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Difference between Liquid and Illiquid investments

It is often said in investment, that asset allocation is key. It’s asset allocation that drives the performance of any portfolio of investments.

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Difference between Liquid and Illiquid investments

It is often said in investment, that asset allocation is key. This means that it is asset allocation that drives the performance of any portfolio of investments. When taken at a higher level, there are indications that many portfolios are allocated between liquid and illiquid investments. But what are liquid and illiquid investments, and what are the differences? When the word “liquidity” is used in investment, it simply means the ease or ability to turn an investment asset or security into cash without losing much of its value. In essence, cash is the most liquid of all investment assets, while real estate property is almost the most illiquid.

The fact that cash is the most liquid, while property is the most illiquid, implies that there is a wide range of degrees of illiquidity or liquidity among asset classes. While treasury bills are very liquid, long term bonds are not as liquid, especially if they are long term bonds of companies that are either unknown or are financially unstable. Treasury bills and long-term bonds are both fixed income securities, but one is more liquid than the other. In the same way, publicly-traded equities are more liquid than private equities. That means that even among same asset classes or types, degree of liquidity differs.

Risks of investing Illiquid assets

Asides the fact that an investor may not readily convert the value of an illiquid asset to cash as at when required, there are other risks that go with illiquidity. Because the holding period of illiquid assets is longer than that of liquid assets, an investor is exposed to increased volatility, fluctuations in interest rates and changes in economic conditions, among other risks. In addition to that, an investor has a higher opportunity cost with illiquid assets because he or she will have to tie down his or her money in the illiquid asset for a longer time.

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Importance of Liquidity in Investing

Given the dynamic nature of stock markets around the world, there is no gainsaying the fact that liquidity matters. One of the benefits of liquidity generally is that it leads to pricing transparency, which helps in valuing assets. On the other hand, liquidity offers investors the flexibility they need to trade on their assets.

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The price of investing in Illiquid assets

If illiquid investments are not easily convertible to cash, why would anyone be interested in such assets, as an investment. The reason is that those who have the risk appetite and tolerance to invest in illiquid assets and the patience to wait for those investments to come to maturity or fruition, get compensated, oftentimes handsomely. This compensation is what is called liquidity premium. There is liquidity premium in most investments but it is more pronounced in illiquid assets. For example, when you look at a typical yield curve, you will discover that a normally shaped yield curve is upward sloping.

[READ MORE: 5 habits of Nigeria’s business billionaires you should emulate]

This means that bonds that have longer maturity and are therefore less liquid than short maturity bonds, compensate the investors with higher interest rates or yield. This is because longer-dated bonds carry higher risk and rewards investors for the added risk with the added yield, just like illiquid assets carry higher risks than liquid assets and as such, rewards investors with some liquidity premium. It is these added or magnified investment risks which call for higher liquidity premiums that an investor should demand when investing in illiquid assets.

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Illiquid assets are good for diversification

It is often said that portfolio diversification is better achieved when assets that are not perfectly positively or negatively correlated are held together. Therefore, the low beta and low correlation between publicly-traded securities and illiquid assets makes investments in illiquid assets good ingredients of investment diversification. Investments with low beta, help cushion volatilities that emanate from the mainstream markets. Correlation is a statistical measure of how two or more variables move or change in relation to each other, while beta is a measure of the relationship between changes in the stock market and other investments.

The need for proper Asset Mix

It may be tempting to invest in illiquid assets like property, gold, vintage cars, stamp collections or artefacts, because of the premiums that come with them. It may also be tempting to shy away from them because of the additional risks involved. That is why some investors try to strike a balance in their asset allocation or asset mix between investing in liquid and illiquid assets. It is advisable to keep a portion of your investment in liquid assets so that they are at your beck and call, whenever you need to convert them to cash. It is also advisable to have some assets in illiquid assets so as to take advantage of the premiums that they generate.

