The Importance of Liquidity

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Introduction

In this article we are going to look at the subject of liquidity and how this can impact a person’s financial planning. Liquidity simply means how easy it is to sell an investment or asset into readily available cash that can be spent.

Sometimes, for new clients, when we are reviewing their existing assets, we notice that there is a liquidity issue. This can happen in a number of ways and can cause significant impact.

I have set out below four recent examples.

#1 - Fixed Term Cash Deposit

In this example, a 2 year Fixed Term Cash Deposit was rolled over into another Fixed Term Cash Deposit with a similar term but a much lower interest rate. The client missed the maturity letter that was issued. The problem is the Building Society in question won’t allow access to the money until the end of the term.

#2 - Structured Products

In this example, the client invested into a Structured Product with a seven year term and will need to wait until the end of the period to get their money based on the terms of the contract. Some Structured Products (known as Auto-calls) can pay out earlier if certain conditions are met and, in some cases, there is a secondary market albeit the spread (the difference between the selling and buying price) can be relatively high.

#3 - Non-Standard Investment in a Pension

As Self-Invested Personal Pensions (SIPPS) became increasingly popular over the last ten to15 years, so a number of smaller SIPP providers sprung up allowing more esoteric investments to be held within their SIPPs. In some cases these investments were illiquid and ultimately failed subsequently being valued at zero.

This can be particularly challenging if someone is going through a divorce and a Pension Sharing Order is placed on the person’s SIPP. Let’s say the ex-spouse is expecting 50% of the value of the SIPP, however, there is no liquidity to fulfill the Pension Sharing Order and the investment ultimately falls to zero. Ideally, the illiquid nature of the underlying investment would have been picked up when the Pension Sharing Order was drafted and alternative arrangements could have been made.

#4 - Enterprise Investment Schemes (EIS)

These are investments into small companies and start-ups and come with a number of tax breaks. They are also high risk and often have high failure rates and typically the shares cannot be sold until there is a liquidity event. This is usually as a result of a trade sale or, in a small number of cases, a listing on a stock market. In can take several years before a liquidity event can take place and this is in the hands of the management team and not the investor.

Financial Planning

When someone has a need for liquidity, often this can be pre-planned and so having a well- designed financial plan in place is critical for achieving this.

When a new client has a disparate collection of investments each one needs to be reviewed, not only to take into account charges and performance but also for liquidity and how this fits in with their overall financial planning goals and objective.