We are used to looking at investments in isolation, without considering the whole portfolio. Investments are made at different times, and perhaps, through different advisors, which does not help in consolidation. By default, we end up creating a somewhat diversified portfolio, which takes care of risks, and partially, returns. But a critical factor that is impacted when we consider investments in isolation is liquidity. There are several instances where liquidity is commonly short-changed.
First, a craving for an investment in real estate, land or property. Most of us do not stop at having a roof over our head but stretch ourselves too much. We buy a bigger than planned house, at a budget exceeding our initial estimates. A self-occupied residential property is 50 per cent of the assets of most households, and it generates neither income nor capital gains. But growth in its value is a matter of immense satisfaction.
The impact that it can have on our liquidity requirements is seldom highlighted. If a household needs to generate liquidity, a huge investment in property hits in two ways — we have to pay equated monthly instalments (EMIs) and the asset that cannot be partially sold to raise money. Such households meet sudden liquidity requirements through expensive credit cards and personal loans.
Second, a preference for fixed-term products. Products like bonds with a fixed maturity date, close-ended mutual funds, fixed maturity plans, fixed-tenure bank and company deposits require careful planning of liquidity. Most of us buy these products for an attractive return, or safety of knowing the rate of return in advance. But we end up holding illiquid instruments, which cannot be encashed if there is a need before the instrument matures.
Third, lured into buying exotic products like art funds, private equity funds and structured products, which seem to enhance our sophistication quotient as investors. Most of us fall for the attractive return and the exclusiveness of the offer, but fail to ask whether liquidity constraints in the product suit our needs. We then seek redemption from an art fund bang after a three-year lock-in, without considering the market downturn and low prices.
Liquidity is the flexibility that our investment holds for us, being amenable to be converted to cash — both fully and partially. It enables us to encash our investments in a short time, at a lower cost and at a fair price. Flexibility is not restricted to having three-six months’ cash in a savings bank. It is about being able to re-jig your investment portfolio.
For example, how much of your loans can you retire if you need to reduce your EMI outgo? If most of your loans have funded your house and car, which are your assets, but are illiquid, you have limited flexibility. Instead, if you have equity shares and open-ended funds, you can reduce your EMIs by liquidating these investments.
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If you need to reduce your insurance premiums to generate liquidity and your insurance policy has a low surrender value, you are locked-in in an illiquid product. If you have to raise money against your deposits and gold, and find that the margin and interest rates are steep, you are in illiquid products. The degree of liquidity as well as the time and cost involved in encashing vary in these examples.
Balance your portfolio to ensure that at least 40-50 per cent of it is traded, liquid and capable of being moved, if need be. If you have invested a large chunk in your house, make incremental savings in liquid products like equity shares, open-ended mutual funds and deposits with a bank where pre-sanctioned loans at deposit-linked rates are available. Always ask for a product’s liquidity features before buying. Since we cannot see our future, a flexible investment portfolio that enables rebalancing helps manage wealth.
The writer is MD, Centre for Investment Education and Learning. Views expressed are her own.
