Three dimensions to an updated investment strategy
Traditional, outdated investment strategies are not only ineffective, but they can also be harmful to the average investor. One of the most traditional ways of thinking about investing is the risk versus reward trade-off. It goes something like this:
- Investment options that are considered safer carry less risk but also offer the potential for less return.
- Riskier investment options carry the burden of volatility and a greater potential for loss, but they also offer a greater potential for large rewards.
Most professionals move their clients back and forth along this range, shifting between investments that are safer and investments that are structured for growth. Essentially, the old rules of investing dictate that you can either choose relative safety or return, but you can’t have both.
Updated investment strategies work with the flexibility of liquidity to remake the rules.
There are three dimensions that are inherent in any investment: Liquidity, Safety, and Return. You can maximize any two of these dimensions at the expense of the third. If you choose Safety and Liquidity, this is like keeping your assets in a checking account or savings account. This option delivers a lot of Safety and Liquidity, but at the expense of any Return. On the other hand, if you choose Liquidity and Return, meaning you have the potential for great return and can still reclaim your money whenever you choose, you will likely be exposed to a very high level of risk.
Understanding Liquidity can help you break the old Risk versus Safety trade-off. By identifying assets from which you don’t require Liquidity, you can place yourself in a position to potentially profit from relatively safe investments that provide a higher-than-average rate of return.
Choosing Safety and Return over Liquidity can have significant impacts on the accumulation of your assets. In Bert’s case, the paradigm shift from earning and saving to leveraging assets was a costly one.
» Bert is a corn and soybean farmer with 1,200 acres of land. He routinely retains somewhere between $40,000 and $80,000 in his checking and savings accounts. If a major piece of equipment fails and needs repair or replacement, Bert will need the money available to pay for the equipment and carry on with farming. If the price of feed for his cattle goes up one year, he will need to compensate for the increased overhead to his farming operation. He isn’t a particularly wealthy farmer, but he has little choice but to keep a portion of money on hand in case something comes up and he must access it quickly. Most of his capital is held in livestock in the pasture or crops in the ground tied up for six to eight months of the year. When a major financial need arises, Bert can’t just harvest 10 acres of soybeans and use them for payment. He needs to depend heavily on Liquidity in order to be a successful farmer.
Old habits die hard, however, and when Bert finally hangs up his overalls and quits farming, he keeps his bank accounts flush with cash, just like in the old days. After selling the farm and the equipment, Bert keeps a huge portion of the profits in Liquid investments because that’s what he is familiar with. Unfortunately for Bert, with his pile of money sitting in his checking account, he isn’t even keeping pace with inflation. After all his hard work as a farmer, his money is losing value every day because he didn’t shift to a paradigm of leveraging his assets to generate income and accumulate value.
Almost anything would be a better option for Bert than clinging to Liquidity. He could have done something better to get either more return from his money or more safety, and at the very least would not have lost out to inflation.
As you can see, choosing Liquidity solely can be a costly option. The sooner you want your money back, the less you can leverage it for Safety or Return. If you have the option of putting your money in a long-term investment, you will be sacrificing Liquidity, but potentially gaining both Safety and Return. Rethinking your approach to money in this way can make a world of difference and can provide you with a structured way to generate income while allowing the value of your asset to grow over time.
Do you want to discuss Safety, Return, and Liquidity with a financial professional? Fill out the form below or call (317) 903-9157 to schedule a no-cost, no-obligation visit with the retirement experts at ReJoyce Financial.