The Illusion of Liquidity – Episode 570

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[00:01] Welcome to the Prosperity Podcast. Prosperity thinkers, we’re going to be talking about the illusion of liquidity. And this is something that as I read in books, as I talk with others, the more questions you ask, the more you can see that they don’t really understand. So Kim, at the end of this episode, we’re going to be crystal clear. Our listeners are going to know what liquidity means, why cash and access to it quickly is important, especially right now because of all the volatility in the market. So first, let’s do a definition. Let’s define, let’s get the language correct, liquidity. What does that mean? One to ten days dollars ready to be redeployed in your checking account. That’s what liquid means and unconnected to any economic event that would go on.

[01:09] In other words, it is not liquid if it’s in the stock market and the stock market is down and so you don’t want to sell. That is not considered liquid money. OK, let’s add in a couple other layers here because I’ve got to play devil’s advocate on this. So as far as the seven to ten days, who do you need to get permission from to have it a liquid asset? Well, that’s a great question. So if you have to get permission, then that person can say no. And so this is a great example of home equity lines of credit because the bank can say no. The bank can take your line of credit away. The bank can call the line of credit if you already have debt on it. And that is an excellent example of the illusion of liquidity.

[02:03] First of all, I would challenge that really equity, which is money in the walls of your home, is liquid at all. But if you think it is because of this line of credit, it may very well be, but it may not. And so that does not qualify. OK, how about this as far as liquidity having to fire sell assets? Where would that sit? Well, far sell means you don’t get to sell them for their full value because you have to sell them fast. And so that does not count either. A fire sale also is not guaranteed to happen. We’ve got a family situation where the home needs to sell in May. Well, we’re midway through the second week of May and it’s not happening yet. And so now what? Right. I mean, this really back to something that we talk about in The Seven Principles of Prosperity, which is control.

[02:58] And the illusion of liquidity goes right along with the illusion of control. And us human beings think that we control a lot more than we actually do. OK, I’m going to lay in one more, call it complication. The money is tied up in cryptocurrency. That’s liquid, right? You used a word there, Spencer, tied up. So again, yes, in theory, cryptos can be liquid. But I would ask the question, what are you going to do if it’s down? Because if it’s down and you don’t want to sell, then it is not liquid. It is not turn in a bowl two dollars immediately in your checking account. OK, so second order effect of liquid, which is this a transaction has to happen in transaction doesn’t mean selling. It could mean withdrawing or whatever that is.

[03:54] The transaction has to happen to be liquid. What is the effect of my tax burden? Let’s talk about that. Yeah, excellent. So it is very interesting to me. Most people that do have liquidity will have an emergency opportunity fund for literally 80 to 90 years. Right. In theory, we start them in our 20s and we live to 100. That’s 80 years of paying tax on the growth of your emergency opportunity fund if you don’t have it structured properly. And so while some emergency money absolutely may be in a position of having to be taxed just so that it’s super liquid, like one day liquid, the bulk of your opportunity money should be in a position where it is not taxed. And the easiest place I know to solve this problem of taxation on your opportunity money for the rest of your life is to store it in the cash value of whole life insurance at a mutual life insurance company.

[05:07] Now, mutual life insurance companies have a history of paying dividends every single year. And so you can be confident that money is liquid. You do borrow against it and you are in control of that loan. So unlike a line of credit where the bank can say no, unlike any other type of loan where the account can be closed, you as the owner are in control of your life insurance cash value, which means you’re in control of your life insurance loan, which means you have the ability to borrow against it. No questions asked for any purpose at any time and within that seven today environment, all the while not being taxed on the gross of that fund, whether you have it borrowed against or not is irrelevant.

[05:59] And as we know, when we have loan money, we are not taxed on that loan either. Like if we get a car loan, we’re not taxed on that money or a mortgage. We’re not taxed on that money. If we get a loan from the life insurance company against our cash value, we’re not taxed on that money. So it’s a very tax-efficient environment, this cash value of life insurance in a mutual life insurance company. I really like that. You mentioned one little phrase in there that some of our listeners may have experienced, some may not have experienced, which is when you are going to remove some capital from there, you know, withdraw, taking out a loan, using very particular language, then you are not subject to being asked what is this money for and them throwing a condition.

