Over the past few weeks, we’ve been looking at what makes a good portfolio. We’ve talked about Modern Portfolio Theory and why risk matters. This week we’ll look at a much simpler but equally important aspect of a good portfolio: can you get to your money if you need it.
The ability to access your portfolio is what is known as liquidity and it becomes increasingly important in retirement when you begin to rely on your portfolio to pay for your lifestyle needs. It’s common to assume that you can access your money whenever you want, but that’s often not the case. There can be many obstacles to getting cash out of your portfolio especially if you want to do so efficiently in a manner that minimizes fees and taxes. When it comes to evaluating whether your advisor has created a portfolio that meets your liquidity needs, consider the following:
Is your account a taxable account?
If the answer is yes, then you’ll want to understand what your advisor is doing to invest in a tax efficient manner. Whenever you sell a position in a taxable account to create cash you recognize whatever gain or loss the position had. Furthermore, if you sell a position within a year of buying it, that gain or loss is considered “short term” and the associated tax rates are higher. A good portfolio is one that is invested for tax efficiency, taking care to harvest losses to offset gains and thereby minimize taxes (you can read more about tax loss harvesting here).
Is your account being traded in an efficient manner?
Fees are one of the largest detractors of performance and it’s incredibly important to understand not only how much you’re being charged in trading fees, but how often your advisor is trading in your account to generate the cash that you need. A good advisor will be efficient when it comes to trading and will consider the type of liquidity you require before investing in funds that cost a lot to trade. Additionally, many funds have a lock-up period during which they charge an additional fee for you to trade before the lock-up period has expired. A good advisor will make sure that your portfolio is spread out among investments with differing lock-up periods to make sure that generating cash for you won’t also generate a bunch of penalty fees.
Is your account being invested in funds for which there is a market?
There is a false belief in the investment world that special, exotic investments are a great way to make it rich, but what many fail to realize is how illiquid these investments can be and the danger they pose to liquidity. One of the main reasons these investments are so illiquid is because the universe of interested buyers is so much smaller. At any given moment there are hundreds of investors willing to take the other side of a trade when you need to sell a well-known stock or mutual fund and that makes it really easy for you to sell it at a good, competitive price. On the other hand, a little-known foreign stock or a private real estate deal has a much, much smaller market which makes it significantly harder to unload one of those positions especially at a decent price if you need cash.
If you’re concerned about the liquidity of your portfolio and would like another opinion on it, please feel free to shoot us an email from our contact page. We’re happy to review your investments and give you our feedback.