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Is Illiquid Investment good for you

Though I have noted that illiquid investments are good to have in a portfolio to achieve a good asset mix and diversification, it may not be good for every investor. It is good for those investors that have high-risk tolerance, high-risk appetites, high rate of return expectations, and with long investment horizon. Remember, invest according to your risk chemistry.

Uchenna Ndimele is the President of Quantitative Financial Analytics Ltd. MutualfundsAfrica.com and mutualfundsnigeria.com (both Quantitative Financial Analytics company website) is a leader in supplying mutual fund information, analysis, and commentary on African mutual funds. We provide reliable fund data; and ratings information that will add value to fund managers, the media, individual investors and investment clubs.

2 Comments

2 Comments

  1. Oluwafemi B. Onojobi

    November 8, 2019 at 5:08 pm

    Thanks for this educative information.

  2. uchey

    November 10, 2019 at 2:36 pm

    My Pleasure

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Personal Finance

How to improve your investing habit

Valuable tips to help you improve your investing habit and make more money.

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investor, Steps to investing, Steps to developing a growth plan for your business, Breaking down the biggest misconceptions young people have about investing , Here’s how your business can grow revenue in tough conditions (PART 1), Here are ways to find the right investor for your business, How to build up your investment knowledge, This simple advice could help solve your investment challenges 

The best route to financial freedom and wealth is by saving and investing your funds. With the rising inflation rate in the country, money saved in the bank is useless and would depreciate with time. The best thing to do as a smart person is to invest your money and sleep while your money works for you. Investment entails more than just knowing about the stock market and investing, it involves having a healthy investing habit. It takes a lot of study and growth to imbibe these habits. Keep reading for tips on how to improve your investing habit and make more money.

Keep at it 

A good investor doesn’t start today and stop tomorrow. You have to be consistent with your investment plan and learn not to eat all your returns. Reinvest your interest and keep investing till your last breath, that is how you make more money. When Albert Einstein was asked what man’s greatest invention was, he said ‘compound interest’. According to him, “compound interest is the eighth wonder of the world, he who understands it, earns it; he who doesn’t pay it.” Imbibe the art of reinvesting today and keep at it.

READ: 10 Actions That Can Make You a Succesful Investor

Have a plan

‘A goal without a plan is a wish.’ Having defined your financial goals, you should come up with a plan on how to achieve your goals. Gone are the days when you just invest blindly. To improve your investing habits, learn to plan ahead. Decide what to invest in, look out for the risks involved in your investment, calculate your interest rates and see if it would benefit you, and track your investment.

READ: Studying after COVID-19: How education will be changed in 2021

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Spend more time on research 

“It has long been the prevalent view that the art of successful investment lies first in the choice of those industries that are most likely to grow in the future and then in identifying the most promising companies in these industries”
An excerpt from the book, “The Intelligent Investor; The Definitive Book on Value Investing” by Benjamin Graham, updated by Jason Zweig.
The importance of research cannot be overemphasized. As a smart investor, you should do thorough research on the industries that have great potential and would give you better results. You should also do in-depth research on the risks involved in investing in specific industries. Arm yourself with enough data before investing.

Learn from your mistakes 

There is no successful investor that has not made a financial mistake or lost money due to some sloppiness. However, what makes you a better investor is the ability to learn from your mistakes and move on. This rule applies to all facet of life so it shouldn’t be new to you. If you make an error in your numbers or make some huge mistakes, pick yourself up and try again.

READ: MTN Nigeria records gain, investors profit up by N42 billion

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Wait on it 

You can not be an investor and not know how to be patient, disciplined and eager to learn. One of the habits of successful investors is patience. You have to learn how to let go of your funds and let it come back to you when it is ready. Also, the market won’t always be proposing huge returns or favourable investment plans; your patience will go a long way in helping you survive situations like this.

READ: Fidson reports over 500% increase in profit for 2019

Be a copycat but also think for yourself 

Do research on successful investors, find the ones that have the philosophy that aligns with you and follow their steps. You cannot know it all. You should also learn from their mistakes along the line; that is the key to becoming better than them. You must also be able to harness your emotions and think for yourself as an investor. Don’t underestimate the power of your intuition.

