Monitoring Financial Health: Liquid Term

by | | Investing, Other Cool Stuff, Retirement

Liquid Term

What is Liquid Term?

Liquid Term indicates the number of years you could live on your current liquid assets. “Liquid assets” refers to money that is not in a retirement account. This includes cash accounts (checking and savings) and nonretirement investment accounts (also called taxable accounts or brokerage accounts). It does not include retirement accounts like 401(k)s and Roth IRAs.

Total Liquid Assets / Annual Living Expenses = Liquid Term

Example: If you have $50,000 in cash and $300,000 in a nonretirement investment account, and you spend $100,000 per year, your Liquid Term is 3.5. $350K liquid assets / $100K spending = 3.5.

Liquid Term (Lt) is one of four Elements that make up your Total Term.

Why is Liquid Term Important?

With adequate liquidity (a healthy Lt), you feel less anxious about finances in turbulent times, and you can pursue opportunities. For ER docs:

  • If volume drops and so does your income, you can still meet all your obligations for an extended period of time.
  • You can give away a few shifts on short notice for a spontaneous family trip.

Liquid Term measures your preparedness for emergencies and early retirement.

Emergencies

Liquid Term is a good proxy to measure emergency expense preparedness. For example, an Lt of 0.5 indicates 6 months of expenses covered. If the underlying mix of that score is mostly cash, you have a good buffer for unexpected expenses without needing to sell any investments.

Early Retirement

In most cases, you can’t withdraw from your retirement accounts without a penalty until you’re over age 59 1/2. If you want to retire before age 59 1/2, it’s important that you have a high enough Liquid Term.

For example, let’s say you want to retire at 55. At a minimum, you should have an Lt of 4.5. This means you can live on your liquid assets for 4.5 years, from 55 to 59 1/2, so you don’t have to withdraw from retirement accounts and pay early withdrawal penalties.

Improving Your Liquid Term

One way to improve your Liquid Term is to increase your Savings Rate. Save more, and put the increased savings into cash or a nonretirement investment account.

If you don’t want to change your Savings Rate, but still want a higher Lt, change where your current savings go. For example, save less in your 401(k) and more in a nonretirement investment account.

The last way to improve your Lt is to reduce your spending (or Burn Rate). Annual living expenses is the denominator in the Liquid Term calculation. Even a small reduction in spending has a big impact.

Example #1:

  • Liquid Assets = $300K
  • Annual Living Expenses = $120K
  • Lt = 2.5 ($300K/$120K)

Example #2:

  • Liquid Assets = $300K
  • Annual Living Expenses = $100K
  • Lt = 3 ($300K/$100K)

Do you know your Liquid Term? Do you have a healthy balance between liquid assets and retirement assets? That’s where we come in. Schedule a FREE Financial Pulse Assessment™. This is a 3-step process to get clarity on your finances and “test drive” our services.

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