What Is Liquidity? Role of Liquidity in Financial Planning

Suppose one saturday morning, you wake up with a loud sound that seems to emanate from under the kitchen sink. You decide to search along the corridor, and you find a pipe that has been broken, and water is coming out in large volumes. Stress begins to build up – you require a plumber urgently, and such crises do not occur at the most appropriate time on the business calendar. In addition to the water damage, you are now looking at a possible high plumbing cost to repair the damage.

Now, consider two scenarios. First, you have not optimally planned the financial management with the desired flexibility of cash in the form of quick sale assets. You have certain amount of money, most of which are invested long-term. Getting to those funds would not be easy and, in effect, may attract hefty fees and charges. This stress rises a notch higher because of the financial side of the equation given that this is an expense that that was not planned for.

In the second scenario, you’ve built a healthy emergency fund with readily available cash. While the pipe situation is still frustrating, you know you have the financial resources to handle it. You can call a plumber without worrying about immediate payment and focus on mitigating the water damage.

It takes time and proper planning to mold your financial planning, the same as you have to prepare a house to be strong, especially when it comes to storms that are unexpected. This foundation also has liquidity inserted into it, which is the available cash you may need to address short and urgent cash requirements. Let’s understand the concept of liquidity and understand its importance in securing your financial future.

What Is Liquidity In Simple Terms?

The ability of an asset to be turned into cash is referred to as “liquidity”. An asset is considered more liquid if it is simpler to turn it into cash. Most people consider cash to be the most liquid asset. Taking cash out of an ATM or transferring money between bank accounts is easy and quick.

However, cash on hand stagnates and, if left uninvested, even loses value over time. A bank savings account offers a low interest rate in exchange for quick access to liquid money when needed. You may choose different financial instruments that let you grow your money until you need it if you’re seeking a marginally larger return on your investment.

Why Liquidity Matters in Financial Planning?

Financial planning isn’t just about accumulating wealth for the future. It’s also about guaranteeing you have the resources to handle life’s curveballs. Here’s how liquidity plays an imperative part:

• Emergency Fund: Sometimes, things happen in life that you do not expect, for example, bills to pay when you get sick or have a car that needs repairs or loss of a job. Savings are important; at least three to six months’ worth of living expenses should be kept in cash or other highly liquid and readily accessible forms such as a mutual fund for emergency fund which is designed to offer safety and liquidity for unforeseen expenses. These funds make investments in low-risk, highly liquid assets, guaranteeing that investors can access their money fast and without suffering a large loss in value. This way, you are able to navigate through such circumstances without undermining the long-term capital or even experiencing debt.

• Taking Advantage of Opportunities: Sometimes, opportunities arise that require immediate access to cash. Perhaps you will find a great deal in a used car or investment property. Having liquid resources allows you to seize these opportunities and potentially grow your wealth.

• Meeting Short-Term Goals: Financial goals are not just to save and invest up to retirement. Perhaps you are planning to accumulate money to put a down payment on a house or for a dream vacation. Having liquid assets assures you they are available when called upon to help obey the set financial planning map.
• Maintaining Peace of Mind: Knowing you have a buffer of readily available cash can significantly reduce financial stress. It allows you to weather unexpected situations without panicking or resorting to drastic measures.

Role Of Liquidity In Mutual Funds Decoded!

Liquidity is a key component of financial planning since it helps you achieve your short-term, medium-term, and long-term goals. Liquidity is important in financial planning for a number of reasons:

Highest Liquidity

Saving the equivalent of six months’ worth of income in fixed deposits for emergency or cash reserves is often the best course of action. This is just a rough guideline, and the exact amount may vary for different people depending on their own circumstances. In an emergency or situation requiring great urgency, this reserve may be used. Additionally, you can keep the required amount in your savings account to pay for ongoing costs.

Medium Liquidity

If your financial objectives are medium-term, that is, more than a year out but falling within the next five years, you need assets with less liquidity. You can invest in products like debt funds, which offer respectable returns based on your investment tenure, to increase your wealth over the medium term. Investing in debt funds offers several advantages, including a low-cost structure, consistent returns, robust liquidity, and adequate safety.

Lowest Liquidity

Investing is one of the perfect ways through which you can fulfil your monetary objectives, and long-lasting investments are good for this. Though some of the investments are not very liquid, like PPF, ULIPs, and NPS, when we invest more, they even have more growth. These investments are ideal if you want to be saving for a particular goal in the future, for instance, to buy a home, provide for your children’s education, or perhaps for your retirement.

Winding Up!

Liquidity is one of the cornerstones of any sound financial planning and management. Thus, considering your necessities and forming a portfolio with the diversification of the corresponding type of assets, you can guarantee the stability of your financial position and be ready for any occurrences in life. That’s right; financial planning is more of a process than it is a goal. Regularly assess your liquidity needs and adjust your strategy as your life and goals evolve.

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Disclaimer – This article is for educational purposes only and does not intend to substitute expert guidance. Mutual fund investments are subject to market risks. Please read the scheme-related document carefully before investing.