Liquidity Risk

Posted November 4, 2025, By Cole Ferrier

Key Takeaways:

• Liquidity Risk is the danger of not being able to convert an asset into cash quickly without taking a significant loss in value.

• Retirees need liquidity to meet both planned income needs and, more importantly, unplanned financial shocks like a health crisis, home repair, or unexpected tax bill.

• Becoming "house rich, cash poor" by over-investing in illiquid assets like real estate, private business interests, or collectibles can force you to sell at the worst possible time.

• Solutions involve creating a dedicated liquidity pool (cash reserves), understanding the trade-offs of different asset types, and establishing contingent credit lines like a reverse mortgage line of credit.

We have spent the last two articles debugging the inherent volatility of your portfolio's engine room—the stocks and bonds that power your retirement. We managed Market Risk with diversification and Interest Rate Risk with duration. Now we address a more practical, plumbing-level problem: What happens when you need cash, right now? This is Liquidity Risk.

Liquidity risk is the danger of being unable to meet your cash needs without being forced to sell an asset at a fire-sale price. It’s the classic "house rich, cash poor" dilemma. You can have a multimillion-dollar net worth on paper, but if all your wealth is tied up in your home, a private business, or a collection of antique fishing lures, you might struggle to pay an unexpected $30,000 medical bill.

From my engineering perspective, liquidity is the system's cache or RAM. It’s the readily accessible memory your financial operating system needs to handle immediate processing demands. A system with a powerful long-term storage drive (your illiquid investments) but almost no RAM will be slow, inefficient, and prone to crashing when faced with a sudden, complex task. A resilient retirement blueprint must have a robust plan for both long-term storage and immediate cash needs.

By the Numbers

• $29,000: The median transaction account (checking, savings) balance for households aged 65-74 in 2022. While this seems reasonable, it's often insufficient to cover a major unexpected shock like a new roof or a significant medical event. (Source: Federal Reserve, "2022 Survey of Consumer Finances")

• ??%: The discount a seller might have to accept on an illiquid asset, like a private business interest or a unique property, if they are forced to sell it quickly under duress rather than waiting for the right buyer. The more urgent the liquidation is, typically the higher the discount, as the seller is not waiting for the right buyer.

• 7-10 years: The typical surrender charge period for a deferred annuity, a common retirement product. Accessing your own funds within this window can result in significant penalties, making the asset effectively illiquid for that period. (Source: FINRA, "Deferred Variable Annuities: What You Should Know")

From the Case Files

Meet Richard and Susan, a high-net-worth couple in their late 60s whose portfolio was heavily concentrated in their successful small business and a portfolio of five rental properties. Their net worth was impressive, but their cash reserves were slim. One spring, they were hit with a large, unexpected state tax bill from a prior year's audit that had to be paid within 90 days. Panicked, they realized they didn't have nearly enough cash. They were forced to list one of their rental properties for a quick sale. In a sluggish real estate market, they had to accept an offer that was nearly 15% below what they felt the property was worth, costing them over $75,000 in lost value simply because they couldn't get their hands on their own money fast enough.

Understanding the Risk: The Spectrum of Liquidity

Liquidity exists on a spectrum. On one end, you have perfectly liquid assets; on the other, highly illiquid ones.

• Highly Liquid: Cash, checking/savings accounts, money market funds. You can access the full value almost instantly.

• Liquid: Publicly traded stocks, bonds, and ETFs. You can sell them on any business day and have cash in your account within a few days.

• Less Liquid: Deferred annuities with surrender periods, certain limited partnerships. Access is possible but may come with penalties or restrictions.

• Highly Illiquid: Real estate, private business interests, collectibles (art, cars, etc.). Selling these assets can take months or even years, and the final price is uncertain.

It's crucial to distinguish between planned liquidity for regular income and contingency liquidity for financial shocks. A plan to sell $5,000 in stock each month for income is very different from needing to raise $50,000 in two weeks for an emergency.

The Impact on Your Plan: A Forced Error

A liquidity crunch doesn't just cause a loss; it forces you to make other, more damaging errors.

