Liquidity when used as a financial term is a way to describe how easy it is to convert an asset into cash. Money in your checking account is considered very liquid because with just a swipe of an ATM card at your local bank branch, you can have immediate cash in hand with no fees. On the other end of the liquidity scale, you might find your real estate holdings. Your property may be of great value, but selling it will normally take weeks or months, and require you to pay commissions, fees, taxes, etc. that will reduce some of the asset’s value. Furthermore, a weak real estate market may force you to hold off on selling that asset for a few years until the market recovers. Real estate is not liquid.
Often you will find that the best earning investments are the least liquid. Banks and insurance companies will usually pay more interest on money they can count on having in their vaults for longer periods of time. This is why the best financial strategies always include a mix of liquid short-term investments and less liquid longer-term investments. We all need money for day-to-day living, but we should also leave some money untouched so it can earn interest and grow.
When evaluating the liquidity and access to your money, it’s important to determine how much liquidity your situation requires. Most financial products allow access to 100% of your current balance, but liquidity is determined by the cost of withdrawing that money from your account. Liquidity costs are usually realized as commissions, fees, penalties, and/or taxes.
Some financial products like bank savings accounts offer 100% liquidity without any cost and other products like Fixed or Fixed Index Annuities during the surrender period offer fee-free liquidity up to a specific percentage of your account balance (often 10% per year).
Determining how much liquidity you require begins with defining why you need liquidity at all. Some investors truly have a need for 100% liquidity of their funds.
Example: Bob has $100,000 to invest today, but plans to use all $100,000 of that money to help his daughter by a new house in 1-2 years. Bob will need 100% liquidity after one year.
However, some investor’s liquidity requirements are not “full balance liquidity”. They require liquid access to their funds mainly for everyday emergencies like a new water heater, car repairs, or unexpected medical expenses. In these situations, it is unlikely that they will need liquid access to all 100% of their investment.
Example: Mary has a fixed annuity with a 10% free-withdrawal allowance and a $200,000 balance. During Mary’s surrender period, she is unexpectedly hit with an $8,000 roof repair expense. Mary will be able to withdraw up to $20,000 from her annuity without incurring any penalty fees. In this case, the annuity provided enough liquidity for Mary’s home repair expense and still has liquidity left for Mary to use for future emergency expenses. Mary will continue to have access to 10% of her annuity funds per year during her “surrender period” (usually 7-10 years), then she will have access to 100% of her annuity balance, fee-free after her surrender period ends.
*Some financial products including many Fixed and Fixed Index Annuities allow for 100% fee-free access to your funds in cases of catastrophic illness or death of the annuitant. In these emergency situations, you have full fee-free access to your funds.
Finally, the money invested in a Fixed or Fixed Index Annuity is never at any time locked away from you. You will always have access to your funds. If you do come across a situation where you need to withdraw an amount above your free-withdrawal limit, you can do so, but you may be subject to surrender fee charges.