5 Questions You May Be Asking About Your Liquid Net Worth

Many investors grow familiar with the concept of net worth as they begin accumulating assets, saving consistently, or preparing for a major financial transition. However, total net worth (assets – liabilities = net worth) only tells part of the story. An individual may hold meaningful wealth in a home, business, retirement accounts, private investments, or commercial real estate, while still feeling constrained when cash is needed for near-term financial goals. Concerns often grow during recessionary periods.

Determining liquid net worth helps answer a different, practical question: how much of your wealth can support your life, financial goals, and decision-making with limited advanced notice? Would you need to sell illiquid assets (resources difficult to sell quickly without a loss or material delay) at an inopportune time to support your lifestyle in the event of an emergency? Understanding the distinction between liquid net worth and total net worth is important if you are a business owner, real estate investor, engineer, attorney, airline pilot, executive, widow, divorcee, retiree, or an individual navigating complex financial decisions.

Five Questions You May Be Asking About Your Liquid Net Worth

1. What is your liquid net worth? And how does it compare to your total net worth?

Your liquid net worth consists of cash and any assets you can readily convert to cash within two to three days’ time. Typically, liquid assets will include bank accounts, money market funds, and publicly traded securities like stocks, many Exchange-Traded Funds (ETFs), certain mutual funds, or bonds contained in non-retirement investment accounts. In contrast, your total net worth consists of all assets you own, including real estate, business interests, mineral interests, retirement accounts, pensions, private equity, and all liquid assets.

2. Why does your liquid net worth matter? And how can it help you formulate stronger financial decisions?

Your liquid net worth supports your short-intermediate-term financial goals. It is critical to hold enough liquid assets to support you throughout any time of economic recession or volatility in capital markets. Maintaining an adequate, liquid emergency fund and liquid assets in non-retirement accounts serves to provide more peace of mind when recessionary periods inevitably impact the economy.

Investors who strictly hold illiquid assets such as real estate or business interests may feel pressure to liquidate those assets during an economic downturn when the value of such interests is more depressed or when income temporarily falls. Adequate liquid assets serve as a relief valve throughout challenged economic cycles, so you can benefit from the economic recovery.

3. What level of liquid net worth is needed to support your goals? And how can you find the right balance between liquid and illiquid assets?

To determine an adequate liquid net worth, you need to consider when you will need cash to support your financial goals, your tolerance for risk, and the volatility in the valuations for your illiquid assets.

If there are specific financial goals you wish to achieve in the next three-five years and there is not a guaranteed source of income to support those goals, setting aside funds in more liquid investments is often prudent. Consider that the depth of the most severe recession of many of our lifetimes lasted from late 2007 to 2009, but capital markets did not recover fully until 2011 to 2012.

To the extent your tolerance for volatility is lower or you own illiquid assets which fluctuate in value materially, it is advisable to consider keeping five or more years of projected expenses in less volatile, liquid investments like cash, money markets, and bonds. In contrast, if your tolerance for volatility is higher and your illiquid assets historically did not fluctuate in value materially, you may feel comfortable keeping only three or four years of projected expenses in more liquid assets such as money markets and fixed income securities like bonds.

You also need to consider if your illiquid investments such as private stock, real estate, and private equity funds are consistently earning a higher rate of return to justify their illiquidity relative to stocks, bonds, and money market funds. If you are not earning an "illiquidity premium" (a higher rate of return) on your illiquid investments relative to more liquid options, it will behoove you to reevaluate your strategy.

4. Where should you keep your liquid assets so they are available when you need them?

Funds earmarked for very short-term goals likely to occur in the next six to twelve months are often best allocated to a high yield savings account, short-term certificate of deposit, or money market fund in a taxable brokerage account like an Individual Account, Joint Account, or Revocable Trust Brokerage Account. For goals likely to occur twelve to thirty-six months in the future, a short- to intermediate-term bond allocation or longer-term certificates of deposit held in a taxable brokerage account are often a suitable choice, depending upon your risk tolerance. If there are specific goals you will need to fund from your liquid net worth in three to ten years, you can begin to consider some exposure to more volatile liquid investments in a taxable brokerage account, including certain types of publicly traded stocks, stock ETFs or mutual funds, and higher yielding bonds. Importantly, inflation may drive you to consider higher yielding investments subject to more volatility for goals occurring more than three to ten years in the future.

5. How can you increase your liquid net worth and create more financial flexibility?

Creating a plan to save for short to intermediate-term goals is a prudent first step. If you are an individual who enjoys budgeting, track how much you are able to save on average each month and set up a recurring monthly transfer to a high yield savings account for short-term goals and a brokerage account for intermediate-term goals. If you do not enjoy budgeting, track how your checking account balance changes from month to month, and you will determine how much you can begin saving on a recurring basis to increase your liquid net worth.

If you hold material illiquid assets and face a shortage of liquid assets, work with your trusted financial planner and tax accountant to systematically begin liquidating a portion of your illiquid assets. You benefit from a team of advisors to help you consider how much you should set aside in more liquid investments and how best to mitigate the tax consequences as you liquidate your illiquid investments. Furthermore, a trusted team of advisors will help you weigh the appropriate timing for liquidations of illiquid assets based upon the present economic cycle. If you currently hold material illiquid assets and do not have a team of professionals to support you, consider interviewing a fee-only financial planner who can guide your planning process and connect you with a tax professional to analyze the tax implications as you plan for liquidity.

Concluding Remarks

Liquid net worth is not simply a measure of cash on hand. Instead, liquid net worth is a planning metric which can influence your ability to weather recessions, fund near-term financial goals, avoid forced sales of illiquid assets, and formulate decisions with greater confidence. If you are someone with concentrated wealth in a business, real estate, private investments, or retirement accounts, evaluating liquidity is often as important as evaluating total net worth.

A prudent liquidity strategy considers your upcoming goals, income stability, tax circumstances, risk tolerance, and the expected return from both liquid and illiquid investments. The optimal answer on where your liquid net worth should land is rarely the same for every person, which is why coordination between a financial planner, tax professional, and other trusted advisors can prove valuable for you. If you are uncertain whether your balance of liquid and illiquid assets supports your financial goals, a thoughtful review of your current financial picture may reveal opportunities to strengthen your plan before liquidity becomes urgent.

If liquidity planning is growing more important in your life, consider beginning a conversation with a trusted, fee-only financial planner.

Author:

Justin Reede, CFP®, CKA®

Disclosure: The investment returns of investment securities are subject to various risks and are not guaranteed. Consult with an investment advisor representative for formal investment advice. For tax compliance advice, we recommend you consult with a CPA or Enrolled Agent. For legal advice, we recommend you consult with legal counsel. This blog post should not be considered investment or tax advice.