Welcome to
"StockBreakthroughs Newsletter"
August 19, 2005.
In this issue...
The Importance of Liquidity and Liquid Assets.
The term liquidity refers to how fast something can be turned into cold, hard cash (the
kind you stick in your wallet). Liquid assets are those that are thought to be turned to
cash immediately.
On one extreme of the scale are the dollar bills and change you have stuffed in a cookie
jar or mattress at home. These are the most liquid assets (meaning you can immediately
spend them), but the least safe. On the other end of the scale are assets such as real estate, which can take months or even years to convert into cash.
When seeking liquidity, there are several places you can stick your cash. They include:
· Your house (hopefully well hidden)
· A savings or checking account.
· A money market account.
Money markets are for borrowing and lending money for three years or less. The securities in a money market can be government bonds, Treasury Bills and commercial paper from banks and companies.
· Short-term certificates of deposit.
These are debt instruments issued by banks and other financial institutions to investors. In exchange for lending the institution money for a predetermined length
of time, the investor is paid a set rate of interest. Maturities on certificates of deposit can range from only a few weeks to several years with the interest rate earned by the investor increasing in proportion to the time his capital is tied up in the investment .
In most cases, depositing your money in a bank is considered extremely safe. Money
market funds can cause problems because, in the event yours is administered by a mutual
fund company, you may lose access to your cash if the financial markets shut down, which
is precisely what happened to many investors on September 11th. After the September 11th terrorist attacks, the American financial system was shut down for four days. With stock exchanges closed, investors learnt the importance of liquidity after they temporarily lost access to their cash and investments.
For emergency purposes, you should not consider stocks, government treasuries, annuities
or insurance policies as liquid assets. In addition to normal market fluctuations, these investments may become completely illiquid if the exchanges are closed.
Why should I keep liquid assets?
Even if you don't own any investments, you still need a cash reserve. Why? Think back to 9/11. Once Manhattan was shut down, many businesses could not operate. In some cases, employees were not paid for several weeks, leaving them without a source of income.
What if there was a tragedy or extraordinary event in your area and you suddenly couldn't report to work? Taking the scenario one step further, what if such an event caused your company to run into tough financial times and it either closed its doors or started laying off most of the work force? How would you survive? If you had realized the importance of liquidity, you would be able to stay afloat for at least several months using your cash reserves.
What degree of liquidity should I personally maintain?
The level of liquid assets you should keep on hand largely depends upon your estimated monthly expenses. In all cases, you should be able to support yourself and family for at
least a month or two; most financial planners agree that six months is ideal. It's important
to remember that national emergencies are much less likely than personal emergencies
such as car repairs, layoffs, washer and dryers falling apart, etc. Having cash on hand will allow you to stay the course with far fewer worries.
Yours in Successful Trading,
Ricky Schmidt
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