hen we talk about investing, we predominantly consider liquid capital available for investing in equities. But before such capital gets invested or reaches brokerage accounts, it is usually found sitting in various bank accounts.
The accumulation of capital normally starts at bank accounts. Sources of capital may be various and numerous, such as income, savings, inheritance, sale of assets etc. At this stage we are not going to concern with the sources of capital. It will suffice to know that the capital is located inside the banking system. In other words, we consider bank accounts as the origin of investing capital.
That being said, the capital doesn’t need to be sitting in a bank account necessarily, but it has to be in such a form that it can easily be deposited. That is what we mean by liquid capital. For example, cash under the mattress or stored in some kind of a safe deposit box, requires only a single trip to local bank branch to be deposited or transferred to the bank account.
Even if bank deposits are tied to some term deposit contracts, they are also considered liquid. Those contracts are easy to break with minimal penalty and possible loss of interest. What is important, the entire value of original principal is preserved.
n the other hand, capital that has already been committed to alternative investments or assets may not be considered liquid. The issue is that such capital may not be readily available for transfer to bank account (thus not liquid) and the amount of capital may suffer in value if attempted to be moved. Real estate or fine art are good examples of illiquid capital. It is not possible to directly deposit land or a property or piece of art to a bank account. Such assets need to be sold first and proceeds can then be deposited to a bank account.
Illiquid assets can be valued based on their market value. That is if actually you can find a similar asset that recently transacted and the value of such transaction is known. Quite often, illiquid assets are unique and it is difficult to assess their true market value thus the one can only be estimated. The trouble is, if illiquid asset needs to be sold in a rush, the actual transaction value could be significantly lower than originally estimated value. Finding a buyer for quick sale may cost a good portion of an asset’s value.
Thus we either do not account for illiquid assets or we discount them significantly before we consider those assets as a bank account capital.
ust because you have your savings or other liquid capital, that doesn’t mean such capital is available for investing. This issue has to be given serious consideration in any investing effort, especially in Solid Wealth Strategy. The best approach to figure out if capital is available to be invested is to answer the following question:
Is my current and expected future financial situation such that if I never see this capital again, I would be fine and I wouldn’t fall into financial hardship?
In other words, if there is a chance that you may need that capital (or portion thereof) in foreseeable future (let alone in this moment), it would not be a good idea to consider that capital available for investing. Once capital is dedicated to investing it should not be disturbed or pulled back for other purposes.
It may sound harsh, but if you can write off that capital (or consider it lost before you even started) and you are still financially (and emotionally) fine, that is the best position to start investing from. If you are honest to yourself at this stage, further investing will be nothing but a breeze.
Figuring out availability of capital is a mandatory step in investing process and inextricable part of solid investing planning. Unfortunately many people fall prey to this step. Some skip it altogether and never give it a thought, while others seem to take it easy and get lost in their lust for riches where they imagine enjoying unrealistic investment returns before they even started investing.
If you ask yourself the question above and you hesitate answering, or the answer is NO, that is OK. The saying goes: Better safe than sorry! You can actually start this process with very small amount of capital and keep increasing it until you get uncomfortable. I am sure you’ll be fine if you lost $10. If $10 is all the capital you have for investing, so be it – at least you know you need to save some more. If you get YES for $10, then ask yourself again for $20, $50, $100 etc. Proceed until the answer becomes negative or until you hit the amount you have at the bank. Either way, you should be able to determine this way the amount of capital you have available for investing.
In Solid Wealth Strategy, we give the most consideration to planning stage. Once you have your planning completed squeaky clean, the rest of the strategy becomes child’s play.
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