Sunday, January 26, 2014

Liquidity risk Part II: The individual investor

I don’t really have much to say on this topic, but I guess the liquidity risk series won’t be complete if I didn’t at least talk about liquidity risk in relation to the individual investor. Since I don’t have any lame sex jokes to lighten things up, we’ll just jump straight to business.

Before you start investing in stuff, please make sure that you have set some cash aside for emergencies. I personally think that everyone should try to set aside cash amounting to 6-8 months of their total expenses (including taxes, insurance expenses, etc.), but everyone have different circumstances and some people may need to set aside more cash than that. Some of you may probably be thinking that this is so basic that any aunty or uncle on the street can tell you that (in Malaysia we usually refer to any middle-aged or old person as auntie or uncle).  Yes, what I said is simply common sense that any auntie or uncle can tell you. But a lot of aunties and uncles still get financially destroyed because emergency struck and they didn’t have enough reserve cash because they invested it in “hot stocks” (which are now worthless) recommended by some technical analysis bullshitter. Make sure you have an emergency cash reserve and only invest in stocks when you have extra money that you don’t intend to use in the foreseeable future. That way you minimize the risk of ending up as a financial jerk-off.

I’m a long-term investor, so I don’t really mind investing in stocks that are a little bit illiquid. However, I try to make sure that the stocks I invest in have enough daily trading volume so that I can exit my position in a day if the company’s business fundamentals get impaired.    

If debt is employed in your investment portfolio, you need to make sure that the portfolio both maintains a healthy cash balance and generates enough dividends to comfortably service its debts. A certain percentage of the portfolio should be allocated to cash to act as a buffer so that the portfolio can service its debts in rough times when dividends might get cut. Another reason to maintain a cash balance is that debt instalments are generally due every month while dividends are received much less frequently. Investors can dip into the cash balance to pay the debt instalments first and replenish the cash balance once they receive their dividends.

If I were to use debt in my portfolio, I might require that the dividends from my portfolio be twice the size of my debt instalments, and that there’s enough cash to service the debt for 18 months (this is just an example, please don’t blindly follow it).  While I’ve never used debt before, I won’t be a fucking pussy like some financial bloggers and tell you that you should avoid using debt at all costs. Using debt conservatively can create value. However, debt can also ruin you if you don’t have a deep enough understanding of finance to intelligently employ debt.  The same goes for driving and weird sex positions; you can get a lot of benefits if you know what you’re doing, or you can get hurt real bad if you don’t know shit. If I were to use debt, I would also avoid using shares as collateral as they can be volatile and I don’t want to get my ass margin called. I would use real estate or bank deposits as collateral instead. I would also make sure that I could easily service the portfolio’s debts with my other sources of income and liquid assets that are independent of the portfolio. Even if you don’t use debt, you should still put together a portfolio that generates some dividend income and have some cash on hand to take advantage of market downturns.

Thank you for reading. Sorry if my analysis of stocks has slowed down. It takes time to find interesting companies. I’ve also been busy reading up on the insurance industry and playing pokemon (seriously).  Take care and stay rational!

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