Liquidity has a Value of its Own

What's worth more, a violin with an appraised value of $10,000, or $9,000 in cash? It seems obvious. $10,000 is greater than $9,000 so clearly the violin is more valuable.

However, if you need immediate access to that value, the equation tilts the other way. With the cash in hand, you can hop into your car and take it to your bank. Within minutes it's available for any kind of financial transaction.

Getting the $10,000 out of the violin is a different story. To get the appraised price, you need to find someone reputable to sell it for you. Perhaps a fine instrument dealer who then needs time to find a buyer. Even if all goes well and you get full price, you'll be out a sales commission and all the time it took to set up the sale.

Liquidity, the ability to quickly turn an asset into cash, has a value of its own.

Wall Street Journal columnist Jason Zweig makes this point with the example of Ivy League endowments.¹ These are the huge financial reserves that institutions of higher learning maintain to help ensure their future survival. Brown University has more than $7.2 billion in their fund. Northwestern has amassed over $14.3 billion. And Harvard dwarfs them all with its $53.2 billion endowment. All of it invested by some of the purportedly smartest people in finance. Yet earlier this year, these schools had to borrow hundreds of millions of dollars to meet short-term operating expenses, paying millions in interest.

Zweig explains that the reason for this borrowing was that these institutions have invested substantial amounts of their endowments in alternative assets—hedge funds, private equity, venture capital, and other investments that don't trade publicly. It can take months to sell these kinds of assets. And if you need money right away, you get a loan until a buyer comes along, or you sell at a loss.

This spring, after months of effort, Harvard finally was able to sell $1 billion in private equity funds, but only after discounting them by roughly 7%. That's $70,000,000 below their stated value. "The lesson is so simple," writes Zweig, "that even Ivy Leaguers should be able to understand it." 

In good times, when cash is plentiful, investors generally don't think much about liquidity. It's not until bad times, when they urgently need cash, that they suddenly see its value. One of the advantages of having a portfolio invested largely in stocks and bonds is that they are highly liquid. If you wished, you could liquidate your entire portfolio in a few trading days. Of course, another advantage to owning marketable securities in the publicly traded global market is the opportunity to widely diversify across sectors and borders.

Our advisors work with your and focus on long-term success. With a plan based on your unique situation, we help provide the guidance and accountability designed to put you in a financial situation to do the things that matter most.

 

1. http://go.pardot.com/e/91522/-basic-investing-test-747c8b8c/96xzls/2932087517/h/4baFZozymxLpZreFITtfS7iTfyvr-rh-9yXrkCNRL-0