Understanding liquidity – your ability to buy or sell an asset within a particular period of time – is 100% essential. ETFs, for example, are highly liquid: they can be bought or sold with the click of a mouse. Real Estate, on the other hand, is often illiquid. During a market downturn, it may literally be impossible to sell. Hence, the repercussions of intelligently connecting your investments’ relative liquidity to your individual financial needs may well mean the difference between being a millionaire on paper and bankrupt in reality. This is not to say that, for some investors, illiquid investments don’t still provide outstanding opportunities or cannot play a highly positive role in a diversified long-term portfolio. Again, the “fundamental” here is understanding the specifics of how liquidity affects your finances.
Hedge fund and private equity investments, for example, are nearly always illiquid because recouping one’s cash frequently requires providing notice to the manager followed by a prescribed waiting period. Recognize also that some liquidity problems develop unexpectedly – most often when other investors seek a sudden simultaneous withdrawal. Finally, never underestimate the value of owning assets that allow you to profit quickly when prices are high, to get out fast if markets start to plummet or to enjoy the self-assurance which comes from knowing your money will be there for life’s unforeseen events.