Liquidity is a term associated with the ease in which your assets may be converted into cash. High interest savings accounts and money market investments are extremely liquid and can be sold and converted to cash within a day. Holding a portion of your assets in cash is important for ongoing cash flow purposes and emergency reserves.
Fixed income investments, such as guaranteed investment certificates, are typically purchased for a period of time, but may be sold in a pinch with cash raised usually within three days. Bonds can also be sold through a financial firm’s fixed income-trading desk.
Convertible debentures, also known as convertible bonds, are fixed income investments that trade on a stock exchange and have a three-day settlement timeline.
Equities that trade on a recognized stock exchange are typically classified as fairly liquid. Cash can generally be raised within three days after the investment is sold. Typically one could look at the number of shares trading each day to determine the volume.
We caution any investor buying too large of a position in a company, especially a small company with low trading volumes. It may be easy to purchase the shares but selling is often a bigger challenge.
Equities that do not trade on a recognized exchange may or may not be liquid. Most mutual funds is whether you purchased these on a deferred sales charge basis. If a fee or penalty exists for selling an investment, then we would classify this as “liquid for a cost.” Structured products such as principal protected notes, hedge funds, venture capital investments, may have restrictions with respect to liquidity. If liquidity exists then you should understand the associated costs to sell the investment.
Non-registered investment accounts should be considered more liquid than RRSP investment accounts. Withdrawals from an RRSP account are considered taxable. We prefer planned RRSP withdrawals rather then required withdrawals due to emergency cash requirements. Some registered investment accounts are considered “locked-in” and have restrictions with respect to withdrawals.
There are several categories of illiquid assets, which cannot be converted into cash quickly. In most cases, it is a result of not having a market in which it regularly trades. An asset is usually illiquid when the valuation is uncertain. Two common types of illiquid assets are shares of a private company and real estate.
Retirement plans are more complicated when illiquid assets are meant to fund retirement cash flows. In some cases, these assets generate net cash flow, such as rental income.
But what happens if a roof needs to be replaced, or you have tenant vacancies? If the real estate is financed, how will a rise in interest rates impact you?
If the majority of assets are considered illiquid, this will cause cash flow pressures at retirement. Planning should look at the different options, including selling assets. By planning in advance, you should be able to factor in the most tax efficient option. It may take longer to sell an illiquid asset. We recommend that our clients plan ahead to ensure they do not find themselves stuck, having to sell an asset at the wrong time.
To illustrate our point we will use Norman and Pauline Baker. Norman is 66 years old and Pauline is 70. The Bakers have a personal residence valued at $750,000 and an 18 acre parcel of land valued at over $1 million. They have registered investments valued at $250,000. Annually they have been living off of CPP, OAS and small registered account withdrawals.
Pauline would like to sell the 18 acre parcel of land and enjoy retirement while they can. She knows that if they sold the property that they would never have cash flow problems again. Norman is a retired realtor, and feels that they should hold onto the land for a couple more years so that they will get a greater value.
The above situation highlights that the Bakers failed to factor in liquidity as part of their retirement plan. Waiting too long to sell an illiquid asset could result in unfavourable timing, such as a depressed real estate market. Although the Bakers have a good net worth, this has not translated to cash flow at retirement for them.
In order for the Bakers to begin enjoying their net worth to the fullest extent they will need to sell their 18 acre parcel of land. With the proceeds we will assist them in developing a liquid portfolio that generates the cash flow they require.