Upside, safe, liquid. 
Qualities to consider. 
Pick two out of three.

When I worked in visual effects, there was a mantra artists would use as deadlines approached and creative directors demanded last-minute changes:

“You can have it fast, cheap, or good. Pick two.”

The idea was that you can have something fast and good, but it won’t be cheap. Or you can have it fast and cheap, but it won’t be good. Or you can have it cheap and good, but it won’t be fast. Etc. It was a helpful and simple way to make sure revisions aligned with budgets, schedules, and the desired quality of the end result.

The holy grail of portfolio design is to have a diversified mix of investments that can grow over time, protect against losses, and can be liquidated as needed without restrictions or penalties. While an overall portfolio may achieve this balance, individual assets within the portfolio probably won’t.

When an investor is building a portfolio of diversified assets, a good framework for any one investment is:

“You can have growth, safety, or liquidity. Pick two.”

If an investor wants an investment to have growth potential and liquidity, she will likely have to be willing to endure losses.

If she wants it to grow and have protection against market losses, there will likely be a loss of liquidity.

If the investor wants both safety and liquidity from an investment, this will almost certainly come at the expense of growth potential.

Let’s look at some examples of how this plays out with specific instruments:

Stocks

Whether holding stocks directly or via a mutual fund or ETF, equities have long been considered a tried and true means of long term wealth creation. For this reason, stocks generally belong on the growth side of a portfolio.

Many, but not all, stocks also have the benefit of being reasonably liquid. Stock from a Fortune 500 company will most likely be heavily traded, with potentially millions of trades on the stock happening every week. This means there is a market waiting to buy the stock if the investor needs to sell it. Once sold, you will need to wait two days for funds to settle, but that time delay is tiny compared to the weeks or months it might take to, for example, receive funds from a real estate sale.

This potential for both growth and liquidity comes at the cost of safety. Investors can watch a stock soar by double digit percent in a single day, as we saw with Nvidia this week. Stocks can also take double-digit losses and, in the worst cases, go completely to zero. The roller coaster of price volatility can be nauseating for some investors. When it’s too much to stomach, the investor can seek safer options.

This quest for safety exposes the importance of the “Pick Two” framework. Here’s a quick rundown of how it plays out with some investment options with historically much less volatility than stocks.

Savings Accounts

The closest thing to have keeping cash under the mattress. Bank savings accounts are fully liquid and, as long as the amount on deposit is under $250,000, completely safe thanks to FDIC insurance.

So if something is 100% liquid and 100% safe, what kind of growth can we expect? Very little. Even in a high interest environment like we see today, bank savings accounts won’t keep up with short term Treasuries, Money Market funds, or CDs.

Treasuries

For investors seeking more growth from a safe haven than they’d get in a savings account, they can look at Treasuries. Bills, Notes, and Bonds are named as such based on their maturity schedule. Bills mature in 1 year or less. Notes have maturity schedules between 2 and 10 years. Bonds are long term debt and mature on any schedule longer than Notes, often 20 or 30 years.

By increasing growth potential while maintaining safety, the “Pick Two” framework tells us we need to expect a reduction in liquidity. That’s exactly what the maturity schedule of a bond is.

Bonds can be sold prior to maturity, but that will come at the risk of price volatility. The market price for the bond you want to sell may be less than what you sold it for. So, the only way to increase bond liquidity is to make a sacrifice in the safety category.

One way to view the term “safety” in a portfolio is “consistency.” The more consistent the price of an investment, or the more consistent the income it produces, the safer that investment is. The price risk introduced by selling a bond prior to maturity means the investor is introducing a bit of volatility into her portfolio, and therefore reducing safety and consistency.

Annuities

Insurance products generally sit squarely on the conservative side of the investment spectrum. Annuities are frequently used to either guarantee income over someone’s lifetime or to guarantee that a certain part of a portfolio will have zero loss potential.

A reasonable expectation for an allocation to a fixed or fixed indexed annuity is that the account will earn, over time, somewhere between 3-5%. While this is hardly like winning the lottery, this rate of growth exceeds the Federal Reserve’s target inflation rate of 2%. As such, annuities can fairly be expected to outperform cash over time.

If an annuity is growing someone’s money at a rate that, over time, exceeds the rate of inflation, while also completely protecting the investor against losses, what are we giving up? As you probably guessed, annuities can have complex liquidity restrictions.

Annuities, almost without exception, have surrender schedules. For example, a 10 year annuity will have a 10 year surrender schedule. During those 10 years, if the contract owner wants to surrender her contract and get all of her money back, the investor will have to pay a penalty – sometimes as high as 10% or more – on a portion of the withdrawal.

In addition to the contractual penalties associated with liquidating an annuity before surrender, if the annuity was purchased with after-tax dollars, the investor may be exposed to tax penalties as well. If an investor is under the age of 59 ½ and makes a withdrawal from an annuity funded with after-tax money, any portion of that withdrawal that represents growth will be penalized 10% in addition to the ordinary income taxes the investor will need to pay on the growth portion of the withdrawal. The need for inflation-beating growth and total safety means a big liquidity sacrifice.

I frequently meet people who are frustrated that a portfolio either hasn’t grown as much as they would like or has lost more money than they expected. In many cases, these frustrations come down to a misunderstanding of how the instruments within the portfolio work. If someone isn’t sure how something works, there’s a good chance it will be misused. Owning investments that don’t align with either goals or risk tolerance is a recipe for unhappiness.

Using the framework of “Growth, Safety, or Liquidity: Pick Two” can be very helpful in understanding what you own and how it works. Often, the problem is not that an investment has failed. The problem is that the investor wanted something the investment wasn’t designed to deliver.

Our first job as planners is to help people understand what they have and how it works. If your portfolio is failing to deliver the growth, safety, or liquidity you want, it may be a good time to look at other options. We’d love to hear from you.