I had previously touched on investment policy and ideas for handling a $1M windfall, within this post I gave a relatively detailed recipe for a diversified passive income generating portfolio. More detail here.
Building on this portfolio we will discuss the liquid portion of your portfolio. In my investment policy I dedicate 10% of my assets to liquid holdings.
What is a liquid asset? A liquid asset is anything that can be converted to cash in a short period of time. Cash is the most liquid asset. Other liquid assets include money market accounts, government securities and if you operate a business accounts receivable.
On a company’s balance sheet liquid assets are reported as “current assets”.
The Purpose of Liquid Assets in Your Portfolio Is:
- To allow you to act on opportunities in markets;
- To protect you financially against volatility in markets and holdings; and,
- To protect you financially against unexpected expenses
In liquid assets legal tender is the most desirable because it is supported by the largest established market of available buyers and transfer is simple.
“Cash … is to a business as oxygen is to an individual; never thought about when it is present, the only thing in mind when it is absent.”
– Warren Buffett
In the above example with $1M windfall my investment policy requires that 10% of this, or $100,000, be held in liquid assets. This may seem excessive until you hit a market downturn like we saw this past March with losses exceeding 30%. If you now connect our discussion on the link between profit and loss found here you can see that having liquid assets available to you is critical for absorbing the downturn without being forced to sell other assets at a time when their value has been eroded.
Many people will argue that holding $100,000 in cash is money that is not working for you, and at times when inflation is high that cash will lose value. This is true, and there are several ways to protect yourself from this loss. However, diversification of your financial portfolio is ‘insurance’ or protection against loss. Stocks, bonds, mutual funds, ETF are not insured, your insurance is created by the investment policy.
For our discussion today we will focus on protecting your liquid assets. As your portfolio grows you must have a plan for how to hold liquid assets and ensure they are protected against potential bank insolvency, fraud or loss due to shifts in global currencies.
How Do You Protect Your Deposits?
(it would be preferable if you found a form of posit)
In Canada your deposits are protected, without cost to you, by a federal crown corporation called Canada Deposit Insurance Corporation. In the US this same protection is provided by the Federal Deposit Insurance Corporation, with limits for each country. For the purpose of our examples we will assume you are the sole account holder.
For our $1M portfolio, the 10% liquid asset holding is relatively simple to protect against loss. $100,000 is insured in either country in any Savings, Chequing (Checking), Money Market, GIC, Foreign Currency or CD.
In the US there is protection of deposits as long as you do not exceed $250,000 at any single bank. Your liquid assets can be spread across a variety of accounts in any form and it protected up to the $250,000 maximum as a single institution.
If your portfolio value exceeds $5M and you are holding $500,000 in liquid assets, in the US, you would need to divide these holdings across two banks with $250,000 total holdings in each bank to protect against loss.
For Canadians, there is not a maximum limit attached to your bank. The limits for Canada are attached to a maximum balance in any single account and a caveat that “not every deposit you make at your financial institution is eligible for CDIC protection”. Fine print. In Canada your assets are protected for up to $100,000.
If your portfolio value exceeds $5M and you are holding $500,000 in liquid assets, in Canada, you would need to divide these holdings across five different holdings (insured category) with a maximum of $100,000 in each holding. For example, $100k in Chequing, $100k in Savings, $100k in GIC, $100k in Foreign Currency and $100k in CD. In Canada you are also insured for up to $100k in RRSP, TFSA and your property tax account for a potential total of $800k. Contents of your safety deposit box are not insured unless you purchase an insurance policy.
A Critical Question To Answer:
In Canada, is your bank a CDIC member?
In the US, is your bank an FDIC member?
If you answer no to these questions your liquid assets are not protected if the financial institution becomes insolvent. Move your money and avoid these other Great Destroyers of Wealth.
Additionally, all of our posts in the Financial Freedom series can be found here.
And finally additional content can be discovered on our Youtube channel.
