Let’s talk illiquidity & possible benefits
What is Liquidity / Illiquidity?
Liquidity is the ease in which an asset or security can be converted into cash without losing its market value. Individual investors tend to view liquid investments as more valuable, and deem illiquid investments to be inherently higher risk.
Individuals like liquid investments because they have easier access to 100% of their portfolio, they know the market value of their portfolio at any given time
Individuals find illiquid investments to be more risky because they don’t know the current liquidation value, they might need the money for an emergency, they don’t know when they can access the value of the investment - however, they already have illiquid investments in their primary residence.
Individual’s portfolio can usually tolerate some illiquidity. For example, depending on an individual’s age and needs, their retirement accounts are usually invested for long-term growth.
What products are considered liquid?
Cash is commonly considered the most liquid asset. This is due to how easily it can be converted into other assets. Some other “liquid” investments include publicly traded stocks, some exchange-traded funds, and government bonds (such as U.S. Treasury bonds, which trade on an accessible secondary market). These kinds of investments are significantly regulated, as they are publicly traded securities and often provide an easy means to liquidate their investments.
What products are considered illiquid?
In most cases, tangible, private assets, such as real estate, fine art, and collectibles,are considered less liquid, or “illiquid”. Also, private equity funds, hedge funds, and other private investment vehicles such as venture capital or energy funds are traditionally recognized for their lower liquidity compared to the aforementioned liquid products above.
Although most illiquid assets share a degree of similarity as being hard, tangible assets, this is not the primary contributing factor as to why they are considered illiquid. Illiquidity comes from supply and demand within an asset’s market, the ease of valuation and the ability to transact when the investor wishes to do so. Transaction costs, demand pressure, inventory risk, and the inability to find buyers and sellers, contribute to the illiquid nature of these assets.
Can illiquidity help your portfolio?
For some investors, there are some benefits to illiquid products. Here are the top benefits of maintaining some illiquid investments in your portfolio:
No opportunities for rash decisions due to market changes or hype
Let us be honest, many of us are swayed by market hype and fears. All of us constantly fight the battle with our emotions when it comes to money and investing. By removing the opportunity to make rash emotional or market hyped decisions, we let investments continue based on predetermined strategy.
Greater returns to illiquidity premium
With some investments, they understand you are taking on this liquidity risk, thus they need to help sweeten the deal with an increase in returns on your end. Thus, it is crucial to understand which investments reward you for their illiquidty.
Often debt-like products - leading lower risk of full loss of capital
Again, not all but some of the products offer a debt-like return, putting the investor return of capital above the company and leadership during times of less than optimal returns. You just have to find the investments that fit your risk profile.
Interested in learning more?
Consider how much liquidity do you really need and then decide if you want to learn more illiquid investments to diversify your portfolio. Wealthhouse Advisors are always here to help. Reach out to us if you are curious.
