Why Liquidity Matters for Your Saving and Investing Goals

When it comes to getting the most from your money, holding on to cash may not be the first strategy that comes to mind.

After all, when you have a solid cash reserve, why plant your bills in a savings account when you could potentially earn higher returns by investing in the stock market or purchasing a rental property? 

Still, having liquid assets like cash is smart for any portfolio, especially during an economic downturn. Not only does cash come in handy for taking care of life’s unexpected expenses, it can also free you to take advantage of opportunities.

For example, if market conditions work in your favor and you want to buy stocks to add to your portfolio, or put in a down payment for a car that now has better lending terms – you’ll need cash for that. 

To ensure that you have enough liquid assets on hand for your goals and financial situation, here are some things to consider. 

Define your money goals

When it comes to building liquidity, it’s usually worth taking stock of your financial needs and goals first.

Thinking about your cash goals in a time frame (short-term versus long-term) can help you determine how to divvy up your funds.

Your immediate or short-term goals might include having enough cash on hand to cover every day expenses or to build up an emergency fund if yours needs a boost. Longer-term goals could be saving for a vacation home, or socking away funds to start a new business. 

Assess your cash flow

After sizing up your goals, a good next step is to lay out how much cash you’ll need to fund each one.

For covering everyday expenses, financial experts recommend one to two months' worth of spending money plus a buffer of 25 to 30% of the balance in your checking account.

Next up comes your emergency fund. A solid emergency fund generally has about three to six months’ worth of living expenses, though you may decide to keep less in it if you’re part of a two-earner household or more if you're starting a family. 

How much you’ll need for bigger, perhaps more long-term goals like buying property or new car, will depend on many factors, including your credit score, the market, and where you live.

A 20% down payment on a $500,000 home, for example, will be $100,000.  

Accounts that make sense for your goals

It’s likely that you’ll use different accounts for your various goals and financial needs. Before committing to a particular type of account, consider when you’ll need the money and how quickly you’ll want to withdraw it.

Checking accounts are a good place to keep funds for everyday expenses and regular bills because you can withdraw funds using a debit card, check, or electronic transfer, with fewer limitations than other types of accounts.

However, this flexibility comes with little – if any – interest-earning potential. Over the past decade, the average rate for interest checking accounts was approximately 0.05%. 

For cash that you won’t need to access for a few months or are still in the process of building up – like saving up for a new car in the coming months or buying a vacation home in a few years – you might consider an account that earns more interest on your money, like a high-yield savings account, money market account, or certificate of deposit.

Your emergency fund can go into one of these accounts, too, or you could even split it up between accounts. 

As of June 2020, the top rates on high-interest accounts from online banks were between 1.2% and 1.35% APY. The average APY for a one-year CD under $100,000 is 0.25% and 0.51% for a 5-year CD.