Matt Conradi, Head of Client Advisory at Netwealth, explains how investors need to strike the right balance between maintaining adequate liquidity whilst meeting their long-term investment goals.
In any financial plan cash plays an important role. It is liquid (you can always access it) and because it doesn’t fluctuate in value like other investments it can provide certainty when you most need it.
When we think about different types of assets and their role in an overall financial plan, what we call the Three Pot Theory™ helps us plan effectively: how cash helps meet our short-term incomings and outgoings, and how it fits in with less liquid investments and those which generate stable returns over the medium to long term.
This is how it works. Pot 1 is your ‘daily’ pot where all your short-term incomings (like your salary) and outgoings (bills, living expenses etc.) sit. Pot 3 is your ‘long term’ pot which holds less-liquid, but often emotional investments – our homes, art or private equity. In the long run these investments may generate great returns but they can’t be used to meet short-term cashflow needs.
Therefore, we may often hold more in Pot 1 (cash) so we can be certain we can cover these needs. Yet this can result in us being too cautious, and have a significant impact on our wealth over time.
This is where Pot 2 comes in – holding investments that can generate growth in order to meet our investment goals, but which remain accessible if we need the money in an emergency. Pot 2 is a liquid, low-cost investment portfolio or combination of portfolios. It is made up of equities and bonds designed to provide returns over the medium to long-term.
While investments in Pot 2 will fluctuate in value more than cash, you can choose different levels of risk for different portions of this pot. This gives you control over how much risk you are taking, measured against your specific income and capital needs over your chosen investment timeframes.
Of course, your needs will evolve over different stages of your life. The key is to get the balance right: you need enough cash on hand to prepare for everyday outgoings (and some surprises), but not so much that it impacts on your ability to meet your investment goals.
For information on Netwealth’s cost efficient investment service, visit netwealth.com
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