The older I get – the smarter my Dad seems. He always told me to save as much as I could in the company plan; and pay off my house as quickly as I can. The first seems like great wealth-building advice – the other great debt-elimination advice. But both ignore a key financial risk most of us don’t fully consider – liquidity risk.
Liquidity risk is the measure of how fast – and how inexpensively – we can convert an asset into cash. Both company-sponsored savings plans (like 401ks and others); and houses – are examples of assets that are neither easily nor inexpensively – liquidated.
I have two friends who learned this lesson the hard way. One suddenly lost a job after 26 years. She had built a whopping sum in the company 401k plan, but she’d saved little elsewhere. After just a couple months without a new job, she had to dip into her 401k, and pay both taxes and penalties to get at her money. Her liquidity risk was high – and the price she paid was higher.
Another friend had a nice chunk of equity in his home when he was offered a new job on the other coast. But he owed more on the home than he could sell it for. Not only was his equity lost to the market – he had to dig into his pocket for the shortfall, which meant he couldn’t buy in his new hometown.
Liquidity risk isn’t hard to avoid – we just have to treat it with the same serious resolve we do other financial risks like losing money, paying taxes, and others.