Are you an illiquid millionaire? Even if you don’t have $1 million-plus in net worth – and more and more people do as they age and the value of their home and investment portfolio continues to grow – taking care of your long-term financial security is only part of a prudent financial strategy.
Also vitally important is what to do when an immediate financial need pops up. It might be an opportunity to purchase a second home, invest in a business, buy a recreational vehicle, or help an adult child with a down payment on a first home.
Many people with a significant level of wealth have too much of it locked up in illiquid assets, such as personal or commercial real estate, a small business, or perhaps in stock options that are years from being cashed in. So, what can you do if this describes you?
Maintain diversification
Ideally, we should all have diverse portfolios, and aside from the right mix of stocks, bonds, alternative assets, and cash/cash equivalents, that also should include having sufficient liquidity for your lifestyle or life stage. What are the chances that you’ll need to draw on your assets within days to fund a quick and unexpected need?
Relatively quick, painless, and easy ways to create liquidity
Even if you feel constricted or trapped by having a large amount of wealth tied up in illiquid assets, you likely have numerous options. But be aware of the drawbacks, such as having to pay income tax or capital gains tax in the event of an asset sale.
Here are some options to consider:
Borrow against your assets
Use a securities-based line of credit: Let’s say you have sufficient liquid assets, such as stocks, bonds, and mutual funds in a non-retirement investment portfolio. However, you’d like to avoid potential capital gains taxes. In that case, consider using those assets as collateral for a line of credit. You can generally draw from it whenever you need cash and make monthly, interest-only payments. Because these are typically flexible demand loans without a fixed maturity date, you can pay down the principal at your own pace, provided your investments maintain enough value to cover the debt.
Take an asset-backed loan: Another option is to borrow against your home equity with a home equity line of credit (HELOC). HELOCs offer a set "draw period" (often 5 to 10 years) where you can access cash and typically make monthly interest-only payments. After that, the loan enters a "repayment period" (often 10 to 20 years), during which your monthly payments will increase to cover both the principal and the interest until the balance is fully paid off. You can also look into borrowing against other physical assets, such as an art collection, but always be aware of keeping the interest rates at a reasonable level.
Borrow from your life insurance policy: If you have a permanent life insurance policy, you could borrow from that policy, drawing on your accumulated cash value. If you decide to go that route, be sure you understand the policy’s rules and repayment terms to avoid either reducing the death benefit or triggering a taxable event.
Do a reverse mortgage: If you are retired and lack more-liquid assets, don’t ignore the value of your home. There are plenty of reasons not to do a reverse mortgage, including high upfront fees (closing costs as with a regular mortgage), and accruing interest and fees while decreasing your home equity.
On the other hand, there are no monthly payments of principal and interest, and you have access to tax-free cash. And as long as you adhere to the loan terms, you can live in the house and continue to own it for the rest of your life.
Rebalance your portfolio: Perhaps your portfolio is no longer balanced. With the stock market having had a few stellar years recently, most people should consider doing this as regular portfolio housekeeping.
In this event, rather than buying bonds or bond funds with the proceeds created by selling some stocks or stock funds, you might consider moving the freed-up assets to something more liquid, such as a money market fund, with the intention of short-term access. Be aware that this move would likely trigger capital gains taxes.
Preventing a future liquidity crunch
At the end of the day, true financial peace of mind comes down to balance. It is great to see your net worth grow as a result of long-term investments, but it does not help much if you are trapped when an emergency hits or an amazing opportunity pops up. By setting up easy backup options ahead of time—like a line of credit or a solid cash reserve—you can have the best of both worlds. Your money keeps growing, but you can still grab it whenever you need it. Treating liquidity as a must-have part of your financial plan, rather than a backup thought, means you can handle whatever life throws at you without stressing over your long-term security.