Managing Liquid Assets
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Managing Liquid Assets
As the opportunity costs, as mentioned in Need for Liquid Assets, is high, you should minimize your holdings of liquid assets.
There are two steps to good liquid assets management. The first step is to determine the minimum amount of liquid assets you wish to maintain for the purposes of making routine expenditures, maintaining an emergency fund for unforeseen contingencies and saving for the future. The next step is to choose the liquid asset that best satisfies each of the three needs.
Planned Expenditures
Most individuals hold liquid assets primarily for payment of planned expenditures. These expenditures cover living expenses such as food, utilities, rent, medical costs, insurance premiums, transportation, personal care, recreation and entertainment, and children’s education expenses. Planned expenditures also include purchases of assets, tax payments and debt payments for your housing, car loans and tuition fee loans, if any.
To determine the amount of planned expenditures, refer to your expenditure records for the past year if you have kept records of it. Take note of the dates when you need to make the payment because it will help in your management.
The two liquid assets that are most suitable for payment of planned expenditures are interest bearing current accounts and savings deposits. The interest bearing current account has the advantage of allowing you to write cheques and make payment.
Savings for Emergencies
It is advisable that you maintain an emergency fund for unforeseen circumstances. These emergencies include illness and retrenchment. The size of the emergency fund depends on the medical history of your family members and security of your job.
For families whose members suffer from known illness, you emergency fund should be larger, and it would be advisable to take note of the medical expenses if possible, if it is a daunting tasks, consult your financial planner. Even if your family has no medical problems, it is advisable to save at least three to six months of your monthly income in an emergency fund. This is because most people tend to find a job within three to six months of their retrenchment, assuming a growing economy.
As the likelihood of using the emergency fund is quite low, it is not advisable to keep these funds in a liquid asset that yields low interest. It is also not recommended that you keep funds in a long maturity time deposit even though it pays a higher interest rate. This is because in the event that you need to use the funds, you may suffer a penalty for premature withdrawal of the deposit. Hence, it is recommended that you put your emergency funds in a savings deposit or very short-term fixed deposits.
Saving for the Future
Another reason for holding liquid assets is to accumulate savings. Most individuals prefer to diversify their investment risk by holding a portfolio of stocks, bonds and liquid assets. Since the primary purpose of savings and investments is to generate returns, the recommended liquid assets would be a fixed deposit or an ACU deposit.
How you should allocate your wealth among the many asset classes depends on your risk appetite, need for liquidity, current interest rate and prospects of other risky instruments.
If your risk appetite is low or risk averse, then you should invest a substantial amount of your wealth in fixed deposit. Although you are getting lower average returns compare to stocks or bonds, you are not affected by the volatility of these two markets, with the former being the most volatile. You can approach financial planners for help in determining the best asset allocation for you based on your risk appetite. Below is a table of possible asset allocation. (Note: These are recommended allocation, please consult a financial planner if you have any doubts)
| Type of Investor | Stocks/risky assets(%) | Bonds(%) | Deposit(%) |
|---|---|---|---|
| Aggressive | 60 | 40 | 0 |
| Conservative Growth | 60 | 30 | 10 |
| Moderate Risk | 50 | 40 | 10 |
| Conservative Income | 30 | 60 | 10 |
Occasionally the interest paid on fixed deposit may rise to an attractive level. And given such situations, the opportunity cost of investing your wealth in other risky instruments becomes correspondingly high. Unless you are quite confident of earning a return higher than the current interest rate, it may be better for you to hold fixed deposit when the prevailing interest rate is relatively higher.
Since most risky assets such as stocks and properties goes through cycles, there may be periods when the prospects of such assets are poor as in a bearish market. In such situations, it may be advisable to park your wealth temporarily in deposits and wait for the opportune time to re-enter the risky assets markets when the prospect turn around.
