Managing a Liquidity strategy

Michael Crook, 
CAIA, CRPC


CIO Global Wealth Management


Introduction

At UBS, our wealth management approach organizes your financial picture into three key strategies: Liquidity— to help provide cash flow for short-term expenses, Longevity—for longer-term needs and Legacy—for needs that go beyond your own.

Liquidity strategy in focus: Why is it important?

The notion of survival (i.e. avoiding financial ruin), should be first and foremost in every investor’s mind. Ruin can happen in a wide variety of ways: capitulating during a market downturn, experiencing large unexpected expenses (e.g. healthcare), loss of human capital through disability, job loss or the failure of business ventures, or simply being forced out of risk assets at the wrong time. At its heart, a well-designed Liquidity strategy acts as a barrier against ruin.

At its heart, a well-designed Liquidity strategy acts as a barrier against ruin.


What comprises a Liquidity strategy?

It can be tempting to think about portfolio cash flow as separate and distinct from other sources of income, like Social Security income, pension income, or annuity income. However, in order to provide the best possible outcomes, you should look holistically at your sources of cash flow and how they fit together. There are three main sources of cash flow that together make up a Liquidity strategy:

Stable income

provides stable cash flow that cushions you from
market risk and longevity risk. Examples include
Social Security, pensions and annuities.

Flexible cash flow

provides cash flow with a high degree of certainty while retaining the flexibility to make changes down the road if you choose to do so. Examples include cash, short-duration fixed income, certificate of deposit ladders, and bond ladders.

Borrowing facilities

access to a borrowing facility, such as an asset-backed line of credit, can prevent the need to hold excess assets in cash that could be used in an emergency situation where a large, unexpected outflow is necessary.


How do you actually build a Liquidity strategy?

When you‘re working

Sizing and emergency fund: Determine how long you think it would take you to find an appropriate role in your field during a recession and then double it.

Planned major expenses: We suggest holding all major planned expenses that will occur in the next three years in your Liquidity strategy in high-quality, short-duration fixed income.

Borrowing: We also suggest securing an asset-based borrowing facility in order to handle unexpected expenses in a flexible manner.

When you’re retired

Determine planned spending: Develop a clear understanding of spending needs for the next three to five years.

Match cash flow: Match that spending to sources of guaranteed cash flow and then fill the gap with flexible cash flow strategies.

Replenish liquidity strategy: On an ongoing basis withdraw funds from the Longevity strategy. As a rule of thumb, the general sequence of withdrawal should be taxable assets, then tax-deferred assets, and then tax-exempt assets.

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