Why Liquidity Is Important in Financial Planning

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You may already be familiar with the concept of liquidity, which refers to how easily an asset can be converted into cash without losing significant value. Common examples of liquid assets include cash – like the money in your checking or saving accounts – as well as certain securities like stocks and bonds, depending on how quickly you can sell them on the market.

Understanding your liquidity needs is an important part of financial planning. Knowing how much cash you need to have on hand allows you to meet your financial obligations today and plan for your goals tomorrow – such as your retirement.

Need a refresher on the basics of liquidity and liquid assets? Check out our explainer article here.

Role of liquidity in personal finance

Because liquidity is one important measure of your overall financial wellness, it’s something to consider in your financial planning. Here are a few examples of how liquidity could help.

Cash flow. We all have bills to pay, and having liquidity helps us to meet everyday cash needs and short-term financial obligations – whether we’re talking about groceries, car payments, rent or mortgage.

Emergency preparedness. Being able to tap into your cash reserve when dealing with life’s surprises (say, a leaky roof) can provide peace of mind. Having access to cash to handle an emergency means you’re less likely to have to tap into your investment accounts or take out a personal loan. The general rule of thumb is to have enough cash on hand to cover at least three to six months of living expenses.

Debt management. Maintaining the right balance of liquidity can also help you manage debt. For example, being able to pay your credit card bill in full and on time each month helps you avoid interest charges and late payments. If you have personal loans, making timely payments can help you avoid defaults.

Financial goals. When you’re liquid, you may feel you have more flexibility when it comes to making decisions about your financial goals. Liquidity allows you to be nimble and take advantage of timely financial opportunities as they come up. For example, let’s say you’ve been eyeing a new car and the borrowing terms have finally turned in your favor – you’ll need cash to put in that down payment and lock in your rate.

Figuring out your liquidity needs

Everyone’s liquidity needs will be different depending on your monthly expenses and financial goals. For instance, if you’re planning to buy a home in the near term, your liquidity needs may be higher. Mortgage lenders often assess your liquidity as part of the application process.

Also, in times of economic uncertainty, you may want to hold on to a little more cash in your bank accounts to help cushion any unexpected financial hits – like a sudden job loss.

Here are a few general tips to keep in mind as you assess your liquidity needs.

  • Understand your financial needs and goals. It’s usually helpful to first take stock of your financial obligations and goals. Your immediate or short-term goals might include having enough cash on hand to cover everyday expenses and maintain an emergency fund. Longer-term goals could be paying down debt or saving for a vacation home.
  • Assess your cash flow. A good next step is to calculate how much you’ll need to fund your goals and establish a timeline for each one. Remember, generally, you’d save for short-term goals and invest for long-term goals. And a short-term goal is typically anything you’re planning to achieve within a five-year period.
  • Consider using accounts that make sense for your needs and goals. Money that you’ll need for everyday expenses and your emergency fund should also be kept somewhere safe and fairly accessible – like a checking or high-yield savings account. For money you don’t need right away, you may want to consider a certificate of deposit (CD) account. A CD typically offers a higher APY than a traditional savings account, but you’d have to keep your money deposited for a certain amount of time.

A quick word on investing and investment liquidity

If your cash reserve is solid – meaning you have an emergency fund in place as well as enough liquid assets to cover your everyday expenses and short-term goals – you may want to consider investing any extra cash for your long-term goals, which gives you an opportunity to potentially earn a higher return and combat cash drag.

Keep in mind, however, that investing involves risk. There are no guaranteed or predictable returns. Market volatility means you could make money, or you could lose money – including your principal.

While investments like stocks and bonds are considered liquid assets because they can be sold and turned to cash relatively quickly, this doesn’t necessarily mean they can provide the liquidity you need in an emergency. For instance, while you can sell your stocks almost anytime, doing so during an economic downturn could mean you’re selling them at a loss.

Again, if you have questions about how to properly build liquidity and find the right financial vehicles for your goals, talk to a financial advisor.

This article is for informational purposes only and shall not constitute an offer, solicitation, or recommendation to buy or sell securities, or of an account type, securities transaction, or investment strategy. This article was prepared by and approved by Marcus by Goldman Sachs®, but is not a description of any of the products or services offered by and does not reflect the institutional opinions of The Goldman Sachs Group, Inc., Goldman Sachs Bank USA, Goldman Sachs & Co. LLC or any of their affiliates, subsidiaries or divisions. Goldman Sachs Bank USA and Goldman Sachs & Co. LLC are not providing any financial, economic, legal, accounting, tax or other recommendation in this article and it is not a substitute for individualized professional advice. Information and opinions expressed in this article are as of the date of this material only and subject to change without notice.  Information contained in this article does not constitute the provision of investment advice by Goldman Sachs Bank USA, Goldman Sachs & Co. LLC are or any of their affiliates, none of which are a fiduciary with respect to any person or plan by reason of providing the material or content herein. Neither Goldman Sachs Bank USA, Goldman Sachs & Co. LLC nor any of their affiliates makes any representations or warranties, express or implied, as to the accuracy or completeness of the statements or any information contained in this document and any liability therefore is expressly disclaimed.

Investing involves risk, including the potential loss of money invested. Past performance does not guarantee future results. Neither asset diversification or investment in a continuous or periodic investment plan guarantees a profit or protects against a loss.