When people picture a liquidity crisis, they tend to imagine running out of money entirely. For high-net-worth families, the reality is different and often harder to spot.
According to Jeffrey Fratarcangeli, founder and CEO of Fratarcangeli Wealth Management, a family can look financially secure on paper with a strong net worth and still be exposed to a liquidity crunch thanks to lack of access to capital.
“In this scenario, they’re illiquid,” Fratarcangeli explained. “They simply don’t have enough liquidity available when they need it. And then when they need to find liquidity, their illiquid assets may go through a scenario where they are just not selling as quickly, and at the price they had previously.”
Below are four takeaways Fratarcangeli shares on what a high-net-worth liquidity crisis actually looks like, and how families can avoid one.
Being asset-rich doesn’t mean being liquidity-ready
Fratarcangeli pointed to business owners as a common example. Some mortgage company owners, he said, tend to keep the bulk of their money inside the business itself because they earn a return acting as the credit facility.
“When that mortgage industry falls, now you do not have the liquidity or the income,” he said.
The lesson applies broadly. Wealth tied up in a business, real estate or other illiquid holdings can look strong on a balance sheet while also leaving a family with no way to quickly access cash when it’s needed.
There are specific liquidity benchmarks to maintain
Fratarcangeli was direct about the baseline liquidity numbers he considers necessary.
He breaks liquidity needs down into three layers: an individual should have a minimum of six months’ worth of liquidity available at all times, 18 months of liquidity available to cover income needs, and ideally, four to five years of liquidity built into an overall financial plan.
“You want to avoid having to sell something within that four- to five-year window, especially if the market has crashed or is in a recession,” he explained. “If you are forced to sell, you could find yourself selling at a major discount.”
Retirement and death are the two moments when families are most exposed
When asked which life events create the sharpest liquidity risk, Fratarcangeli named two: retirement and death.
“When it comes to retirement, the main risk is that you did not plan for the income you are going to need,” he said. “That could force you to sell assets, potentially at a bad time.”
Death carries a different kind of exposure. If a breadwinner dies without adequate life insurance, the household can lose both income and liquidity at the same time.
Market conditions and poor planning are rarely separate problems
Fratarcangeli pushed back on the idea that a liquidity crisis is caused by either bad markets or bad planning. In his view, the two are connected.
“Those who avoid a crisis during calm markets sometimes mistake good timing for a sound plan,” he said. “But if you do not have the liquidity when a market crisis hits, you will likely find yourself in trouble.”
As for the mistake he sees most often, even among families who otherwise appear financially disciplined, Fratarcangeli didn’t hesitate.
“When households overleverage themselves,” he said.
For more insight from Jeffrey Fratarcangeli, visit www.fratarcangeliwealth.com.
