Financial Planning

Asset Rich but Cash Poor? Here’s How Insurance Can Boost Your Liquidity

It can be surprising to learn that many wealthy High-Net-Worth Individuals (HNWIs) are asset rich but relatively cash poor. This lack of liquidity leads to higher risks—especially in times of market turmoil.

According to Forbes magazine, Elon Musk, founder of Tesla and SpaceX, had an estimated net worth of over US$30 billion at end-March 20201. That puts him among the top 30 richest people in the world. With such numbers, you would think that having enough cash on hand to finance a lavish lifestyle would be no problem at all.

And yet, it was reported that at the end of 2018, Musk took out US$61 million in mortgages for five properties in California2. To put things into context, US$61 million represents a mere 2% of his net worth; this is equivalent to someone with a US$1 million net worth buying five properties for US$20,000!

This raises the question—why does a mega-billionaire like Musk even need to take out mortgages? And Musk is not the only ultra-HNWI to have done so—he just might be one of the most famous (and richest). This is a prominent example of what it means to be asset rich but cash poor.

Asset Rich and Cash Poor – A Glimpse at the Data (and the Risks)

They say you can’t get truly wealthy working for someone else, which is why most HNWIs are business owners. But it also means that their wealth is tied up in these business assets. As such, it does not necessarily follow that those who are rich in assets are also rich in cash. They can—and often do—lack liquidity.

Here’s some data. According to the UBS’ 2019 survey on global family offices3, the average family office held only 7.6% of their total assets in cash or their equivalents. Their largest asset allocations are:

  • Public equities – 32.4%
  • Private equity – 18.7%
  • Real estate – 18.0%
  • Bonds/Fixed income – 16.3%

These four comprise over 85% of their total asset allocation. And while it’s true that assets like public equities and bonds are usually considered liquid assets, the saying “cash is king” exists for a reason—nothing is as liquid as cash. This lack of liquidity can result in increased risks. Here are a couple negative scenarios to consider:

Scenario #1: Market turmoil and share-backed loans leading to cash needs

One way many HNWIs use to boost their liquidity via loans collateralised by publicly traded equities. This is what Elon Musk did for his US$61 million in mortgages, pledging shares in Tesla as collateral. But in the event of strong market turbulence—such as the one seen in global markets in early 2020, driven by the Covid-19 pandemic—there is a good chance that the value of such collateral could sharply decline.

If the decline is severe enough, it could result in loan covenants being breached. If that happens, the borrower can either top up the collateral or prepay the loans—which requires cash. If they can’t, the lender usually has the right to sell the collateral, which will usually be at the prevailing depressed market prices. To come up with the cash, the borrower might have to sell other non-pledged assets in a down market, likely turning paper losses into real losses.

Scenario #2: Higher than expected tax bills

The greater your net worth, the more scrutiny you will likely attract from the tax authorities. Once tax filing season rolls around, there is a chance that HNWIs could be hit by a higher-than-expected tax bill, which would create an immediate need for cash. Of course, proper tax planning and hiring the right tax advisors can go a long way toward mitigating this, but the risk is always there.

For instance, consider that in mid-2019, it was reported that Morgan Stanley’s wealth management business saw US$10 billion in outflows4. The reason for this record outflows was a change in the US tax code, indicating that the banks’ wealthiest clients’ tax bills took them by surprise.

Luckily for them, this was in mid-2019, when the US stock market was still approaching the peak of the longest bull market in history5. So those HNWIs who had to liquidate some investments to cover their tax bills probably did so at very favourable prices. But what if they had to do so in the middle of a major bear market, such as the one seen in early 2020? They would be doubly hit, both from the tax bill and from having to liquidate some of their investments at low values.

Fortunately, in Singapore, the tax code is very straightforward compared to other developed nations. There is also no capital gains tax6, which is beneficial for HNWIs. However, many HNWIs also have international investments, which can make tax filing significantly more complex—and increase the risk of higher than expected tax bills.

Higher than expected tax bills
Photo by Denny Müller on Unsplash

The High-Net Worth Dilemma – Liquidity vs. Returns

As the examples and scenarios above demonstrate, liquidity is important. But there are good reasons most HNWIs don’t keep a lot of their assets in cash.

