How much liquidity to maintain in your investment portfolio?
How much to save in a fixed deposit or a bond fund depends upon your living expense? You must maintain a sufficient balance so that there is no panic if the situation arises.
Liquidity refers generally to the investment portfolio's ability to efficiently meet anticipated and unanticipated demands for cash distributions. Significant liquidity requirements constrain the ability to bear the risk. Liquidity requirements can arise for any number of reasons but generally fall into one of the following categories:
The ongoing costs of daily living create a predictable need for cash and constitute one of the investment portfolio's highest priorities. Because of their high predictability and short time horizon, anticipated expenses must be met using a high degree of liquidity in some portion of the investment portfolio.
As a precaution against unanticipated events such as sudden unemployment or uninsured losses, keeping an emergency reserve is highly advisable. The reserve's size ranges from three months to more than one year of your anticipated expenses. Individuals working in a cyclical or litigious environment may require a larger reserve than those in more stable settings. Although the timing of emergencies is by definition uncertain, the need for cash when such events do occur is immediate.
Negative Liquidity Events
Liquidity events involve discrete future cash flows or major changes in ongoing expenses. Examples might include a significant charitable gift, anticipated home repairs, or a change in cash needs brought on by retirement. As the time horizon to a major liquidity event decreases, the need for portfolio liquidity rises.
If you are in a regular job, maintain 3-months of your living expense. If you are an entrepreneur or someone whose monthly income varies, maintain 12-months of living expenses.