How do I know if I am investing too much? Finding a balance between having cash savings and investing

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Dubai: Let’s say you can strictly set aside and invest more than 50% of your income. Is it too much? How much cash should be saved and how much of that should be invested?

There is a downside to investing so much that you won’t be able to free up cash for emergency expenses. Here’s why and how you consider liquidity when investing.

Particularly in the current environment, investors are looking for new ways to achieve their goals. So knowing what liquidity is and how it impacts portfolio returns can help investors make more informed decisions.

Why is investment liquidity important?

The term liquidity in finance refers to the time and cost required to convert an investment into cash. Often, investors – new and experienced alike – focus only on the long-term goal of securing their retirement, ignoring the possibilities of unprecedented events.

What investments are considered cash?

Liquid assets include things like cash, money market instruments (like bank accounts, deposits, some mutual funds) and marketable securities like stocks and bonds. These can easily be converted into cash in a short time.

On the other hand, illiquidity occurs when a security or other asset cannot be easily and quickly sold or exchanged for cash without substantial loss in value. Some examples include the sale of assets such as land and real estate investments, equipment, art, vehicles, jewelry, and collectibles.

It is essential to consider liquidity and not tie up all your capital, as you may need emergency money at any time. Simply put, liquidity is the accessibility to your investment.

This takes into account how long it would take you to access your investment when you need it. The process of such a conversion differs from asset to asset. In the case of your pension fund, you will not be able to liquidate the funds without the necessary paperwork which can take time.

On the other hand, your money market funds (bank accounts, deposits, some mutual funds) are highly liquid and can be viewed through a linked checkbook or can be easily transferred to your designated bank account.

Is it easy to access your savings, your investments?

Is it easy to access your savings, your investments?

Thus, liquidity is the extent to which a security can be easily and quickly bought or sold without its price being affected. Your liquidity is determined by how quickly your investment can be converted into cash.

For example, you may have invested some money in stocks and you suddenly need cash. You have the ability to sell your shares quickly for a fee, through a broker, and get cash.

Likewise, if you are considering a less liquid investment such as real estate, it is not so easy to convert the sale. This is accompanied by administrative formalities, the market valuation of the property, the search for potential buyers, etc.

Invest money in liquid and illiquid investments

No matter how much you invest in illiquid assets, you need to keep a small portion of your money aside for instant access. This keeps the value of your funds intact rather than changing the value due to conversions.

The money you have should only be used for emergencies and should be replenished immediately. There is often a debate about the appropriate amount for such provisions, but this is a personal parameter that differs from individual to individual depending on their needs.

A rough estimate would suggest having at least three months of your take home pay in cash or near cash in reserve.

How much of my investments should be liquid?

It is advisable to have at least 60 percent of your assets invested in liquid assets such as stocks, bonds, mutual funds and other alternative investment funds. These are funds that you can cash out monthly.

In the case of an investment option listed on the stock exchange, you will need to ensure that you invest with a long-term horizon to avoid any impact on the price.

Another key point to keep in mind concerns private investments, where a certain fraction of the investment is under easy redemption options.

Evaluate the liquidity of emergency funds, real estate, stocks and mutual funds

If you invest in emergency funds, you will have high liquidity, but the returns will be low, as will the risk. Real estate investing comes with low risk and higher return, but the liquidity aspect is compromised.

Going for stocks and mutual funds, long-term, generates higher returns with cash, but it also comes with higher risks. But despite these scenarios, it is an important component of portfolio investment.

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Having liquid funds greatly reduces the time between when you put the asset up for sale and when you find a buyer.

Liquidity is an overlooked attribute

Having liquid funds greatly reduces the time between when you put the asset up for sale and when you find a buyer. Stocks are a good example of liquid assets that can be traded on any business day.

It is easier to find a buyer for a liquid asset than for an illiquid asset. This does not mean that one should not have illiquid funds at all, but rather that one should not depend on illiquid funds for emergencies.

The value of liquidity in the field of investment is still underestimated. In the race to secure the future, many investors fail to make provisions for unforeseen events that can arise at any time.

Not having this security can force you to dig into your long-term investment plans, defeating their very purpose.

Cash retains its value

To a large extent, liquid funds manage to hold their value when they trade hands, unlike many illiquid funds.

When you break into your long-term investments to meet your emergency needs, chances are you will face a fine.

When you sell your real estate or property, you may or may not get the price depending on market conditions. But when you break your access to your savings account, there is no such loss in value of your funds.

Key points to remember

When planning your investments, it is imperative to factor liquidity into your plans to ensure that you have met your long and short term needs. This will ensure that you are not going to touch your long-term investments.

When investing in different asset classes, make sure you have enough liquid funds to use when needed.

A fully liquid investment portfolio may not help them achieve their long-term goals. Thus, the combination of liquid and less liquid investments can help investors achieve certain goals.

Investors generally demand a higher rate of return in exchange for giving up cash. This is known as the “illiquidity premium”, and is often a key factor for those investing in less liquid and illiquid investments.

Finding low-correlation assets, that is, assets that do not move relative to each other, is key to building diversified portfolios. Less liquid and illiquid investments have historically shown a lower correlation with traditional investments.

Investment firms have long turned to less liquid and illiquid investments to help smooth returns in their portfolios to drive long-term performance by reducing the impact of volatility on the portfolio.


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