The Four Factors℠are: Growth/Yield, Liquidity, Fees and Volatility. Every investment option can be analyzed for each of The Four Factors℠. An example would be investing in raw land. There’s no yield, but there is growth depending on the local real estate market. The fees would be transaction costs paid to a realtor, interest and fees on any loans and taxes, if any. Volatility would be low, because there’s no valuation day to day. Liquidity would be low, because it’s very difficult to turn the land into cash without along process and more transaction costs.
Oftentimes you must trade one or two factors to get another two factors. In the raw land illustration, you may have high growth expectations and enjoy the low volatility. But you gave up some higher fees and taxes and very difficult liquidity to get those other two.
So one of those factors is liquidity, and Americans have a love affair with liquidity. They want to be in or out of an investment whenever they see fit. Liquidity gives you freedom and control, and that makes sense.
However, compare your love affair with liquidity with something like Social Security. You have been contributing to Social Security, ostensibly to your own account. In reality, your Social Security taxes now are paying today’s retirees, much like a typical Ponzi scheme.
Let’s say you could contribute to a work-based retirement plan that was similar in contributions as Social Security. Hypothetically, let’s say you could put 6.2% of your salary into an account. Your employer would match it at 6.2%. That would be a match to your portion and your employers portion of the Social Security tax.
We’ll assume a conservative rate of return of 3%. If you earned a static $50,000 for forty years, with no raises or inflation adjustments you’d have a big pot of money in our hypothetical comparison. Roughly $465,000 would be in your account. You would expect to have access to that principal in retirement. Give me liquidity or give me death!
However, in Social Security, you don’t. And when you turn 62, or full retirement age, or 70, a check starts coming to you in the mail for the rest of your life. Many of my clients find Social Security to be, at the very least, 1/3 of their total retirement income. They love it! They absolutely love the fact that they have a pension. However, what they often forget they never had liquidity or access for all those years to have this pension. They traded liquidity for the stability of a lifetime income.
Can you see that liquidity is a factor that has positive and negative characteristics? Liquidity can oftentimes raise investment volatility. It can oftentimes raise fees. And it doesn’t necessarily guarantee growth and yield the other three factors. If you're going to have liquidity, find out what you're giving up by keeping it. If you're going to give up some liquidity on your assets, make sure that it's worth giving up that liquidity. The answer is not all or nothing. The answer is having a balanced portfolio where each investment considers the four factors and allocates appropriately.
The key here is don't fall in love with liquidity for liquidity's sake. Feel free to click here to contact us, if we can help.