The Liquidity Bucket

Cash is a vital part of a person's financial plan, but it can be difficult to determine exactly how much is needed and in what form it should be held.

As we've previously discussed, by assigning assets to different "buckets" of wealth, you can better understand and utilise your money to support your intentions.

One such bucket is the liquidity bucket, which is designed to provide access to money at all times for a variety of purposes, including day-to-day expenses, a psychological safety net, large purchases, and opportunistic investments.

This blog provides a framework for building a liquidity bucket, offers questions to consider, discusses strategies that may be useful, and examines common behavioural biases that can influence decision-making.

A Framework for Your Liquidity Bucket

The purpose of the liquidity bucket is to provide financial security and confidence in the face of any unexpected events or expenses. To do this, it is important to identify specific categories of cash needs, including operating cash flow, a psychological safety net, big ticket items, and any desired opportunistic funds.

When planning for retirement, operating cash flow refers to the money needed to cover daily expenses for 2 years, while the psychological safety net is the amount of cash that helps a person sleep well at night. Big ticket items are earmarked for large expenditures or financial commitments in the near term, and opportunistic funds are "dry powder" set aside for timely investment opportunities.

To determine the appropriate amount of cash to keep on hand, it is helpful to ask yourself a series of questions.

For operating cash flow, consider your expected annual expenses, both essential and discretionary. It also worth considering your reliance on investment portfolio income vs secure income (such as from defined benefit pensions), the inclusion of a buffer for one-time expenses, and the liquidity of longer-term investments.

For big ticket items, consider any planned large purchases or outlays in the near term, how flexible you can be with their timing, and any potential inflows that could cover these outflows.

For the psychological safety net, consider the amount of cash needed to feel safe in the face of stock market volatility or other uncertainties, and whether it allows for taking on prudent risk in other investments.

For opportunistic funds, consider the amount set aside for timely investments, the importance of being able to act quickly, and the potential impact on your overall portfolio.

Final Thoughts

Building a liquidity bucket requires careful consideration of your financial goals and needs.

By identifying specific categories of cash needs and asking yourself relevant questions, it is possible to determine the appropriate amount of cash to keep on hand and in what form it should be held.

By regularly reviewing and adjusting the liquidity bucket, you can ensure that your money is being used in a way that supports your intentions.

For a more detailed discussion on this topic, please feel free to contact us. Our team are always available to answer your questions and to help you with any of your financial planning needs. Here’s what we offer: A cup of coffee… and a second opinion.

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