You should consider what your emergency cash needs will be when deciding on what you will be putting in your investment portfolio.If you are living paycheck to paycheck, you may want to keep your investments very liquid and if you have a fairly large reserve then you may be able to afford to have much of your money in better performing non-liquid investments and a small cash reserve.Either way, your strategy depends on you cash requirements over a given period of time.
Liquidity in terms of investing refers to the time needed to change your investment into cash.Cash itself is the most liquid, while investments like real estate and long term bonds would be considered not very liquid.Real estate can take months and in some cases years to sell and pull your cash out.Additionally, you can face up to 10% of your investment being lost in fees and transaction costs.You will not want to invest in real estate if you will need your money in a month or two.
1.Cash
Cash is the most liquid asset you can have.Cash is virtually accepted everywhere and it maintains its face value.However, cash is not very easy to deal with at times because it can be a security risk and large and bulky to transfer when dealing with large amounts.You would not want to deal with cash when purchasing a house or other large investment.
2.Cash equivalents
Cash equivalents are assets that are very liquid even though you don’t hold the cash itself.The most obvious liquid asset would be a bank account.You have nearly 24 hour access to the account and you don’t have to wait for an item to be sold or traded.However, this type of account is very likely not to provide good returns on your investment.Because you can pull your money from your account at any time the bank typically will only give you, at best, a few percent interest on your money.This will most likely not even keep up with inflation.
3.Short term investments
You may also invest your money in Cash Deposits (CDs) or other short term investments.These will give you a higher rate of return but your liquidity is decreased.You can purchase a short term CD, for 6 months or even a month.This will give you the opportunity to change your investment at the end of the term.However, if you must cash in your CD early, you will most likely have to pay a penalty.The reason the bank can pay you more for a CD than a bank account is because they have a reasonable expectation to keep your money for the given period of time.
4.Long term investments
You can also choose a much longer period of time to invest your assets.However, these investments have very low liquidity.The upside, however, is that these investments most often have the best returns on your investment.For instance, you could purchase a house and hold it for a year and make 10% or more per year on your investment.When you sell the house you could make a nice profit when leveraging the bank’s money.However, long term CDs, real estate, and other investments provide the most penalties when you need to liquidate your assets quickly.
In summary, you need to decide how much of your portfolio needs to be kept in a liquid state so that you can have the needed funds on demand.Also, you should determine which funds will not be needed so that they can go in a longer term investme