401(k) Financial Planning Retirement Income Retirement Planning

True Liquidity Versus Allocation Liquidity

Two hydrogen atoms to one oxygen atom and you get an amazing substance! H2O, AKA water, is a shape shifter. It can be a gas, invisible to the eye. Physically harmless to touch. It can be a solid when frozen into ice. Get wacked with that, and OUCH! Leave your hand on it too long and it’ll turn blue! Don’t forget the form it takes that most of probably think about when we hear its name. As a liquid it must be contained in a vessel otherwise it will run all over the place and eventually disappear back into thin air.

You may have heard someone say, “I want to keep my money liquid, I don’t want to tie it up.” Maybe that someone was you. The desire to keep our money liquid seems to be strong across all social economic and political spectrums. Why do we insist on keeping our money in a liquid state? What does that really mean, to keep your money liquid?

Perhaps “liquid” for most people translates into CHOICE. When my money is liquid, I have choice. When I “tie it up” it seems that I’ve given up choice. I no longer get to decided what I want to do with it, when I want to do it. Whatever that might be.

Think of your money as water. It must be kept in some sort of vessel. Bank account, brokerage account, or coffee can, if your money isn’t confined to a vessel you might find it running all over the place, and eventually disappearing into thin air.

That being the case, if I keep money in a coffee can is it really liquid? Do I have the choice to do anything I want with it whenever I want to? Maybe, then again, maybe not.

It all comes down to timeline and purpose. What is the purpose for the money, and in what time frame do I need it to be available for that purpose. In other words, does the coffee can provide me true liquidity, or just the illusion of access and choice, AKA allocation liquidity?

Let’s start with a latter. When someone says, “I don’t want to tie my money up, I want to have it liquid,” most likely they are referring to having the flexibility of choice to choose one container over another in which to hold their money. They don’t want anything with a lid on it. Anything resembling a time capsule is completely out of the question! They want to be able to pour it into something else that they might perceive to be a better basin for their dollars if the opportunity comes up.

 Savings accounts, for example, are considered liquid. You can draw on that bank account whenever you feel like it. You can also pick up one account, and transfer all of the money inside of it over to another account. Ask folks if this money is liquid, and most would likely say, “yes.”

Perhaps you like mutual funds. You can choose to buy one mutual fund today and sell it tomorrow to buy another one. Or you could sell it and do something completely different altogether. In this case, your money may feel liquid. It has the illusion of choice and flexibility. …But is it really “liquid?”

On the other hand, vessels with penalties for making early withdraws are considered to be illiquid. Real estate for example, depending on the market, may be very illiquid. It may be difficult to find somebody to buy what you own, let alone for the price you want. Limited partnerships are also considered to be illiquid. They may be very difficult to liquidate in order to move your money somewhere else. Deferred annuities may also be considered illiquid because they often carrier steep surrender penalties that may be applied when excessive and early withdrawals are made. All of these aforementioned vessels for containing money are considered to be illiquid.

What if you subscribe to the theory that every dollar has a purpose and every dollar has a timeline, as we do at Triplett-Westendorf Financial Group. Then what I’m about to say may not shock you. However, for some of you this may be a new concept to wrap your arms around.

Although someone might keep money in place that was previously described earlier as liquid, it may be just an illusion! For example, money in a savings account is liquid, right? Or is it?

If I intend to buy groceries with it tomorrow to feed my family and myself is it still liquid? What about the money that I keep in a bank money market account because I want to be liquid, but I intend to use it to purchase a new car in the next 24 months. Is it liquid too? Lastly, what about the retirement savings specifically set aside to cover retirement expenses 20 years from now. I’ve been keeping it in a portfolio of mutual funds and stocks because I want to keep it liquid, but is it? Could I spend it on a new sports car without any repercussions to my future lifestyle?

Cars not your thing? Me neither! I love floating fiberglass, and internal combustion engines! What would happen if I took that same dollar that was intended to cover retirement expenses 20 years from now and instead, I used it to buy a really cool boat today.  What would happen to my older wiser self 20 years from now? How would that impact my ability to retire, how I want and when I want?

If my resources have been designated with a specific purpose, and a timeline, no matter how near or far it may be, those dollars are not truly liquid. What I do have is the illusion of liquidity. I have ALLOCATION liquidity.

