Hi guys,
liquidity section of the IPS is for me super confusing. What should we look for in this section?
I have seen living expenses sometimes be in there, sometimes not, a house owned, sometimes not, illiquid securities, sometimes not, only one-off expenses? etc… How do you tackle this? Do you use a kind of checklist of things to include?
Your comments on this would be really welcome!
I had the impression that the following should be checked for:
positive/negative liquidity events; illiquid holdings ; ongoing expenses; emergency reserve
Unfortunately this is totally not what I can find in the guideline answers…
You can read the question carefully, and see if there is any current year within a year financial goal is there (like education goal-Tuition Fee), add that as well apart from ongoing expenses & emergency/cash reserve.
Is there a rule somewhere in the text that says to include only the events that’ll be happing soon? ie. next year?
Can’t remember which exam but one couple had young children (I think less than 7 yrs old) and liquidity constraint didn’t include anything about their education cost.
Also another confusing factor. If a couple will be receiving 1mm but will be paying 200m for debt, the net investable asset becomes 800m. Do I need to include 200m as a liquidity constraint? I think the mock answer guides say yes. My understanding is that the IPS constraints are for portfolio asset bases and since 200m is not counted towards asset base, it’s not a liquidity concern.
Liquidity, in general, is short term which implies < 1-year
A child being 7 with an anticipated tuition cost in 13 years would not be a liquidity issue. That’s an investment horizon (stage) constraint for consideration.
If you’re receiving 1m now and paying off 200k of debt now, you investable asset is 800k. Since it occurs at the same time there is no time gap between the 1m and 200k which would cause this situation to not be a ‘liquidity event’.
If you’re receiving 1m now and paying off 200k of debt in 3 months, your invest asset base is 800k and your liquidity need is 200k - as there’s a 3-month gap between the inflow and outflow.
So you would be just including the cash flows (in or out) happening in the coming year?
Would you include living expenses if no other sources of income are available (i.e. no salary received)?
Yes, every example I’ve seen include living expenses (or portions of living expenses that exceed income if income is insufficient)
and do you need to include it in the liqui requirements when its the other way around? I mean when salary exceeds expenses.
I would not. Unless the person was retiring next year in which case he no longer has income to cover his living expenses the following year; thus, he would need to draw funds from his portfolio to cover and this would constitute a liquidity event.
I would not. Unless the person was retiring next year in which case he no longer has income to cover his living expenses the following year; thus, he would need to draw funds from his portfolio to cover and this would constitute a liquidity event.