The first reason is ability—many of them simply can’t. For instance, much of their wealth could be tied up in the family business. They cannot just decide to sell business assets or their shares in the business (which will likely be private).

The second reason—which is also the main reason why even the ultra-wealthy don’t keep a lot of cash on hand—is the opportunity cost of foregone returns. Cash doesn’t give any meaningful returns. In fact, because of inflation, it most often loses value in real terms instead. As billionaire hedge fund manager Ray Dalio once famously proclaimed, “cash is trash!”7 in the 2020 market.

Not all feel the same way. Warren Buffett’s company, Berkshire Hathaway, for instance, is also famous for sitting on US$128 billion in cash8 (as of March 2020).

Neither is wrong or right. They simply represent how much importance each is assigning to short-term liquidity. Buffett wants that huge pile of cash to snap up opportunities that have yet to materialise, while Dalio (at that point in January 2020) abhorred cash because it meant missing out on market returns.

But Buffett is an outlier, the greatest investor in the world. Most people, especially HNWIs, would follow the Dalio approach—a globally diversified portfolio with minimal cash. And as we saw in the data above, this is indeed what most HNWIs are doing.

Therein lies the dilemma. Most HNWIs do recognise the importance of cash, and the risks created by not having enough on hand. Yet, they either can’t keep a lot of cash on hand, or don’t want to give up the potential returns from staying invested in the market.

Using Universal Life Insurance as a Liquidity Source

Obviously, insurance is a not a perfect solution for the liquidity vs. returns dilemma. The truth is, there is no such thing—it is an unavoidable trade-off. Individuals must decide for themselves where on the spectrum they want to be, which will be based on their own unique circumstances, including risk appetite.

But insurance does have a unique characteristic that sets it apart from other financial assets, one that is particularly useful in this context. That is its ability to both generate liquidity without sacrificing its risk mitigation and protection aspect.

Generating consistent cash flow

The first way insurance can serve as a liquidity supply is through serving as a consistent source of income, similar to fixed-income assets like bonds. Some universal life insurance plans, for instance, are structured to pay out a regular monthly income after a single upfront lifetime premium to purchase the policy. This is on top of the usual death benefit.

In addition to helping fund everyday lifestyle needs, this regular cash flows can be used as proof to obtain further financing. Consider that, in the UK, the Mortgage Finance Gazette—an industry publication for mortgage professionals—reported in 2019 that HNWIs worth millions of pounds were being turned away for mortgages9. The main reasons for such rejections? Irregular cash flows, or in some cases, no cash flow at all.

As a source of leverage

Universal life insurance policies usually have a single upfront lifetime premium payment, which creates immediate cash value from day one, typically at a very high percentage of the premium cost. This can then be leveraged on through the ability to borrow against this cash value, which can serve as an immediate source of liquidity should any unexpected needs—such as a sudden tax expense—arise.

An advantage to such policy loans is that they are comparatively easy to qualify for (since the policy is already there). Plus, since it is based on cash value, there is no risk that adverse market movements would lead to calls to top up collateral (and thus further strain liquidity).

Universal Life Insurance – A Valuable Asset in Every HNWI’s Portfolio

Again, universal life insurance is not a perfect solution to the liquidity versus returns dilemma. But it is a useful tool that every HNWI should consider, especially since the upfront premiums can usually be financed through the family business.

We have focused in this article on how universal life insurance can serve as a source of liquidity. But keep in mind that this is only one aspect of its overall benefits; the main ones being things like legacy planning and wealth transfer. What’s great about certain universal life insurance plans is that they can add as a liquidity tap while still maintaining their primary protection advantages. This multi-faceted flexibility is what makes them such a valuable asset in every HNWI’s portfolio.

If you’re interested to learn about how Manulife Signature Income (II) can help you with your liquidity needs, speak to one of our financial consultants today.

Speak to me today!

Share this on

Articles for Get financial planning insights straight to your inbox

Get financial planning insights straight to your inbox

Sign up to my mailing list to receive exclusive tips, insights and news on financial planning.

Thank you for your subscription!