When it comes to investment assets there are lots of ways to categorise them. You can categorise by asset type, geography, sector, and so on. One of the most commonly overlooked is liquidity. Generally speaking, assets fall somewhere on a spectrum of liquidity, which refers to how easily convertible they are into cash.
Large, listed commodities such as shares are pretty liquid – they’re listed on global stock exchanges with prices regularly updated. If I want to buy a share, I get the price from the exchange and place a buy order. Likewise if I then want to sell it. On the other hand, a collection of gold coins is less liquid – I’d have to source a buyer and negotiate a price with them based on the current price of gold (although there’s no guarantee that anyone will agree to buy my gold at this price, especially if they’re going to try and sell it on for a profit themselves).
Cash is therefore the most liquid asset you can hold. Although I couldn’t walk into a shop and attempt to buy my groceries with a deed to a piece of land I hold, I could walk in with a stack of cash and use it to pay immediately. If all my investments were in land, I would have an illiquid portfolio – extremely difficult to convert into cash and difficult to accurately value on a regular basis.
It would also be a highly risky portfolio. If land prices collapsed, I wouldn’t be able to offload the land quickly enough to prevent myself losing money. If all the land was in a single area, I might also depress the price even further by trying to sell all my land at once.
By comparison, a liquid asset is one which is unlikely to decline significantly in value if you sell your holdings. For example, if I hold 1000 shares of a company that has 100,000,000 of them then the price is unlikely to shift when I sell my holding.
How I use liquidity in my portfolio
In a previous article, I wrote that I keep between 10-15% of my assets in cash throughout the year. On top of this, a further 65-70% of my assets are in ‘liquid’ alternatives (mostly listed shares and funds). Of these, I grade my holdings – some are short-term holdings that I’d be happy to liquidate at their current prices, others are medium-term holdings that I wouldn’t consider touching for several years, and a final tranche are long-term ‘core holdings’ which I only really top up over time.
In addition to these, approximately 20% of my assets are in illiquid form – non-listed private placements, private pensions, property, and a small amount of jewellery and antiques. These are assets which I wouldn’t be able to liquidate in a hurry (or at least, if I tried to, I’d probably have to take a significant discount on their actual value to do so). Over time, I continue adding to these, but will always try to keep them in proportion to the rest of my portfolio.
By trying to keep these percentages reasonably consistent in my portfolio (15/65/20), I ensure that I always have sufficient funds available for emergencies, repair works to my properties, taxes, in addition to having the flexibility to pursue new opportunities as they arise in the market. It all comes down to risk perception and how comfortable you are with investing.
Some of my friends and relatives are extremely risk-averse. They see investments as highly risky and hate the idea of ‘losing money’. As a result, they hold pretty much nothing more than a conservatively managed pension fund and cash. They’d look at my portfolio, which is 85% invested and gasp with horror.
But in truth, they’re losing money every year to inflation, which is a real risk that has crystalised in their portfolio. Certainly, the value of my investments can go down as well as up, but over time, I’m refining my strategy and generating real returns in advance of inflation. If I diversify (which I do) and follow a clear strategy (which I do), then I manage my risk of investing in poorly performing assets. By comparison, how do you manage your risk of losing money to inflation each year? In the event of keeping it all in cash, you’re not managing it at all…you’re ignoring it.