Industry

The importance of liquidity

Piggy bank standing on blue background. Horizontal composition with copy space. Great use for savings concepts.

Piggy bank standing on blue background. Horizontal composition with copy space. Great use for savings concepts.

Take a glass full of water. Take another glass and fill it up with tomato ketchup.

Now, take two more glasses. Pour water from one glass into another freshly-taken new glass. All the water will get transferred and immediately. Here both words ‘All’ and ‘immediately’ are of essence.

In another freshly-taken glass pour ketchup. Firstly, complete ketchup will not get transferred. Some will be stuck on sides. There will be wastage. Also, it will take time to get transferred.

Liquid investments are those which can be encashed at the earliest with least impact of tax, brokerage or any other incidental cost.

Lower the impact of incidental cost and faster the ability to get encashed the more liquid the investment.

Getting stuck

In June 2015, I received a call from Dr. Sharma from a town on the outskirts of Mumbai. Both his wife and he were medical practitioners. They had established their name as respected doctors; their 16-bed nursing home had the latest equipment and their earnings were good. Their yearly income ran into seven digits. They had total assets worth more than ₹12 crore. These were over and above the house they lived in, their nursing home and other assets of personal consumption. In comon man’s parlance, they were ‘doing very well for themselves.’

Dr. Sharma needed a piece of advice. Their younger daughter was about to go to the U.S. to pursue higher education in September 2015. For her education, they needed about ₹75 lakh. Considering their income and the amount of assets they owned, this should not have been a concern.

However, the problem was with the composition of assets. Of the total investment-oriented assets of ₹12 crore, about ₹10 crore was in the form various real estate properties such as land, office space given out on rent, a large warehouse near Navi Mumbai, etc. Another ₹1.5 crore was in bonds and other products, which had a lock-in period. Only ₹50 lakh was liquid. “I have two options: either liquidate one of my real estate properties, which is worth ₹1 crore or go in for an education loan,” said Dr .Sharma. He was right. He was stuck.

‘Tax saving’ – A culprit

While Dr. Sharma was a wealthy person, even the common man faces this dilemma, several times. For the last three years, Mr. Priyesh Nath had been investing ₹1.50 lakh in bank FDs with five-year lock-in periods to get benefits under section 80C of the Income Tax Act. He knew that he would need funds to make a down payment for the purchase of his house, yet he kept investing in bank FDs, which had a definite lock-in period. “The moment March comes along, I suddenly realise that I have not invested enough to get the complete tax benefit available under Section 80C and then a five-year bank FD is the easiest option,” said Mr. Nath.

Easily cashable

Both the above situations arose due to shortage of liquid investments. Liquid investments are those investments which can be encashed easily. They don’t have any lock-in periods; selling or redeeming them is very easy. For example, to sell any real-estate property is a tedious process and most of the time, the cost of getting our money back is very high. For example, to get our money back from a real estate investment, we may have to pay brokerage and there could be capital gains tax, etc. Once we decide to sell real estate, it will usually take a fairly long time before the entire transaction is complete. On the other hand, the cost of selling shares is comparatively very low and the money gets credited into our bank account quickly. A bank FD is also very liquid.

Maximum v/s optimum

As an investor, while investing, we have to keep in mind the risk-return trade off. Many a times, to get good returns we have to lock-in our funds/investments. On the other hand, if we need money on an urgent basis, such investments turn out to be futile. While making investments, keep in mind your financial goals and ensure that money is available when it is needed. Don’t always go for maximum returns; go for optimum returns.

(The writer is a financial planner and author of Yogic Wealth)


Our code of editorial values

This article is closed for comments.
Please Email the Editor

Printable version | May 20, 2022 7:08:13 pm | https://www.thehindu.com/business/Industry/the-importance-of-liquidity/article38089109.ece