Liquidity: How Liquid Are You, Really?
Before diving headfirst into alternative investments, ask yourself: How much of your personal balance sheet is liquid versus illiquid? And more importantly, do you have upcoming priorities over the next several years that require easy access to cash?
Most alternative investments lock up your capital for at least a year, if not much longer, depending on the asset class. So, it’s crucial to understand your liquidity needs for the future.
For example, if you’re saving up for a down payment on a house in two years, you probably don’t want your money tied up in a private equity fund with a 10-year lockup. But if you’re looking to help your child with their first home purchase two decades from now, locking up capital in long-term investments might make perfect sense.
Here’s where things get tricky: Your financial priorities are often spread out over time. Some are one-time expenses (like weddings), while others are stretched over years (like college tuition). Mapping out these goals in detail helps clarify your liquidity needs. It’s like building a financial roadmap that shows where you need liquid capital and where you can afford to let it grow undisturbed.
Protective Reserve: Is Your Safety Net Big Enough?
Even if you think you’re ready to start allocating towards alternatives, pump the brakes for a moment. Ask yourself: Do I have a rainy day fund in place? And if so, how long will it last if I truly need it?
Consider this: What if you work in an industry like hospitality, and another pandemic-like event suddenly brings everything to a grinding halt? Do you have enough of a protective reserve to comfortably navigate a job loss, take an extended break from work, or cover unforeseen expenses like medical bills?
The last thing you want to do in an emergency is sell investments at a loss or, worse, borrow expensive capital just to cover your expenses. Before venturing into the world of alternative investments, make sure your protective reserve is established, accessible, and allocated to low-volatility, liquid assets. A good rule of thumb: You should be able to weather the storm without having to raid your long-term investments.
Allocation: What Can You Afford to Lock Up?
Once you’ve nailed down your liquidity needs and established your protective reserve, it’s time to figure out how much you can responsibly allocate toward alternative investments. This is where things get interesting—and a bit technical.
Start by asking yourself: What percentage of my portfolio can I comfortably keep illiquid? And how diversified do I need to be within my alternative investments?
Let’s say you’re interested in venture capital. First, you need to know the minimum investment amount for the fund you’re considering. Is it $250K, $1M, or something else entirely?
Next, diversification becomes key. Just like you wouldn’t put all your eggs in one basket in the public markets, the same goes for private investments. You’ll want exposure to at least 2-3 venture funds to spread out your risk (let alone other asset classes). This can be achieved by investing across various categories (like B2B vs. B2C), different fund vintages, investment stages (early-stage, growth, etc.), or even geographic focuses.
It’s also important to consider that early-stage venture funds often have 10-12 year life cycles. Not only do you need to be comfortable locking up capital for that time period, but you also need to commit to the asset class for the long haul. Some funds raise capital during times of market highs, others during downturns. New innovations like AI, robotics, and beyond are constantly reshaping the landscape. To mitigate systematic risk, it’s crucial to invest across different fund vintages and times.
Perhaps, more importantly, is venture capital (or any other alternative asset class) right for you? If you are a startup founder, investing in the other fast-growing startups might provide to much concentration risk in your portfolio. So, if you are a startup founder, considering other asset classes, like real estate or private equity, might be a better option for you as you start.
Wrapping It Up
So, where does this leave you? The bottom line is that successful alternative investing starts with thoughtful preparation. It’s not just about picking winners; it’s about structuring your portfolio so you can afford to take risks in the first place. Build your liquidity plan, establish your protective reserve, and then, and only then, consider allocating toward alternatives.
Need a Second Opinion?
If you’re feeling a bit overwhelmed after reading this, you’re not alone. Evaluating liquidity needs, building a protective reserve, and figuring out how to responsibly allocate to alternative investments can feel like juggling flaming swords. The good news? You don’t have to go it alone. If you’d like some guidance working through any of the topics above, we’re here to help. Just reach out whenever you’re ready.