Whether you're helping a family member purchase a home, closing on a new investment property, or getting ready to acquire a business, it's crucial to know how to access cash or quickly convert assets to cash. Ensuring that funds are readily available when you need them—without compromising your long-term financial goals—can be a complex challenge. But understanding the various liquidity management strategies can help you navigate these situations with ease and confidence.
Personal finance
Liquidity management: Your key to financial agility
Personal finance
Wealth management
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Cash investments
"Our clients often come to us asking for help not only to achieve their long-term investment objectives but also to address their near-term liquidity needs," says Massy Williams, CFA, head of Vanguard Wealth Management. "We encourage them to assess all their options to determine how they can meet those needs without significantly hindering progress toward their long-term goals."
When considering liquidity options, the different choices fall within 3 main categories:
- Asset accounts. These are accounts where you've saved money you can withdraw easily, such as bank accounts, cash management accounts like the Vanguard Cash Plus Account, money market funds, and investment accounts.
- Secured credit. These are loans you take that are backed by assets, such as a margin loan, a home equity line of credit (HELOC), and a 401(k) loan.
- Unsecured credit. These are non-asset backed loans, such as credit cards and personal loans.
Let's take a closer look at these liquidity management categories, the various options within them, and the related trade-offs and costs of financing:
Asset accounts
It may make sense to first look at funding your liquidity needs with money you already have saved. Depending on your situation, there are several different options you could consider:
Cash management accounts. Keeping a portion of your wealth in cash accounts provides money you can access immediately. These accounts, which are FDIC insured, include potentially higher-yielding cash management accounts like Vanguard Cash Plus.1
Money market funds. Saving in these professionally managed and diversified portfolios can offer higher interest rates than traditional savings accounts while maintaining liquidity. They're a good option for short-term liquidity needs because the money can be accessed once it's transferred to a bank account.
Investment accounts. Selling some of your investment assets is also a way to fund liquidity needs. Doing this could generate a taxable event, however, so you may want to minimize your tax burden by selling investments with little to no gain from a taxable account.
While some investors consider certificates of deposit (CDs) and Treasury securities to be cash equivalents, these products can impose penalties if the money needs to be accessed before maturity. These products are stores of value, but may not be the best choice to meet short-term liquidity needs.
When considering the trade-offs of financing liquidity needs from your asset accounts, the cost is not having those funds available for other uses. Also, if you're tapping into your investment accounts, it could affect your long-term goals because you're taking that money out of the market. However, selling investment assets may still be a better solution than using credit, depending on the terms for a line of credit and its interest rates.
Secured credit
There are times you may have a liquidity need, but don't have the entire amount required in your asset accounts. Or perhaps you have the funds available, but don't want to deplete a savings account or sell any of your investment portfolio. In these situations, you may wish to consider accessing a secured line of credit through one of these methods:
Investors borrow against their eligible investment assets.
Pros
- No credit check required.
- Flexible repayment terms.
- When an account is approved for use, margin funds can be accessed within a day.
- No loan origination fees.
- Loans are often available in higher amounts, typically capped at 50% of the value of marginable securities.
- Interest may be tax-deductible.2
Cons
If the securities you use as collateral decline in value, you may need to deposit additional money or eligible securities to maintain the required collateral level. If you fail to meet these requirements, we may sell securities in your account, potentially leading to investment losses. In some cases, you could end up losing more than what you initially deposited. Market conditions can magnify potential losses.
Investors can take out a loan against their 401(k) assets.
Pros
- No credit check required.
- Investors pay themselves back in interest on the loan.
Cons
- Reduces retirement savings because the money is taken out of the market.
- Established repayment terms.
- Can take a week or more to establish.
- Loan amount is typically limited to $50,000 (contingent on plan policy).
- If you leave your job, the loan may need to be repaid immediately.
Homeowners can take out a loan against equity in their home.
Pros
- Flexible access to credit.
- Rates can be competitive.
- Rates are typically lower than credit cards or personal loans.
- Interest may be tax-deductible.3
Cons
- Lenders may charge origination fees and fees to keep the line open.
- Setup can take a month or longer.
- Variable rates or payment amounts, in most cases.
- House is used as collateral.
Before taking out a secured loan, consider the available options, review the terms of each loan, and determine which ones have the lowest costs. Besides the interest rates, the costs of taking out a secured loan are that you're increasing your debt load, and the money you'll use to pay back the loan and interest won't be available for other purposes.
Unsecured credit
This third category of liquidity management typically has the highest costs, and, like secured credit, will add to your debt load. The options in this category include:
Personal loans. You can take a loan from your bank with no collateral required and few restrictions on its use. Funds can be obtained quickly; however, the lender may charge origination fees, and the interest rates may be higher than secured credit options.
Credit cards. You can finance your liquidity needs with your credit cards, which don't require collateral and offer immediately accessible funds to be used for any purpose. This type of credit typically has the highest interest rates if the balance isn't paid in full.
"If an investor decides to utilize credit to manage liquidity, it's critical for them to stay disciplined in making the payments and to validate that their monthly budget can support this ongoing expense," says Garrett Harbron, J.D., CFA, CFP®, head of Global Wealth Planning Methodology. "In addition, they should ensure they fully understand the terms of the loan and any additional parameters to monitor during the life of the loan."
A balancing act
Effective liquidity management involves balanced approach. While your asset accounts can provide a solid liquidity foundation, borrowing can offer additional flexibility when needed. However, it's crucial to understand the terms and potential risks associated with credit options. Here are some tips to help you manage your liquidity:
- Assess your needs. Regularly review your financial situation to determine how much liquidity you need and what options are best for your unique situation.
- Minimize costs. Choose the most cost-effective options for your specific needs and try to avoid high-interest or high-risk solutions, if possible.
- Plan for the long term. Ensure your liquidity strategy aligns with your long-term financial goals, such as retirement savings or wealth preservation.
"Liquidity management is the cornerstone of financial resilience," says Harbron. "Maintaining a well-balanced mix of cash and credit options can help you be prepared for any financial situation that comes your way.
To learn more about the liquidity management options Vanguard offers, select any of the links below:
Asset accounts |
Secured credit |
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401(k) loan (contact your plan provider directly) |
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1Your Cash Plus Account may be subject to various restrictions to reduce the risk of fraud. Your transactions may be subject to a 7-day holding period as well as daily transaction limits. Generally, new accounts will be subject to a 60-day holding period for cash and check deposits. During this time, you can invest with this cash, but cash deposits into your account may only be returned to the bank account from which the cash was withdrawn. After the holding period is complete, your funds will be fully available to transfer or withdraw. Bank Sweep program balances are held at one or more Program Banks, earn a variable rate of interest, and are not securities covered by SIPC. They are not cash balances held by Vanguard Brokerage Services, a division of Vanguard Marketing Corporation (VMC); VMC is not a bank. Balances are eligible for FDIC insurance subject to applicable limits. See the list of participating Program Banks (PDF).
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3Under current law, interest is a "below-the-line" deduction and is only deductible on the first $750,000 of total mortgage indebtedness (includes all mortgages). Additionally, for loans taken out in 2018 or later, interest is tax-deductible only if the funds are used to purchase, build, or substantially improve the home.
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