Do you have an investment portfolio? If you are reading my blog, you most likely do. Do you own a home, or at least co-own it with the fine people that gave you a mortgage? Also a likely yes. Home ownership is one of the great tenets of life, handed down from parent to child through scolding comments like, “If you rent, you’re just throwing money away!” or my personal favourite, “You can’t lose money in real estate!” The last one is an especially common one right now in the GTA because housing prices have risen dramatically in the last 10 years.
But I don’t want to debate the merits of home ownership vs. renting, or stocks vs. bonds. I want to clarify how I look at all of the different types of investments available - through a lens of liquidity.
Liquidity is essentially a big word which represents how quickly you can get the fair value for your asset. Cash is the ultimate form of liquidity because you have it in your hands already and except in hyper-inflationary environments, cash will get you what you need from day to day. Everything else has some delay before you receive your value for it.
A simple primer.
Stocks, bonds and their corollary mutual funds and exchange traded funds are also fairly liquid because you can get your money in a few short days and typically very close to what it was worth at that time. Of course that doesn’t mean it was worth what you paid for it so the potential for loss does exist.
Real estate can take anywhere from 30 to 90 days to close on the residential side and a bit longer for commercial real estate. Again, not bad but still the potential to get less than you paid is there with real estate.
The least liquid options are things like shares in private businesses, partnership interests and investments like private equity. A lot goes into determining the value of these and in bad times it can be difficult for you to sell for close to market value.
Why does liquidity matter if you are trying to grow your wealth? The quick answer is because having good liquidity gives you the flexibility to adjust to almost any circumstance. Good times and bad times will happen throughout your life and one of the keys to reaching your wealth goals is to survive the bad times with minimal pain. Liquidity is the linchpin to that.
When a client sits down to start the financial planning process, one of the new things we do for them is show them how “liquid” they are. Finding out what they own that could be sold relatively quickly for a fair price is an interesting exercise to undergo. You quickly realize whether your wealth is properly balanced to your needs by changing your mindset from one of returns on asset to a return of value for an asset.
The optimal strategy for everyone considers their specific needs for quick cash balanced with their tolerance for risk. As an investment becomes less liquid it often can become more volatile over short periods of time. Everyone that is building a company knows this all too well.
This isn’t me arguing you should have everything as liquid as possible. There are real, long-term benefits to diversifying your wealth across not just asset classes but also by liquidity. It’s another way to diversify your wealth which reduces the ups and downs along the way. Real estate and infrastructure-like assets protect against inflation in ways that more liquid assets like bonds and cash cannot. They absolutely have a place in any investment allocation. I just want to make sure that my clients have the proper flow of money to meet their needs and smooth the ride along the way.