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How Liquid Are You?

When people think about spending, we tend to focus on two things – what is being purchased and how much it costs. Sound wealth management asks that we consider a third question – how best to pay for it, especially when it's unexpected.

One of the biggest challenges to the proper management of wealth is accounting for opportunity cost – that once money is spent toward one goal, it becomes unavailable for another. The $50,000 you spent on a new car can't also be used to remodel your kitchen or to cover a medical bill you weren't anticipating. To address opportunity cost, we compromise (let's install a laminate floor instead of wood) and prioritize (let's hold off on the new car until next year) as we try to make the smartest financial decisions for both the present and the future.

We can also plan for opportunity costs proactively. Opening 529 education savings plans and buying life insurance policies are actions we take now to give us financial flexibility for potentially major expenses down the road. Another strategy for mitigating opportunity cost is increasing our liquidity.

What Is Liquidity?

When we talk about financial liquidity, we typically refer to your ability to access cash very quickly. It's often used to describe different types of savings or investment vehicles: $20,000 saved in a bank account is likely far more accessible than, say, $20,000 invested in real estate. In terms of personal spending, a high degree of liquidity can create opportunities that might otherwise be unavailable. Consider:

You're looking to buy a new house in a hot market. You could make an offer that's contingent on the sale of your existing house – but what if you could make an all‐cash offer, or access a bridge loan to pay for the new house now and then repay the loan when you sell your old house? That liquidity could be the advantage you need to secure the winning bid.

You have a large tax or medical bill you weren't expecting. You could sell stock to cover it, but doing so could create an entirely new set of concerns, like the sale's impact on your taxes and broader portfolio. You'd also have to account for any transaction costs plus the possibility of selling in a down market.

You're starting a business. You could take out a business loan to pay for start‐up expenses, inventory and salary, but then you're paying financing charges as well. Access to funds when you need them could let you cover any short‐term cash flow issues and potentially stay afloat during emergencies.

In each of these scenarios, the illiquid solutions create opportunity costs (such as tax increases or being out of the market) that increased liquidity avoids entirely.

The Costs of Liquidity

That said, how you increase your liquidity matters. Taking money out of your 401(k) or IRA to have "at the ready" can create its own opportunity costs in the form of taxes and early withdrawal penalties, not to mention a smaller nest egg at retirement. You can become too liquid if you shortchange your savings in the pursuit of maximizing financial flexibility.

The ideal use of liquidity is to maintain the ability to tap into cash, equity or credit when you need it ‐ without compromising your ability to build and preserve wealth when you don't. Your Baird Financial Advisor can help you determine your own liquidity needs and what liquidity solutions might be right for you.

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