I have the choice to allocate those dollars amongst many different investment and savings vessels. I can contain it, but I cannot spend it, without future repercussions to my desired lifestyle.

Maybe your saying, “OK, smarty pants what is true liquidity?” Fair questions. I’ll fill you in. True liquidity is having the freedom to consume or to not consume, to spend or not, on whatever you want whenever you want without any consequences to your future desired lifestyle or legacy.

True liquidity means that you can spend or give a particular dollar because it either has a fuzzy purpose or no purpose at all. It has no definite timeline either. Dollars that are truly liquid will never be needed to maintain your desired lifestyle. They are excess resources. They are more than what you actually need for spending purposes throughout your life.

True Liquidity is freedom. It is absolute choice! When you have accumulated enough resources to cover current and future expenditures throughout your lifetime, and leave the legacy that you want to anything left over could be used for whatever you want. That freedom to choose, the “whatever you want, “is the hallmark of true liquidity.

How do you get more true liquidity in your life? “Free the hostages! That’s how my friend Curtis Cloke describes it. “What? Hostages? Yep, hostages! What does it mean to free the hostages?

Many folks during retirement, and often their advisors, are holding retirement assets hostage in places that appear to be liquid. They have allocation liquidity. However, they can’t really spend the retirement assets without future consequences.

For example, let’s examine a 65-year-old couple with $1 million in retirement dollars. They plan to draw retirement income over a 30-year timeframe. Their advisor recommends they apply the 4% rule first introduced by William Bengen in 1994 to an asset allocation of stocks and bonds. The widely adopted “rule of thumb” known as the 4% Rule has represented the benchmark for a “safe” withdrawal rate in retirement planning for decades.

4% on $1 million equals $40,000. That means the initial withdrawal from this strategy would be $40,000 adjusted for inflation.

How safe is the 4% Rule? It may not be as safe as once thought. Recently, because of historically low bond yields and high stock market valuation along with an increase in volatility the 4% rule has come into question.

Several prominent studies have shown the rule to have a failure rate as high as 50%. Meaning that a retiree following the rule may have a 50/50 shot of not running out of money over a 30-year period. I don’t know about you, but if the jet plane I’m taking from Des Moines to Denver has a 50% shot of making it, I’m not getting on it!

Perhaps the safe withdrawal rate should be 3% or maybe less. The percentage of assets that may be safely withdrawn is debatable. However, what is not debatable is that the strategy holds retirement assets in a state in which they are not truly liquid because they have already been assigned to cover a future obligation.

Is it possible to free the hostages and create true liquidity? Perhaps. Leveraging mortality credits may help. What? Mortality Credit? You made that up Mark!

No, seriously. It’s a real thing. It happens when people in a peer group pool risk. Risk pooling with other retirees in a similar situation may free up money to be used for whatever, whenever. Mortality credits in simple terms are “other people’s money.” When a group of retirees pool their risk of living too long it is inevitable that some will die sooner and others live longer. People who die early help pay for people who live longer than expected. The net effect is that everyone enjoys a higher income for life today than what they could have achieved without risk as individual investors. Phrased differently, the risk of outliving your income is neutralized and it cost a fraction of what it would cost an individual investing in portfolio of stocks and bonds.

What does it cost today to produce a lifetime income stream equal to $40,000 for a 65-year-old male? It’s about $650,000, or about 65% of the retirement assets. That creates $40,000 of lifetime income with a guarantee that at a minimum all money paid for the promise of income for life will be refunded to the spouse if the man dies prior to receiving 25 years of payments.

What are the chances that the man who owns the income stream outlives his income? Zero. Not 50% failure rate, but 0% that he outlives his income. Would you board a plane that has a 0% chance of falling out of the sky? I would if it was going somewhere cool like Retirement Island!

Implementing a strategy like this would leave $350,000 left over. We know some of the money will have to be used to hedge inflation. Some of it might be used to create a legacy. However, there’s a potential for some of it to be truly liquid and used however and whenever.

Giving up control of some retirement resources may be scary for a lot of folks. However, other than the decision on where to allocate it while you wait to consume it, future obligations in today’s dollars aren’t really liquid. They just have an illusion of liquidity!

Once you come to grips with the fact you really don’t have absolute control over a large portion of your retirement resources it may become easier to take actions that will benefit your overall retirement income plan. You might even be able to create true liquidity. Is it time to free some of your hostages?

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