Liquidity can have varying definitions based on personal experience or financial know-how. Some view liquidity as the ability to control or access money. Want to move money from your checking to savings account at the bank? No problem. Eager to make investment changes to your IRA or 401k? That can be done easily too.
Others deem liquidity based on the ability to sell an asset and receive funds in a certain time. Want to get cash in 30 days or less? You can sell stock and have the proceeds available in a matter of days. But there are assets that you own where that sort of turnaround just won’t do. Take Social Security for example. Can you contact the Social Security Administration and ask them for the present value of your lifetime benefit? Of course not! They’re scrambling to find the dollars just to send your monthly check. That’s a joke – at least for now. But using this definition of liquidity, we would say your monthly Social Security benefit is illiquid.
The ability to transfer, change investments, make withdrawals is all well and good, but for the typical retiree, the definition of liquidity is deeper than that. Any retiree that is close to or already retired understands that the dollars they’ve saved for retirement are not free and clear to do with whatever they please. These dollars are tied to a particular purpose. They will be spent to provide for their lifestyle this year or some year in the future.
Let’s look at a couple of examples to provide some color to this idea.
Our first scenario involves a retiree who is very concerned about any risk to their retirement savings, choosing to put everything in cash or cash-equivalents. This retiree has saved $1M to supplement his income in retirement. The amount he needs each year is $50k. Doing some quick math, he has 20 years’ worth of income-supplement set aside.
Our retiree goes on a fishing trip with a friend. Near the boat launch, they see a boat and trailer sitting with a “For Sale” sign on it. They get out to take a look and find that the owner is asking $50k. Now, using our broadest definition of liquidity, we know that this gentleman has the funds and they are accessible. He could write a check today and be handed the keys. While this is technically true, the decision is much deeper than that – or at least we hope it is! To start hooking this boat and trailer to his truck, he needs to be fine with losing a year’s worth of income. Then, he could ride that boat into the sunset of a 19-year-long retirement!
Our second scenario is a little more nuanced. Let’s say we have a retiree who is more accepting of investment risk. She has $500k in retirement assets and would like to enjoy $25k a year in supplemental income. Her goal is to leave the principal to her 4 grandchildren to provide tuition for their college education. She invests her assets in such a manner that gives her the best shot at realizing a 5% rate of return each year.
This retiree steps into retirement, and for the first couple of years, things go better than expected! She’s taken income from her savings and still has more than she started with. Excellent! The next year, markets are flat and produce a 0% return. She’s unsettled because after taking income, she’s dropped below her starting point. She decides to stick with her investment allocation, again, shooting for a 5% return. Unfortunately, the following year, markets don’t improve and dip into negative territory. Her portfolio is down 17% for the year. She’s only 4 years into retirement, and her portfolio is nearly $400k! Understandably, she wants to stop the bleeding. In theory, she could sell some or all of her investments and park things in cash. But she understands that doing so will also eliminate the ability for her assets to recover. A portfolio of cash can’t produce the return figures she’s looking for. And keeping things in cash means that her retirement withdrawals will cause her principal to shrink gradually over time, making the financial gift she hopes to leave behind smaller and smaller. She’s at a major crossroads. Does she abandon her original legacy goal in preference for less market-related turmoil? Or does she tough it out, hoping things improve?
In each of these scenarios, we see the liquidity illusion. Our fisherman is faced with giving up a year’s worth of income in retirement to purchase a boat he would love to enjoy. Our grandmother is forced to decide between taking an investment approach in retirement that could provide the income and legacy she hopes for, or a less risky path with steady income but a financial legacy that may or may not materialize for her grandchildren’s benefit. In each scenario, the dollars are there and accessible, investment changes can be made – broadly speaking, their money is “liquid.” But the financial decisions these retirees make come with a consequence that affects their entire retirement income strategy.
We can see from these examples that there is a deeper definition of liquidity at stake. The question then is how retirees reach true liquidity. The sort of liquidity where their retirement income strategy is sheltered from major changes related to investment strategy, changes in life circumstances, new goals, etc. This sort of liquidity is reached only when a retiree has an income system where lifestyle will not be impacted.
This may sound unachievable, but for many of our clients, it may be well within reach. The adjustments necessary, though, seem counterintuitive. It starts with identifying a retirement income amount that is higher than you expected. That’s right. Many retirees are bringing in less monthly income than they actually need or have settled into a lifestyle that is disproportionately lower than what they’ve saved for retirement. It seems crazy, but this preservation approach is deeply ingrained in our human nature. And the ironic result is that less liquidity is created.
How? If a retiree has a $50k/yr retirement lifestyle but a $5M IRA account, they would never pay cash for a $1M house at the beach. Why not? This scenario meets all definitions of liquidity that we’ve mentioned. Not only is the money accessible, but their retirement lifestyle would be unchanged by this financial decision. But for this retiree, such a purchase is inconceivable! Their spending behavior relative to available wealth shows that their retirement savings are for apocalyptic situations only.
That’s why the first step toward reaching true liquidity in retirement starts with building an income strategy that may exceed what you thought possible! And that’s just the start.
