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Being liquid describes how quickly someone is able to get to their cash. When we talk about the risk to liquidity, we mean any instance where the investor can’t buy or sell an investment as and when desired. In other words, they are unable to access cash when they need to.
We often hear the saying that someone is ‘asset rich but cash poor’ – and it is often seen in retirement. An example of this would be a retiree with multiple properties, who is drawing a weekly income from rent, but has the rest of their cash tied up in property. Having multiple properties is great, but there are risks – one example would be that there is a break between renters, or the owner is not able to rent out the property. This would stop the owner’s cashflow altogether.
What we’ve seen happening in scenarios such as this one is that people are forced to sell their property faster than they would like, meaning they do not always get the price that they want.
Another issue with selling property is that you must sell the entire property at once. (You can’t just sell the bathroom!) And this is where the property market differs from the share market. If you own shares, you can sell as much of it as you like. Of course, as always, there are associated risks. There is more volatility in the share market. But if you invest in the share market, for example in the top 200 companies, you have a guaranteed buyer (even though you’ll have to accept the price they’re willing to pay). And you also have greater liquidity than when owning property.
As always, we recommend putting your investments across different companies to ensure you have some liquidity.
(Side note: we think Liquidity Risk would be a great name for a racehorse. Although, owning a racehorse would be a liquidity risk.... but cheering it on from the sidelines might be fun.)
Published by Dallas Davison, Michael Hogue and Ali Hogue. January 11, 2021