Liquid investments tricky
Liquidity. It’s a word, it’s a concept, it’s something needed to an extent by every investor. And it is often not thought about. Even worse, when it is thought about it is assumed to exist in places it is not.
If you search the Internet, there are a few definitions of liquidity, but they all center around one main goal: Turning your investment into cash without affecting its price. To that end it would seem that most things are liquid. If you owned a few hundred shares of Apple Computer and needed the cash, trust me, your selling is not going to affect the price. But what if a whole lot of people wanted out at the same time? Well, that’s a different story.
Liquidity, you see, can change. Sell your Apple stock today and you’ll pretty much get what you expect. Sell it during the middle of a bursting tech bubble and you’d be hard pressed to do so without losing some significant value.
Liquidity also implies that you can get out of your investment in a timely fashion. Thus your house, while it might be a good investment, is certainly not liquid. If you needed your cash out if it within the week, you’d have to offer it at a significant discount. And, as the financial crisis showed, that discount could last years.
Even something as safe as a bond may not be all that safe. If you are selling large blocks (not likely) then you can change the price by your trades. If you are selling just a few bonds, then you’ll end up selling at a discount in order to compensate the broker. And that assumes you can sell it at all. During the financial crisis the bond markets froze making it almost impossible to sell your bond position without taking a significant loss.
There was an exception to this: U.S. Government Bonds. So does that make them liquid? Well, yes…unless you are trying to sell them when interest rates are going up. Bond prices generally go in the opposite direction of interest rates. If the interest rates start rising then the value of your bond portfolio will likely start falling…including your government bond holdings.
Then what is liquid, you may ask? Think of the bank. Yes, rather boring, but that’s the idea. A dollar deposited there equals a dollar able to be withdrawn. Stock market down? Doesn’t matter.Interest rates spiking up? Still doesn’t matter. Tech companies falling into a black hole? Same thing. I’d also lump CDs and fixed annuities into this if the early termination charge is less than the interest paid so that you don’t net out a loss if you need cash now. All are liquid and safe no matter what is happening.
The moral of today’s story: If you want your money to be safe; if you want it to be there when you need it; if you want to eliminate the danger of loss, then you need to make sure it is liquid. But is that what you need? We’ll look at that next week.
This article was published under the title "Liquidity can involve fluidity" in the Wichita Falls Times Record News on May 31, 2015.