Dubai: Most people work towards building up their net worth, an indicator of financial progress and life status. However, many times people overlook the need to secure their financial journey by focusing only on long term goals, forgetting to maintain an adequate amount of liquid net assets, an essential factor needed to meet sudden rise expenses or when income is ceased.
So, how does liquid net worth matter, you may ask.
Dubai resident and chartered accountant (CA) Praveen Mehta, said, "We need funds for our day-to-day life but keeping provision for unexpected expenses is also a must."
"The liquid net worth provides for this segment of life, wherein funds are kept as cash or in such investments that can be converted into cash immediately within a few working days in times of need," added Mehta, a management practitioner and social entrepreneur.
Investment Advice #1: Have around 3 to 6 months of expenses as liquid assets.
He added that cash and bank deposits are a must for this purpose, where he ensures to have at least 3 to 6 months of expenses in the bank.
"Funds allocated to stocks and gold should be as per the capacity, but the current health crisis has taught us that these are fluctuating assets that one must hold with a two years' time horizon. There could be random rise and fall in the value of these assets so, mentally one must consider only 50 per cent of value as the liquid net worth when invested in such assets."
As a rule, Mehta ensures 25 per cent of wealth (a minimum of 6 months expenses) is kept in liquid assets.
Investment Advice #2: Don't invest in leveraged investments with a very near term horizon.
In the past, Mehta said he was lured into highly risky cryptocurrencies, forex investments, property and leveraged investments. He said, "These were all sold to me with a view of quick flipping, but I realised the hard way that one should never invest in these assets with a very near term horizon."
"Property investment should be for the very long term. Leveraged investments can turn against you and wipe out your entire capital if not invested with the correct outlook."
Investment Advice #3: For short term investments, non-market linked products make a good choice.
Mehta considered non-market linked products as ideal products for short term investments. "Non-market linked is something that does not fluctuate and is kind of guarantee.
“So, the holder can get peace of mind about his wealth. They may give lower returns, but the money is protected and usually available whenever you need it. Hence, good for liquid investments."
Examples for non-market linked products are fixed deposits that can be liquidated or encashed in a day, National bonds which can be cashed in two days, Mashreq Millionaire certificate that can be encashed almost instantly. So these form the liquid funds, he said.
"In the current age of lower interest, this may not be lucrative, but I believe the safety of your own funds is more important than returns. I trust only government or central bank approved banks for holding my hard-earned funds. I understand that anything that comes with a higher return comes with higher risks, so it is best to check and understand these risks before investing," added Mehta.
Financial experts’ advice on maintaining and improving your cash liquidity:
• How total net worth and liquid net worth are different?
Your total net worth is everything you own minus everything you owe.
Total net worth includes cash plus short and long term assets such as equities, bonds, houses and cars minus the liabilities (mortgages, loans, credit cards etc), noted UAE finance coach Carol Glynn. Total net worth also includes retirement investments and property, which are not easily converted into cash, she added.
Your liquid net worth can also be explained as the amount of money being held in cash or cash equivalents after deducting liabilities from the liquid assets.
The liquid net worth is very similar to net worth. The difference is that it doesn't account for non-liquid assets like real estate, long term assets or any assets, which may not be sold immediately (within 24 to 48 hours) for cash, explained Khetra Reddy, senior wealth architect at Dubai-based financial advisor Elixir Wealth.
"Usually cash in the account is the best form of the liquid asset as the accessibility of the same is very high. At the same time, money market funds, jewellery or a fixed deposit with the bank are also very much considered as liquid assets."
"People must be disciplined while planning for their investment, spending and taking up any debt. It's easy to get a credit card or take up personal finance, but these erode the net liquid net worth," Reddy added.
So, how to calculate liquid assets?
The formula: Liquid asset – liabilities or taxes in that asset = net liquid net worth
For example, let's assume you have Dh100,000 in cash, Dh200,000 in money market fund and Dh100,000 in a encashable fixed deposit. If these are your only liquid assets, the total sum of your liquid assets is Dh400,000.
