Liquidity requirement. Cash flow vs investable assets

From past paper 2009, question 1

Patricia and Alexander Tracy are both aged 59. The Tracy’s investment portfolio will be 1,100,000 by retirement date next year. If they retire at age 60, they plan to pay off their mortgage and associated taxes by withdrawing 100,000 from their portfolio upon retirement. Question says prepare liquidity constraint for Tracy’s if they retire at age 60. Answer includes the 100,000 payment as a liquidity requirement. For liquidity requirements I thought we only include items related to net cash flow, like salary/expenses? Or do we also include payments made by the portfolio/investable assets like they have here?

Liquidity is the cash flows that will be invested into or drawn from the portfolio.

For exam purposes, an investor who is currently working will have a cash flow situation that fall into one of three categories:

  1. Income meets spending needs AND there is money left over to invest in his or her portfolio.
  2. Income meets spending needs exactly BUT there is nothing left over to invest in his or her portfolio.
  3. Income does NOT meet spending needs, so funds must be withdrawn from the portfolio to make up for the shortfall. This is also the likely situation for an investor who has retire

What about one-time payments?

  • Excellent point. It is also common for an investor to have an upcoming one-time payment that must be met by the investor’s portfolio.
  • For example, a one-time expense that cannot be met by regular income/salary.
  • However, the one-time payment could also be a one-time cash inflow such as an inheritance.
  • There might also be a need for an “ongoing liquidity reserve”, but assume that there is not such a need unless it is specifically mentioned.
  • Also, REMEMBER TO USE NUMBERS. (If not given any specific instructions, say how much they will need to spend in the upcoming year).
    What should I be looking for with respect to liquidity needs when reading through a case?
  • How much are the person’s living expenses?
  • What is the person’s (after-tax) income from non-portfolio sources?
  • How much, if any, income is required from the portfolio in order to cover the person’s living expenses?
  • Is there a liquidity event such as setting up an “emergency reserve” or “cash reserve”?
  • Have you been asked for the investor’s ongoing liquidity need, or just for a specific period?