Liquidity and Marketability

Someone, or many people, once said that if you get the fundamentals right everything else eventually falls into place. Doing so doesn’t guarantee the task will be easy, but I think we can all agree that getting the fundamentals wrong makes things a lot harder.

Unfortunately, most people don’t realize they’re getting the fundamentals wrong until times of stress (market, economic, and so forth) or, as has been the case for certain local investors in recent months, until there’s nothing to be done to fix the problem.

Case in point is the recent uncovering of how a highly regarded real estate fund based in Marin turned into a massive Ponzi scheme. The promise of higher returns led many folks to put far too much of their life savings into this deal and now they find themselves between a rock and a hard place. The details of the scheme are available online, so you can look it up if you like.

While there are several investing and planning fundamentals imbedded in this financial tragedy, let’s look at one of the most fundamental: understanding the difference between, and the importance of, liquidity and marketability. A lack of personal liquidity is one of those problems that isn’t until it is and then it’s a big one. And it’s easily overlooked when times are good, even by some of the most intelligent folks around.

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Liquidity – This finance term refers to your cash and how quickly and easily you can access it. This is best thought of as cash held at your bank or within your investment account. It’s you’re your emergency fund and cash for other near-term expenses. There’s usually federal insurance and no time commitments. You can access your cash anytime with no fees or market risk. Anything beyond this general definition should not be counted as part of your personal liquidity.

Understanding this is fundamental because you should, ideally, always have ample sources of liquid cash available. There’s a process to determine how much you need and how to replenish it over time that you ignore at your peril. And this cash is always going to earn you the least amount of interest. This rubs people the wrong way and is a leading cause of the problem. It’s best to think of low returns on your cash as an opportunity cost paid for easy and quick access to it.

There is absolutely a time and place to make long-term investments that shoot for higher returns, just not by dipping into what needs to be liquid. Don’t confuse the two. Your liquidity acts as a buffer against investment losses and is one of the reasons it’s so important. Many of the Ponzi scheme investors were pension funds that can spread losses around. But more were retired individuals on a fixed income who dug too deeply into their cash to earn higher returns. Now the income they were receiving has dried up and their principal will likely be held up for years if they ever see it at all. In short, they’re now in a liquidity crisis that was likely years in the making.

Marketability – This term involves having to sell something to get cash and applies to your longer-term investments.

In the case of selling stocks and bonds marketability is a matter of keystrokes. You might have to sell at a loss, but unless your portfolio is full of high-risk penny stocks your transaction is straightforward. You can see what your positions are worth in real time and the sale is likely accomplished in seconds with minimal or even no transaction fee. In short, these are marketable securities and should be what the bulk of your long-term savings is comprised of.

Private investments like what the Ponzi scheme owned (real estate, trust deeds, etc.) are entirely different. You can often buy with ease but there’s no active market for these kinds of investments once you own them. If you want to sell for cash, you have to ask the fund for permission to sell shares back to them. They may not want to, or they may but with restrictions. Either way, private investments aren’t marketable and should never be considered as such, no matter what the fund folks may tell you during the sales process.

I’m not suggesting that you should never put money into private or other nonmarketable investments. You just need to be aware of the very real risks to getting your money out when you need it, which will probably be during a time of stress. You’ll want to have ample liquid and marketable assets to sell instead, likely making your unmarketable private deals a relatively small portion of your overall portfolio.

Understanding these terms and how they apply to your situation is fundamental and it’s easy to see why. This is one of the reasons I spend so much time structuring client portfolios the way I do. Clients all have available cash outside of their portfolio, then inside their portfolio, and then bonds are included so that there’s always somewhere to go for cash without being forced to sell more volatile investments like stocks. And I never buy private investments for reasons already made clear. All this makes it easier for clients to be successful over time by avoiding big potential problems along the way.

Have questions? Ask me. I can help.

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