Liquidity – An important consideration of portfolio management
February 27, 2020
The idea of Liquidity
In a world where there are a multitude of investment options, one of the most important consideration is often overlooked. When an investment portfolio is being constructed, it is important to consider different aspects. One well understood consideration is diversification. The idea that you shouldn’t hold all your eggs in one basket is an easy concept to grasp. Liquidity is another important consideration and it sounds kind of complicated, so we’re here to simplify it.
What is Liquidity
If an asset is liquid, it can be converted into cash relatively quickly without affecting the price. Conversely, if an asset is illiquid, it takes longer to sell and/or it is harder to sell without affecting the price (negatively) significantly. For example, it takes a while to complete on a house purchase/sale, therefore, properties are considered as an illiquid asset class.
There is another aspect to liquidity that is not really ever mentioned, that being the ability to sell a proportion of an asset. For example, if you wanted to raise £10,000.00 from your property to pay for a holiday, it would not normally make sense to capital raise this amount from your house. Whereas, if you had an investment portfolio (invested in liquid funds), you can realise the funds within days/weeks.
The Problems of Illiquidity
When times are good, liquidity is not so much of a concern, but when it’s bad, everyone will start to focus on liquidity. If you need the cash for whatever reason, you will either have to wait, or accept a lower price which does not reflect their value (both outcomes are not ideal!). It is important that you strike the right balance, but to do that, you need to understand the liquidity of different assets available and how they are structured (e.g. whether there are any unlisted holdings*).
Some investors believe that there is a premium for holding illiquid assets, in other words, you are rewarded extra because there is an additional layer of risk. At Iron Wealth Management, we place a lot of emphasis on daily liquidity and we do not see that premium. That is, a premium that comes with lack of transparency around pricing of assets, and a possibility of lock down during a liquidity crunch. We therefore don’t believe there is any value in holding illiquid funds given the disadvantages of this asset class.
If you would like to understand more about how we construct our portfolios, or how your current portfolio measures up in terms of liquidity, along with other portfolio considerations, we would be more than happy to help.
*Unlisted holdings are company shares that are not available to general public for trading and not listed on a stock exchange, i.e. not traded on the open market. Unlisted holdings are classed as illiquid investments.
Risk Warnings:
The information contained in this article is intended solely for information purposes only and does not constitute advice. The price of investments and the income derived from them can go down as well as up, and investors may not get back the amount they invested. Past performance is not necessarily a guide to future performance.
The Iron Wealth Blog
Eight Years On: Reflecting on Our Journey
It’s Less About Numbers, More About Judgment
When Markets Don’t Feel Fair: How We Reduce the Risk of Being on the Wrong Side of the Trade
In the world of investing, there is always something trending and receives a lot of attention.
We've been taught to save for a rainy day, which is wise to some extent. However, keeping all your money in cash over the medium to long term carries risks, too. In fact, doing nothing with your money is the biggest risk of all, as inflation will erode its value over time.
We are 5! This month we are celebrating Iron Wealth turning 5 years old. We are so ever thankful for everything we have achieved.
Is it worth switching your investment portfolio to cash? In this blog, we discuss why cash isn't all it's hyped up to be, even at 5%.
There is no better time to size your unsheltered portfolio correctly.
Fact: They are rare, inevitable and are a feature of the markets.
An Alternative Source of Income/Capital: Equity Release & Retirement Mortgage