If you owe Dh10,000 in credit card debt and Dh50,000 in other loans, the total sum of your liabilities is Dh60,000. Subtract that from Dh400,000 [400,000 – 60,000] and your liquid net worth is Dh340,000.
• How much is ideal for keeping as a liquid asset?
Investment Advice #4: Keep 20-25 per cent of your money in liquid assets.
If you have Dh100, it is good to keep 20 to 25 per cent of it in liquid assets that can be converted to cash easily in about 2 to 3 days, opined Mufazzal Kajiji, head of Mashreq Gold and executive vice president at Dubai-based privately owned bank Mashreq.
Typically, 10 per cent can be in the bank in savings and fixed deposits (FD), and the other 10 to 15 per cent can be invested in shares, mutual funds and so on, he added.
"These assets are important when you need money to meet some unexpected or emergency expenses. For instance, if you need Dh100,000 to pay the bill for a medical emergency but don't have that amount lying in the bank, you need to generate that cash by withdrawing funds from FDs or selling shares and mutual funds. Investments like shares and mutual funds are cashable in quick time, but you may have a capital loss in doing so.”
“When you invest in shares, you may expect to lose some capital because its value may be fluctuating and could be down 10 to 20 per cent due to market volatility. Hence, when you want the capital to be safe, then the options are fixed deposit, bonds where you can earn interest, and the capital remains more or less stable is an ideal option."
People must realize that big expenses can come up suddenly, and when they do, one needs to fall back on their liquid assets to meet those expenses, he added.
Investment Advice #5: Being mindful of time horizon is crucial when making investments.
Kajiji said when investing, be clear on your money needs and don't base your investment decision only on the potential return you think you can get.
"If you are investing in a product that is saying it will give you a return of 10 per cent per annum that is fixed over five years, but you come back in six months because you need the money. In such a case, to get the money, you will not get 10 per cent return and may even lose a bit of your capital."
He emphasised understanding the liquidity terms and conditions is a must when investing for a fixed period. "The common mistake that investors make is that they don't keep time horizon in mind."
Investment Advice #6: You must plan thoroughly on your long term objectives.
Kajiji said when your goal is to buy a fixed asset like a villa or apartment, you must know that it cannot be sold and converted to cash within a short time. Therefore, when investing in those types of asset classes, you must have a provision of 5 to 10 per cent made in liquid assets, so you don't have to distress sale the real estate in times of emergencies, he added.
• Why knowing your liquid net worth truly matters?
Investment Advice #7: Know how much cash you have to live on, should your source of income cease.
Giving an illustration, Glynn explained this; “If you have cash in the bank equalling Dh50,000, a car without a loan that you can easily sell worth Dh60,000, a credit card balance of Dh10,000, In this case your liquid net asset worth is Dh100,000 [Dh50,000 + Dh60,000 – Dh10,000].”
"If your living expenses are Dh20,000 then you now know if you lose your income, you have five months in liquid assets to carry you over until you run out of money [Dh100,000 / Dh20,000]. It is important to know this number as this is an indicator of your short term financial security."
Investment Advice #8: You may not save enough to provide you with financial security if there is a lack of financial clarity.
Glynn further added that you will not know how many months of living expenses you have access to in times of financial crisis without knowing your liquid net worth.
"This is risky because if you lose your income, you may not have access to enough money to support yourselves until you find a new source of income."
She added that having lots of illiquid assets such as property or fixed-term deposits may generate wealth, but it cannot help you in a short-term cash-flow crisis.
“Many a times, when you are unaware of the risky situation, you will not have the motivation to provide yourself with financial security.”
"If you have large amounts of liquid assets such as cash that you are not investing, then knowing the liquid net worth number may motivate you to make better use of the cash and start investing. For example, if you see you have 18 months of expenses sitting in cash, you can decide how much you need to remain liquid to provide financial security and invest the excess."
Glynn recommended investing in equities or redeemable bonds. “Equities and redeemable bonds can be liquidated on demand, but you need to bear in mind that they will increase and decrease in value. So, if you need the cash urgently, you may need to sell when the valuation is lower than you purchased it."
When the issuer calls its bonds, it pays investors the call price (usually the face value of the bonds) together with accrued interest to date and, at that point, stops making interest payments.