Liquidity means the ability to turn an asset into cash. Having liquidity gives you the feeling of control, but liquidity provides both real control and the illusion of control. The financial reason for wanting liquidity from what are intended to be dollars left untouched until some future date, is the ability to cope with or avoid potential risk. If you have an unexpected financial emergency, being able to sell or transform an asset quickly to get dollars in your hands is real control. This is generally what is thought of when one thinks about their asset being liquid, but liquidity isn’t that simple.
Does liquidity also mean getting the money without a cost? If so, then certificates of deposit within their penalty period could be viewed as illiquid. Indeed, even money market accounts could be viewed as illiquid since federal law limits free withdrawals to not more than six per month. Typically there is a commission or fee if you sell a stock or bond – does this mean stocks and bonds are illiquid?
What is the time limit on liquidity? We use words like immediate or instant liquidity, but unless the money is in our mattress or wall safe we can’t get it this very second. You typically can’t get the money for two days or more when you sell securities; is this liquid? A check is called a demand deposit, but the bank can stop access to those funds for a week by saying they have concerns over “doubtful collectability”. And if a week delay is viewed as liquid, why wouldn’t the two to four weeks it usually takes to get the check from cashing in an annuity also be liquid?
And then there is the illusion of liquidity. Typically a bank will let you cash in that CD or make that seventh withdrawal from the money market account this month, but they don’t have to. A bond sale settles in two days, unless you were trying to sell many of the mortgage-backed bonds in 2008 for which there were no buyers. And, an extreme case, there was zero investment liquidity in the days following 9 -11. Although that was extreme, governmental authorities in some countries believe that some exchange traded funds (ETFs) could become illiquid during a market panic. The financial markets, banks, and even governments all operate on the illusion of liquidity believing there will always be buyers, enough people paying their debts and a government that will be able to ultimately bailout any crisis, but this is only true if people still believe the illusion.
The illusion of control imagines that you will exercise that liquidity well. In the stock market the mirage is that the investor will sell out of the market just as it begins its fall – or will use the liquidity to keep moving from liquid choice to liquid choice to maximize returns. The reality is that doesn’t happen. Indeed, as Investment Company Institute data shows time after time, the liquidity is used to sell at the bottom of markets and often to leap out of rising markets.
The concept of liquidity is not as clear cut as it first appears. If liquidity is defined as not having a cost then many annuities would be excluded, but so would any ETF, stock or bond where a commission or transaction fee is involved in the sale. If liquidity is defined as having instant access to the funds then every investment is ruled out as well as many bank products. What this all means is you need to ask yourself how you define liquidity and what it means to you.
Let’s start with the definition of actuarial assumptions from Investopedia,
“An actuarial assumption is an estimate of an uncertain variable input into a financial model, normally for the purposes of calculating premiums or benefits. For example, a common actuarial assumption relates to a person’s lifespan, given their age, gender, health condition and other factors.”
I have worked with actuaries for many years in my career. First, as president of life insurance companies when we deliberated over benefits, premium, payouts etc. The actuary was the sound voice of reason that kept us in a profitable mode. I also worked with actuaries when contracted to
develop products for insurance carriers. Again, in most cases, the numbers don’t lie - that’s why we need the actuaries.
So, why is it that we as human beings tend to ignore the actuarial tables when we look at our life expectancy and calculate how long our retirement funds will last? Maybe it’s because we have anecdotal evidence of premature deaths of people we have known. I have also witnessed the early deaths, but the actuarial tables show the big picture. And, chances are you are going to live longer than you might think. So, I ask you... how lucky do you feel?
Let’s go to Wikipedia and look at the definition of longevity risk, “A longevity risk is any potential risk attached to the increasing life expectancy of pensioners and policyholders, which can eventually result in higher pay-out ratios than expected for many pension funds and insurance companies.” They go on, “One important risk to individuals who are spending down their savings is that they will live longer than expected and thus exhaust their savings dying in poverty or burdening relatives. This is also referred to as “outliving one’s savings” or “outliving one’s assets.” So, what does this mean? Let’s explore…
First off, we all feel good about Social Security being there (at least for baby boomers) and can count on that as one source of income. Some of us are also lucky enough to have a pension. And, in most cases, that payout won’t be in danger (unless the institution is in serious financial distress). But what about the rest of your money? What about the essential income needs: housing, medical, taxes, insurance, food, etc? Is there enough cash flow? We then look at discretionary needs... vacations, gifts, new cars or whatever. How about that source of funds? Is it in good shape? Let’s look at few factors and a solution to help you sleep better at night.
Okay, pull out your driver’s license and look at your date of birth. Are you at the age where you should be shouldering high levels of risk in your portfolio? Only you can answer that… but the answer is probably no. If you are withdrawing funds in this low interest environment, this could affect how long the funds will last unless you reduce withdrawal amounts. What about your money in equities? If you are like me, you’ve been enjoying the ride. But, will there be a day when the markets will decline? I don’t think I even have to wait for your answer. If that becomes the case, then your portfolio could become very damaged and the amount of your income would have to be reduced or curtailed for a while. Is there an answer? Yes…
There are annuities available which will provide you with an income for life... regardless of interest rates or market turmoil. These annuities allow you to participate in the potential of growth while taking distributions. Many also provide access to funds, on top of your distributions, to be used in the case of emergencies or opportunities. And finally, you are guaranteed to never lose a penny of principal or previous gains even in the case of a market turndown.
So, there you have it. The actuaries say that the risk is there. The result can be painful, but there’s an answer to this risk, and it will allow you to sleep like a baby. All you have to do is inquire and check it out. Want to know how this can be personalized to your portfolio? Contact me and I’ll give you some safe money solutions.
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