Return,
risk and liquidity are the three important pillars of all investment plans. And
though return and risk are given much importance, liquidity seldom gets the
prominence it deserves. Liquidity has always been an underdog in the world of
investing, especially with retail investors in India. However, liquidity is
gaining prominence now due to the unprecedented challenge that COVID-19 has
presented to investment portfolios worldwide.
Let’s
understand how liquidity is important; why it’s hogging all the limelight
today; and how you can infuse liquidity in your investment plans in these uncertain times.
What is liquidity and why it’s
important?
Liquidity,
in simple terms, is the ease and speed with which we can convert an asset into
cash. Meaning, we can sell it easily whenever we need cash. Liquidity is an
important factor because life is unpredictable and job losses, medical
emergencies, business failure and economic slowdowns are a fact of life. Now we
can also add pandemics to that list with what we have experienced with
COVID-19.
The
following example will help you understand why liquidity is important.
In
2012, Anil Sharma bought an apartment worth Rs. 80 lakhs in Gurugram, Haryana,
and took up a home loan to finance his purchase. Real estate investment was
more lucrative than mutual
fund investment at that time with lucrative returns in the range of
16-18%. Anil also enjoyed maximum tax benefits with deductions based on
interests paid on the home loan.
By
2017, however, the outlook started to look grim for the real estate industry
due to demonetization and the ensuing slowdown. Anil had a manufacturing unit
that supplied parts to automobile manufacturers. With the automotive sector in
a severe slowdown by 2018, orders started to dry up and he had to shut down his
factory. Now he was in immediate need of funds to start a new business and pay
off his creditors, however selling his apartment was getting difficult.
After
much delay, he had to sell his apartment at 70 lakhs in early 2019; taking a
hit of 10 lakhs after staying invested in real estate for 7 years. A real
estate investment is an example of an asset class with low liquidity. If Anil
had diversified his investments in equity, liquid funds, fixed deposits, cash and bonds, he
could have easily converted his investment into cash without losing time and
money.
Additional Read – Investing Advice by Experts for Investment in Post Pandemic World
How to create liquid investment plans?
Liquidity
is important but you shouldn’t go overboard with liquidity. The right liquidity
investment portfolio takes into account the predictability of your income. That
depends upon the type of your job and the nature of your business and several
other factors.
Experts
recommend you to formulate your liquidity strategy based on the following:
- Highly predictable income – Liquid emergency corpus
of 3-4 months to meet your expenses.
- Medium predictable income – Liquid emergency corpus
of 5-6 months.
- Unpredictable income with erratic cash flow –
Liquidity of 8-12 months.
How to build liquidity in your
portfolio?
Utilize this lockdown to reduce your
expenses and increase your savings. You can start a SIP in liquid funds with a
target to save 6-12 months of your monthly expenses in the fund. Liquid funds invest in
treasury bills, commercial paper and other short-term fixed-income generating
instruments. These funds are short-term investments and come with a maturity
period of 91 days, which is the most significant feature of liquid funds.
You
can also start a short-term recurring fixed deposit for 6-12 months with a bank
and maintain an emergency corpus with high liquidity. It is also a good idea to
maintain a separate bank account for the purpose of liquidity. You should only
use this bank account to receive money post-maturity of your liquid
instruments.
Selecting liquid funds
When
you select the liquid funds for your mutual fund investment, make sure that you
have carried out proper research and have selected them according to your
financial goals, investment horizon and risk appetite.
The
ongoing coronavirus pandemic has emphasized the importance of having an
emergency fund. Rather than keeping the entire emergency fund in a savings bank
account, we can invest them in various highly liquid but safe investment
products and get decent returns. To ensure that you have adequate funds at your
disposal immediately in times of crisis, you can divide your emergency corpus
into cash, FDs and liquid funds.
If
you are not sure how to navigate the choppy water in these tough economic
conditions, let Tata Capital Wealth help you with bespoke wealth management and investment
solutions. With Tata
Capital Wealth, you can take advantage of holistic and hand-picked
investment opportunities curated according to your investment goal, horizon and
risk profile.
18 June 2020
4 mins read
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