With thoughtful liquidity planning, investors can put capital to work when it counts.GETTY IMAGES
In robust markets, holding cash seems counterintuitive. Investors see rising valuations and wonder why any part of their portfolios should be sitting on the sidelines.
Many wealth professionals view things differently: equity allocations drifting above target, retirees needing to fund next year’s income, clients with tax bills coming due, and possible market pullbacks that could upend return expectations.
That’s why liquidity can be strategic. Properly managed, it gives investors the flexibility to meet obligations, to rebalance from a position of strength, and to act when markets offer better entry points.
“Now is the time you should really be checking your asset allocation,” says Jillian Bryan, an investment advisor at TD Wealth Private Investment Advice in Vancouver.
A first step is distinguishing between cash that accumulates in an account and a deliberate liquidity sleeve. “Liquidity is most useful when it’s intentional,” she says.
That can apply to multiple portfolio functions: meeting near-term cash needs without forcing the sale of long-term assets; creating dry powder for market dislocations; and alleviating behavioural pressure that can lead to selling during volatile periods.
Jeanette Power, senior wealth advisor with The Power Investment Team in Mississauga, part of CIBC Wood Gundy, splits liquidity into two buckets. One is opportunistic capital, held temporarily while waiting for more advantageous times to move into high-quality investments. The other is a true liquidity sleeve, built around known needs such as monthly retirement income, taxes, renovations, weddings, education costs or family gifting.
“In positive markets like what we’ve had recently, I’m continually trimming profits, protecting returns, building that next year’s worth of income and setting it aside,” Ms. Power says.
She adds that not every client requires the same liquidity profile. A younger accumulator may have little need for a lifestyle cash wedge, though they may still hold cash for market opportunities. In contrast, a retiree drawing from a registered retirement income fund may need a dedicated reserve to avoid selling assets during a downturn. And a wealthier household may need liquidity for philanthropy, intergenerational gifts, or helping a child or grandchild purchase a home.
Because liquidity has different jobs, its construction should begin with a time horizon. Money needed within months shouldn’t be treated like investable capital. It should be accessible, reliable and low risk.
“If you have purchased a home and have to close on it, you should be sitting in high-interest savings, or the most minimal risk type of investment, like a T-bill. Six months is not an investable time window,” Ms. Bryan says.
For needs inside a year, people may look to high-interest savings accounts, cash exchange-traded funds (ETFs), money-market vehicles or T-bills. For one- to three-year needs, the toolkit can expand to laddered guaranteed investment certificates (GICs), short-term bonds, ultra-short bond funds or limited-duration ETFs, depending on risk tolerance and the nature of the obligation.
Ms. Power says she may use a high-interest savings account to fund monthly cash-flow needs or, for a client taking annual income, ladder GICs so funds mature when needed. If the time horizon is longer, she can turn to short-duration fixed income or ETFs, while remaining conscious of not stunting the overall portfolio. “You don’t want a performance drag.”
There’s always a balance, she says, adding liquidity shouldn’t be so large that it dampens returns, nor should it be stretched into higher-risk investments simply to earn a few extra basis points.
When markets fall, investors with cash can buy rather than sell. It’s not a matter of waiting for the perfect bottom to rebalance, Ms. Power says, but finding opportunities to add to high-quality positions.
Ms. Bryan frames liquidity as avoiding the trap of being fully exposed at the wrong moment. If a portfolio is 100 per cent invested in equities during a market pullback, there is no room to average down or take advantage of dislocations. Liquidity creates that room.
Perhaps the most powerful role of liquidity is psychological. People who know their next year or two of spending needs are covered are less likely to panic when markets decline.
“It’s definitely peace of mind,” Ms. Power says.
She adds that when people have income needs or other obligations already funded, it becomes easier to remind them that high-quality investments can ride through volatility.
Ms. Bryan agrees, noting that investors with short-term needs already covered are much less likely to sell growth assets out of fear. “Liquidity can be one of the most effective behavioural tools in a portfolio.”