When it comes to financial planning, we are often trying to determine the most efficient way to reach our financial goals. Goals to retire on time, maintain our preferred standard of living, and care for those we love along the way. All of us have to make tough decisions on how we commit our limited resources toward achieving our goals. We find the most overlooked part of financial planning is liquidity.
You’ve seen articles on the benefits of long-term, principled investing. Your relatives, friends, and others have mentioned the significance of spending less than you make. What you don’t hear, though, is that sometimes it makes sense to pump the brakes on your long-term investing to ensure you have enough liquid assets to fund your pre-retirement goals.
This is clearly seen in the following example of a young couple who was eager to get on the right track financially:
Tanner and Tyla met in college and were engaged halfway through their senior year. They had both grown up with parents who emphasized the importance of making good financial decisions. After college, Tanner and Tyla spent the majority of their savings on a wedding. Returning from their honeymoon, they decided that they would contribute 4% each to their company retirement plans to secure a matching contribution and max out their Roth IRAs. Tyla’s job offered to cover the cost of health insurance if you chose a High Deductible Health Plan so they also wanted to contribute to an HSA – something Tanner had read was a must.
By living off of Tyla’s income and saving the majority of Tanner’s, this young couple was able to build an emergency fund of 3 months of their total living expenses, pay off a few thousand dollars of lingering student loans, and max out both of their Roth IRAs. By the second year, they were on track to Max out Tanner’s 401(k), both of their Roth IRAs, and the family maximum contribution to Tyla’s Health Savings account. When it came time to purchase a car for Tanner, they were able to obtain a 3.9% interest rate on a 5-year car loan, and although they talked about using some of their savings, they ultimately decided their funds were better served invested.
Up until this point in their marriage, they had been content renting due to the increased housing cost in their neighborhood. Renting offered flexibility, maintenance, and peace of mind, and they loved their apartment’s amenities. Upon realizing that Tyla was pregnant, they began discussing a home purchase. Tanner and Tyla didn’t like the thought of putting less than 20% down on a home, but they also felt uncomfortable dipping into their emergency fund. They still had the car loan, the anticipated cost of childcare decreased their ability to save as much every month, and they had no other sources of savings they could tap into. Tanner had read they could withdraw their Roth IRA contributions without penalty, but the HSA and 401(k) accounts would tax and potentially penalize them for withdrawing. As you can see, Tanner and Tyla’s desire to max out their retirement accounts early in their relationship was rooted in a knowledge of compound interest and a desire to get ahead, but their financial hurry resulted in a lack of liquidity that is forcing them to delay the home purchase until they can accumulate enough for a down payment.
Now, is delaying a home purchase catastrophic? Of course not. However, overlooking a major short-term goal caused Tanner and Tyla to misallocate their resources. The goal of financial planning is to put a checkmark next to EVERY goal, not slam dunk some and fall short on the rest.
No matter who you are, the ability to access a portion of your investable wealth can prepare you for the intermediate goals you have between now and retirement. We often recommend supplementing your retirement account savings with contributions to a brokerage account. Brokerage accounts, unlike retirement accounts, do not have restrictions on when you can access the funds, and although they are not tax-advantaged, they do provide much-needed flexibility.
Lack of liquidity can be the result of good things in your financial plan, like a pension or investments in real estate, but at the end of the day, accessible wealth is the oil that keeps your financial engine running smoothly. Without a plan that includes liquidity, you can only build wealth you can’t touch.