This is a complex topic that has been the subject of many a spirited debate at the dinner table. It’s not just a matter of how much cash you want to keep in your wallet. Debit cards count as liquid, too. The real question is how much you want to tie up in illiquid investments.
The first argument for having liquid money on hand is to eliminate the need to use your credit cards. If you’re not there yet, use a loan payoff calculator to figure out how long it will take to pay off your current credit card balances by making just minimum monthly payments.
Not having to use credit cards is an obvious pro for keeping money in liquid form. There are also a few cons to it. For your convenience, we’ve listed out a few of both. Consider the following carefully.
Pros of Keeping Your Money in Liquid Form
Avoiding the Use of Credit Cards
We’ve already mentioned this, but it’s important enough to be listed here again. Using credit cards for purchases stunts your financial growth and could get you into serious debt. Paying cash is sometimes much better.
Easy Access to Emergency Funds
When that medical expense or major car repair comes along, you don’t want to have to liquidate assets that are difficult to sell. Money that is tied up in illiquid investments can’t help you in situations like this.
CDs and Money Market Accounts
These count as liquid assets because they can easily be turned into cash for expenses and unforeseen emergencies. They’re in the “pro” category because they also generate interest, helping you grow your money.
Cons of Keeping Your Money in Liquid Form
Your Money Doesn’t Grow
Liquid assets—other than CDs, savings accounts, and money market accounts—don’t generate interest, so your money won’t grow. Even the interest-bearing accounts we just mentioned barely beat the rate of inflation.
Your Money Can Be Stolen
Lose your wallet or pocketbook and your cash is gone. There’s no way to get it back unless some good Samaritan happens to find it. Parking your cash in stocks, bonds, or mutual funds can be much safer.
Cash Doesn’t Build Your Credit
Paying cash will help keep you out of debt, but it won’t build up your credit. There should be a balance between liquid and illiquid assets that allows you to use credit when necessary but pay cash at least half the time.
Avoiding the Debt Trap of Illiquidity
Illiquidity can create the need to borrow money when you shouldn’t need to. Investing too much into real estate, hard assets, or investment funds that charge a withdrawal penalty can leave you strapped for cash when you need it most. Don’t fall into that trap.
For best results, try to have three to six months in expenses available in liquid form. This can be cash in hand, money in checking or savings, or easily convertible CDs or money market accounts. Put the rest into an equity portfolio or Roth IRA. That’s how you build wealth.
Kevin Flynn
Kevin is a former fintech coach and financial services professional. When not on the golf course, he can be found traveling with his wife or spending time with their eight wonderful grandchildren and two cats.