The current economic climate around the world is a topic that can bring everyday folk a lot of stress. With the cost of living rising everywhere, people are looking for solutions to make their money go as far as they possibly can. For many, this is going to mean using a tailored budget planner. For others, it could be bulking up their emergency fund and cash reserves. And for those with generous investment portfolios, it can mean repositioning, rebalancing, and considering different kinds of investments, such as illiquid investments.
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Investing (or reinvesting) your current resources into assets is a common way for you to create a new stream of revenue without adding another job to your already busy schedule. There are many ways to go about this, and each fall into one of two categories: liquid assets or illiquid assets. Each category has its own risks and rewards. While liquid assets are more widely used and understood, the benefits of investing in illiquid assets are often missed out on. In this article, you will learn the basics of illiquid investments and how to incorporate them into your financial strategy. Keep reading to learn more!
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What is an illiquid investment?
What is liquidity exactly? Liquidity is defined as the quickness which an asset can be bought or sold in any given market. When an asset can be sold quickly, it is considered a liquid asset. But when it takes longer to offload the asset, it is considered an illiquid asset, or investment. The liquidity of an asset also factors into how they are valued. Typically, liquid assets will have predictable rates based on the frequency that their markets are interacted with. The pricing for illiquid assets tends to be less clear as they either have a less active market or assets that each offer individual characteristics.
In many cases, liquid assets are the more favourable form of investment. People can quickly turn these assets into cash without too much hassle or the value fluctuating drastically. In addition, it’s easier to turn a quick profit on a liquid asset. For people who err on the side of caution, these types of investments come in handy during times of unexpected expenses or economic uncertainty. Alternatively, they are also good for people who wish to seize random profit opportunities.
Illiquid investments, however, have their own perks. The illiquid state of these assets means that the investor will not be able to sell them at a moment’s notice, unless they are willing to accept a considerable financial loss or no gain. If they are interested in a long term investment, these assets have a higher likelihood of maintaining stability. These assets are much more difficult to sell for a variety of reasons. In some cases, it is the rules that are attached to them, while in others it’s a matter of the market being so niche. Sometimes it’s simply because buyers want to do their due diligence before sealing the deal.
Examples of Illiquid Investments
In most cases, assets that would take 24 to 72 hours or more to offload at fair market value would be then considered illiquid investments. However, illiquid investments can take much longer to offload, sometimes longer than a year. Here are some common examples of illiquid investments:
The real estate market is designed to earn people a profit in the long run. Therefore, it’s typically considered an illiquid asset. In addition, it can take anywhere from a few months to over a year to offload real estate, depending on market conditions. This is because buyers like to do their due diligence before completing a purchase. It is also often the largest purchase people make in their lifetimes, so it’s not something that’s done quickly.
While it is possible to sell shares of a mutual fund in a short period of time, many come with rules and restrictions that deter the shareholders from selling quickly. This often takes form as a penalization.
This investment choice can only be made by people who already have a considerable amount of capital. In addition, these markets are private which means there are less buyers available. It is very niche, so if you want to offload a private equity investment, you have to find someone who is willing and has enough resources at their disposal.
These include non-physical assets, such as ideas, patents, copyrights, goodwill, brand recognition and intellectual property. These illiquid investments have value, but are difficult to sell because they don’t have value to the average individual. They would only have value to someone in your given market. In addition, there must be interest in the market to offload.
If you own a business, there may come a time when you want to sell it. However, it can be challenging to find a buyer for a business due to the work involved to maintain it. Also, external factors can have a great influence on your ability to sell a business and timing is often quintessential. Alternatively, some business owners liquidate their operations instead of selling the entity. This process also involves offloading illiquid assets as it requires you to sell equipment, furniture and so on.
Related Reading: Selling a Business in Canada: Tax Implications
Is a stock an illiquid asset?
In general, stocks are considered liquid assets. This is because stocks can be bought and sold very quickly on the market. In fact, some people make a living off of day or swing trading, which involves buying and selling stocks in the short term. The liquidity of specific stocks does vary depending on the volume at which a certain stock is being traded and the prices you are looking for.
Inherently liquid stocks will have a high volume of buyers, as well as fast paced transactions. These stocks tend to see a consistent price range with minimal fluctuation. Illiquid stocks are much less common, especially with the technological landscape today. These assets are slower paced and don’t have many interested buyers. The most common illiquid stock you would find would be privately held stock that is not actively traded on a public exchange. At times when the stock market is in decline, the liquidity of stocks also falls. Investors can prevent themselves from losing money by pulling out of the stocks and redirecting their money to other assets.
While they aren’t explicitly considered stocks, stock options are a common form of illiquid asset. This is most often seen in startup companies—though certainly not limited to them. Companies will offer stock options to new employees as a way of earning their loyalty. The shares aren’t usually available to you until you’ve been with the company for many years, making them incredibly illiquid. Once you own them, it can be challenging to sell because of a limited market.
All this is to say, while stocks technically are considered liquid assets, there are various factors that can make them illiquid.
Which investment option is the most illiquid?
The most illiquid asset is often considered to be real estate. While real estate is considered a lucrative investment and a major contributor to wealth, it takes significant time to offload. It usually takes at least a few months to sell real estate between finding an agent, cleaning and staging the property for viewings, and finding a buyer who has the capital to complete the transaction.
Furthermore, when we consider commercial real estate, the asset becomes even more illiquid. Commercial real estate usually refers to rental properties, hotels, office buildings, and so on. In essence, selling commercial real estate is similar to selling a business which makes it more challenging to offload. There are employees and notable operational costs involved when compared to a residential property. There is more responsibility and capital required to purchase commercial real estate which is what makes it an illiquid investment.
Speaking of businesses, that is the final example of the most illiquid assets. Whether its a rental business, a beauty products company, or an advertising agency, businesses can be challenging to sell. Sometimes, business owners are unable to find a buyer and choose to liquidate instead of sell.
Related Reading: What are options?
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Are illiquid investments good?
While it may seem like there are many drawbacks when investing in illiquid investments, when used correctly and with the right knowledge, they are fantastic. It ultimately comes down to what your personal investment goals are. Such as what assets you already have, how long you’re planning on investing, and how many different assets you want all play a role in what type of investment will work for you.
In addition, illiquid investments can behave like passion investments. For instance, if you’ve always wanted to start a business or invest in a certain venture, you may choose to do so out of pure interest and available capital. Or maybe you always wanted to have a second vacation property somewhere in the world that isn’t an investment based on turning a profit. These are valid reasons to engage in illiquid investments!
For those of you looking for long term investments, trying to add some diversity to your investment portfolio, or wish to focus on a specific market, investing in illiquid assets might be exactly what you’re looking for. For further help or questions, reach out to a wealth management firm for personally tailored advice on your situation.