounts.
I will always recommend people have some of their money locked up in investments. I think it is a great way to grow your net worth, but be cognizant of how liquid your money is. If you have an individual investor account, the understand how quick you can sell your assets and get cash. Are there any fees? How long does the money transfer take? The same can go with a Roth IRA account. While it is an investment account, you can take out contributions at any time without penalty. You cannot do that with the earnings though.
Maintain Some Liquid Assets
The main take away with regard to your net worth and how liquidity is to make sure you have some money available at all times for emergencies. You can call it your emergency fund, rainy day fund, or whatever you wish. No matter what you call it, just make sure you have some way to get cash out from your assets in order to deal with emergencies.
While growing your net worth is a great goal, remember to understand how diversity plays a part. You need to make sure to diversify your assets and have a mixture in cash, investments, real estate, and any other forms. The concept of liquidity is not hard to understand, but people often forget about it. If you want a well-rounded financial picture, then look at how liquid your assets are.
How about you all? Do you feel you have enough liquid, easily-accessible assets/cash if you needed it in a hurry?
Share your experiences by commenting below!
***Photo courtesy of https://www.flickr.com/photos/vox_efx/3577733056/sizes/m/
