Liquidity Risk in your Investment Portfolio
Ruvan J Grobler • August 22, 2024
Liquidity Risk in your Investment Portfolio
There is nothing worse than being in a pickle and you have no emergency funds. This is when people get into unnecessary debt with high-interest unsecured debt via credit cards and personal loans.
To avoid this, you must plan your investment portfolio around long-term growth as well as liquidity needs. Setting financial goals in the financial planning process is an effective tool in providing a practical framework. But it also gives wealth managers possible investment horizons and importantly, the liquidity needs of a client.
There is a tightrope to walk between providing liquidity and enjoying long-term growth and your age and specific needs will determine how far you lean towards each side. Here are some of the liquidity risks that you may face in your investment portfolio:
- Product Rules: Certain structures allow partial access to funds, and some offer no access to funds within a certain term.
Examples:
- Compulsory investment products like pre- and post-retirement structures.
- Discretionary investment products like endowments, sinking funds and structured products.
- Asset Allocation: With short-term volatility in growth assets like equities you may run the risk of selling during a downturn, locking in losses. It’s important to rather consider the use of conservative interest-bearing assets when planning for short-term or emergency liquidity needs.
- Demand: All assets are not desirable by investors. An example can include private equity shares that may not be well known or desired. This will make it difficult to sell when funds are needed because there might not be a willing buyer.
- Availability: In certain instances, investor funds are pooled together in order to buy a large underlying asset. Some of these assets can have a maturity date attached leaving no room for buy-backs before maturity.
How can you assess the need with asset allocation in mind?
- High liquidity – Conservative allocation – Low volatility
- Low liquidity – Aggressive allocation – High volatility
*This is not financial advice.
Ruvan J Grobler RFP™ (PGDip Financial Planning)
Should you withdraw your Pension and pay off your home? It's perfectly normal to ask whether you should use your pension to pay off your home when leaving an employer. This decision involves weighing the tax on the withdrawal, the interest saved on your bond, the future growth of your pension fund, and the contributions needed to catch up. Example: Anne is 40 years old with a pension fund worth R3,500,000. She bought a home 10 years ago for R3,000,000 and bonded it over 20 years at an 11% interest rate, with monthly repayments of R30,965. After 10 years, her outstanding bond is R2,258,225. If she withdraws her pension, she’ll receive R2,408,300 after tax—enough to settle the bond and have some cash left over. By paying off the bond early: She saves R1,467,919 in interest. She frees up R30,965 in monthly cash flow. However, if she keeps the money invested, her pension could grow to R37,921,470 by age 65 (assuming 10% annual growth). To match this value after using her pension to pay off the bond, she’d need to invest R28,580 per month for the next 25 years. That’s R2,385 less than her current bond repayment, so she does save monthly—but only for the next 10 years. After that, she’s committed to investing R28,580/month for 25 years to break even. Not everyone’s calculation is the same and there are endless amounts of permutations to this calculation, but it’s important to note that you need to consider all of these factors when making these crucial decisions.
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