• Interaction with Health/LTC Risk: A major health event is a "liquidity shock." Without accessible funds, a retiree might be forced to sell stocks at the worst possible time or, even worse, make suboptimal care decisions based on what they can afford right now instead of what is best for their health.

• Interaction with Market Risk: A lack of liquidity forces you to violate the primary rule of managing market risk. Instead of drawing from a cash buffer during a downturn, you're forced to sell your equities, locking in losses and turning a temporary paper loss into a permanent one.

• Interaction with Longevity Risk: Over a long retirement, the probability of facing one or more liquidity shocks—a major home repair, a family crisis, a health issue—approaches 100%. A plan without a liquidity strategy is brittle and unlikely to survive the full ultramarathon without a major failure.

Solutions & Your Risk Mitigation Toolkit

A resilient plan anticipates the need for cash and builds in mechanisms to access it efficiently without disrupting your long-term strategy.

• Tool #1: The Cash Reserve / Bucket 1. This is the core solution and your first line of defense. As discussed in the Excess Withdrawal Risk article, holding 1-3 years of planned living expenses in a dedicated "safe" bucket of cash, CDs, and short-term bonds provides for your regular income needs and a buffer for small emergencies.

• Tool #2: A Contingent Credit Line. For larger, unexpected shocks, a credit line can be a powerful tool. Setting up a Home Equity Line of Credit (HELOC) or a Reverse Mortgage Line of Credit before you need it gives you a source of funds. This allows you to pay for the emergency without selling investments, giving you time to replenish the credit line more strategically later on.

• Tool #3: Life Insurance Cash Value. For those with permanent life insurance policies, the accumulated cash value represents a tax-advantaged pool of liquid capital. You can typically borrow against this value, often at a reasonable interest rate, providing another source of contingency funds.

• Tool #4: A Balanced Liquidity Profile. Especially for FIRE and high-net-worth investors, it’s about intentional portfolio design. While illiquid alternatives like private equity or real estate can entice people to invest for potentially higher returns, it's critical to balance those holdings with a sufficient allocation to liquid public assets (stocks, bonds, ETFs) to ensure the overall plan isn't fragile.

A Strategic Approach to Liquidity

Strategically, liquidity risk is the danger of being unable to meet cash needs without being forced to sell a long-term asset at a fire-sale price. A retirement plan is most vulnerable when it becomes "house rich and cash poor," with too much wealth concentrated in illiquid investments and not enough in accessible cash reserves to handle a financial shock.

A resilient plan addresses this by building multiple layers of liquidity. The foundation is a dedicated cash reserve for planned spending and minor emergencies. This is supplemented by a contingent credit line, like a HELOC or reverse mortgage line of credit, established in advance to handle larger, unexpected costs without forcing the sale of investments. The final layer is a portfolio that is intentionally balanced between illiquid assets and a sufficient allocation to liquid assets to maintain flexibility.

Conclusion: The Great Balancing Act

The fundamental trade-off here is between the potentially higher returns often found in illiquid investments and the safety and flexibility of liquid ones. "Reaching for yield" in private markets or concentrating your wealth in a business or real estate can be powerful wealth-building strategies. But the "great balancing act" is ensuring you don't sacrifice so much liquidity that your blueprint becomes fragile. A truly resilient plan can not only withstand the predictable tides but also the sudden, unexpected storms.

Create Your Financial Compass with Us

Is your net worth statement telling the whole story, or are you exposed to a potential liquidity crunch? We can help you analyze your portfolio's liquidity profile and design a strategy with the reserves and contingency plans you need to handle whatever comes your way. Contact us today.

Resources:

• FINRA - Before You Invest in an Illiquid Asset: An investor alert outlining the risks associated with investments that are not easily sold. (www.finra.org)

• National Reverse Mortgage Lenders Association (NRMLA): Provides consumer information on how reverse mortgage lines of credit work. (www.nrmlaonline.org)

• U.S. Securities and Exchange Commission (SEC): Offers investor bulletins on the importance of understanding all the risks of an investment, including liquidity. (www.investor.gov)