To manage liquidity is to move money around so that expenses and spends that do not fit into our regular income are easily funded. It may be worthwhile allocating some portion of savings to liquid assets, but an investment that features high liquidity may also face market risks.

For example, equity shares can be sold at short notice, but the market price may not be favourable when they need to be disposed of. These assets should, therefore, be liquidated only during emergencies, when all options fail. A portion of the portfolio can be maintained in income-earning investments that can be liquidated at short notice and carry low risk. For instance, an ultra short-term debt fund can generate steady, low levels of return, and redemption proceeds are paid out in one business day.

Any unutilised balance in the savings bank may be the easiest and most convenient way to ensure we have cash when we need it, but it has a high opportunity cost. For the convenience of allowing access to funds at any time, banks offer the lowest rate of interest on savings bank balances. If we use a credit card for sudden, unexpected expenses and pay the entire balance when the bill is due, we actually get the bank to fund our short-term liquidity needs at low or no cost. We need to see this as a tactic to utilise the credit limit at low cost when needed. The cost will convert to the highest, if we do not pay back on time.

It is important to see that borrowing is a valuable tool in managing liquidity. If we all decided to save and accumulate money before buying a home, car, holiday or a gift, we would be poorer, both in terms of the wealth we can build and the joys our incomes can bring.

There will always be demands on our income that are lump sum and large, which require arranging for liquidity, borrowing being a key choice. When we build our assets, we need to keep this need in mind, so we have the flexibility to draw on the value of the asset to generate funds we can use now and repay later. A loan backed by an asset is secure and comes at a lower cost compared with an unplanned, ad hoc, unsecured borrowing. Personal loan, including credit cards and all types of unsecured loans given to individuals, are the most expensive since they have a high risk of default for the lender.

Source: Economic Times