[06:53] I’d say for any of our listeners, if you want to try, go to your banker credit union and say, hey, can I have 20 grand right now? You will see someone with a puzzled face and then a bunch of questions. Have you noticed the same thing? Absolutely. And a bunch of paperwork and hoops to jump through. And you do make an important point with your language because you absolutely can withdraw from your cash value of life insurance. No questions asked, get the money in a day or two and go on down the way. However, savvy personal finance experts, which our listeners are, know to borrow against it instead of withdrawing from it, because borrowing against it enables that cash value to keep right on growing, unaffected by the loan,

[07:41] keep right on paying a dividend if that’s what the insurance company is going to do in that year. And they do have a good history of doing that. And then you still have your opportunity money to go pursue your opportunity, whatever it is. No questions asked. It’s amazing. So let’s do one final tie up, which is let’s take the liquidity and tie that up to the return on investments. And so we have seen in a variety of things where depending on the transaction, you may need to access capital quickly to make a decision. We also understand sometimes acting hastily can make you a little bit more speculative. So let’s talk on that balance of the two and how you’ve coached clients in that way. Well, I love that you brought this up.

[08:33] So my husband, Todd Langford, has done some research around the total rate of return that people tend to get when they have both stocks and bonds. So it’s very common, of course, for a typical securities-oriented account to have stocks and bonds. And people tend to look at just their stock returns and they want to say, oh, my stocks or maybe it’s an index mutual fund or whatever is earning X percent because it’s an S&P 500 or whatever index it’s in. They forget about what the bond portion of the portfolio is doing that’s only earning three or four percent right now to pull down their total return, their average return if you look at the stocks and mutual funds together with the bond. And his research shows that it is sometimes as low as five or six percent

[09:28] once you take into account the entire picture. And this is something that human beings are not very good at doing. We want to look at the Morningstar report or whatever it is that tells us that our average rate of return is X. But we forget about the fees the fund manager takes out. We forget about the opportunity costs that those fees cost us since we now no longer have that money working for us the rest of our lives. We forget about taxes if there are taxes on that account. And then we forget about what the bond portion is doing. And so when you look at this, what might have been a 10 or 12 percent average pulled down by taxes, fees and opportunity costs. You’re back in the often four or five percent range that the bonds themselves are doing.

[10:19] But bonds can move in value. And so what was a hundred thousand dollar bond account, while we may think of that as a four to five percent return, what happens if interest rates adjust and the bond value is now eighty thousand dollars? People just don’t want to look at that. They want to close their eyes and ears and pretend that doesn’t happen. And yet it does. And we’ve seen it. And so so often all we’re thinking about is our index mutual fund or our stock account that’s got X percent of what the industry is reporting as its average earning. And we forget about all those holes in the bottom of the bucket of that fund or account that are draining that money and causing lack of liquidity plus a lot less money

[11:08] and consequently a much lower rate of return. So very true. Knowing those numbers is critical. Take the other piece in what you were talking about. And there’s a flip side. So that’s the effect, the consequence of not understanding the real numbers and the true consequences of it. The other side is the inflated consequence. So for a lot of people that are liquid or the perception of liquid, and they’re over complicating their life, their investments. And they tend to, by over complicating, cherry pick the ones they think were the best. And they forget about the other pieces. And you mentioned that one one element in the puzzle, which is taxes, that often greatest expense in it, rarely do you hear a person that is liquid

[12:06] and investing and doing so many deals, talking about the tax consequence. So we’ve always been grateful for Tom Willwright and his CPA work across the country. And one of the things that he says at the bottom of his newsletter is friends don’t let friends pay too much tax. And so I would encourage you to look at some of your liquid money and see if it is being taxed and if there is possibly a better way. There is definitely a better way to find that better way. Send an email to hello at Prosperity Thinkers. And for all of you out there, we do have a lot of volatility in the market. It is just happening. But if you know the real numbers, if you are financially following principles, you can weather any storm and come out more prosperously.

[13:02] So thanks for listening to this episode. Thank you for listening to the Prosperity podcast. To take control of your money and have it work for you, visit Prosperity Thinkers.