"Usually, just as a holder’s desire to sell an asset increases (because he has become afraid to hold it), his ability to sell it decreases (because everyone else has also become afraid to hold it). Thus (a) things tend to be liquid when you don’t need liquidity, and (b) just when you need liquidity most, it tends not to be there." -Howard Marks
What is the liquidity premium that you will pay to have an asset that holds its price when you want to sell it? How much do you need to be compensated for an asset that cannot be sold immediately? These are question that are not often asked by investors make an initial purchase, yet pricing this trade-off between return and liquidity is critical in any financial downturn.
How much liquidity will I need during "bad times"? Again, this contingency is not often planned for by investors, yet in bad times there will be a greater need for liquid assets since income may be impaired.
Do I prefer a less volatile investment in an illiquid asset or a more volatile investment in a liquid asset? Liquid assets which are priced by the market are generally more volatile than assets that are priced by dealers or through a model. How much extra return do I need for this volatility?
Can everyone have liquidity at the same time? Since liquidity is based on both buyers and sellers in the market, there has to be two way flow and differences of opinion or there is no liquidity. Everyone cannot have good at the same time.
Understanding liquidity is no different than understanding where the exits are in a crowded theatre. The time and cost of getting out of the theatre are a lot different in an emergency than when times are calm. Thinking of liquidity does not require extreme behavior like holding high cash levels, but it does require strategic as well as tactical planning. Bad times are a predictable surprise. Unexpected negative events will occur and investors should not be surprised when there is a liquidity shortfall.
Liquidity is like the price of water - cheap in good times but priceless when there is a shortage.
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