The mix of your assets and your level of liquidity are interrelated. Personal or household liquidity represents your ability to cover current and near-term expenses with available cash or easily convertible assets. Understanding the relationship between your assets and expenses helps in financial planning, including assessing how to manage your cash savings.
The higher your personal liquidity, the more capable you are of meeting near-term financial obligations. The basic formula to compute your personal liquidity ratio is total cash assets divided by typical monthly expenses. If you have $16,000 in cash assets and typical monthly expenses of $4,000, for instance, your ratio equals $16,000 divided by $4,000, or 4.0. This essentially means you have enough cash to cover expenses for four months if you were immediately laid off from your job.
Having an adequate cash cushion, or rainy day fund, is often a first financial goal for individuals and couples. A December 2011 Bankrate.com article indicated that only 24 percent of Americans had an "adequate" financial cushion and another 24 percent had no emergency savings. The ability to cover your expenses for several months after a job loss helps you protect against debt reliance, delinquency and foreclosure.
Your level of liquidity is based on how easily you can convert assets into cash to cover expense needs. Cash itself is the most liquid asset. Personal checking and basic savings accounts that have no withdrawal restrictions are very liquid. Money market accounts which limit you to six monthly withdrawals are slightly less liquid but still easily convertible. Longer-term investments, such as certificates of deposit and stocks, which have penalties or negative financial repercussions for early conversion aren't as liquid. Tangible assets, such as homes and cars require more effort and time to convert to cash.
How to Save
A key concern in financial planning is where to put your money to balance liquidity with investment returns. Typically, you want to have six to 12 months of easily accessed cash in savings or money market accounts. These accounts have low interest returns -- they were just a fraction of a percentage point as of 2013. Once you achieve a liquidity ratio that makes you comfortable, you might consider less liquid investments in real estate or stocks, which have greater potential for returns but also more risks.
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