In addition to the tips listed above, below is the Buffet approach to investment, extracted from “The Warren Buffet Way: Investment Strategies of the World’s Greatest Investors” by Robert G. Hagstrom.

Explore the Nairametrics Research Website for Economic and Financial Data

  1. Never follow the day to day fluctuations of the stock market.
  2. Don’t try and analyze or worry about the general economy.
  3. Buy a business, not its stock.
  4. Manage a portfolio of businesses: Intelligent investing means having the priorities of a business owner (focused on long-term value) rather than a stock trader (focused on short-term gains and losses).

We wish you well on your investing journey.

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Personal Finance

6 things you must not do with your money

Money can go as fast as it comes, but you might just get to keep it for a long time if you follow these tips.

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Coming across this, you probably thought to yourself “what an interesting topic, I wonder what it has to say”. Well, we are right there with you. There are a lot of things you shouldn’t do with your money and even without reading further, you can probably outline about 20 things, (go ahead if you’d like to).

Trust me you’d have fun doing that because it was quite fun coming up with this list and we’d like to present to you the top 6 things we believe you must not do with your money. Have a fun read.

DO NOT BE UNINTENTIONAL WITH YOUR MONEY

Intentional living is important and it is something that has caught on over the years. To be intentional means to be deliberate in your actions and decisions. Basically, what you must understand from this is that you should not be impulsive with your money, whether in your spending, savings, and investment decisions, you must be deliberate. There is a popular saying that goes “failure to plan is planning to fail”.

It is necessary to always have a plan/budget for your money. Never leave your money to chance. Be intentional, be deliberate, and do not be passive with your money plans. To get started, you can focus on three steps; have a vision, create a plan, set limits. You can decide to be intentional with your impulse buying as well. When you create a plan and set limits and you do not go over that limit, even when you decide to splurge, you would still be on track to achieving your goals.

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DO NOT MAKE LARGE PURCHASES WITHOUT CONSIDERING THE FULL COST

Part of being intentional with your money is to avoid large purchases if possible. Things like buying a car or land/homeownership should not be taken lightly. Even if you can afford the down-payment at that time, you have to consider the other charges and fees attached. If you can meet up with maintenance and servicing then, by all means, go ahead. Otherwise, it’d be best to review that decision. One way to achieve such purchase though, if your current earnings aren’t sufficient to support an extravagant purchase is to have a savings or budget plan for it.

Even if you cannot afford a financial advisor, there is a good number of mobile apps that would help you make such a savings plan. If you are the type of person that whenever you come upon ‘windfall’ or unexpected income, you’re already thinking of how to spend it extravagantly, you need to have a change of perspective. Before you think of buying that private jet or getting that car, you need to ask yourself if you are fully capable of maintaining it. Making rash purchase decisions can lead to regrets later.

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DO NOT CASH YOUR PAYCHECK RIGHT AWAY

With the advancement in technology, most employees have the option to have their earnings paid directly into their bank accounts, rather than collecting cheques or cash. But no matter the form you collect your money; you must make provision for part of that money to be saved. Do not spend it immediately. You can automate payments such that a percentage of your monthly income goes directly into your savings account.

This helps to avoid the temptation of dipping into that fund because, “if you don’t see it, you won’t spend it”. Some companies provide retirement savings plans for their employees, a system whereby a portion of their salaries are deducted and paid directly into their retirement account. One such plan is the 401k, of which the Nigerian alternative is the Nigerian Pension Scheme, governed by the National Pension Committee (PENCOM).

(READ MORE: Cashless goes nationwide)

DO NOT PUT ALL YOUR MONEY IN ILLIQUID INVESTMENTS

While investments are fun, and a good way to build wealth, it is important to diversify and have variety. Remember the saying, “do not put all your eggs in one basket?”. The difference between liquid and illiquid investments is simply this; the ability to exchange something for cash. So the rate of liquidity is determined by how easily an investment can be converted to cash. Do not tie up your money by investing in illiquid investments. Your investment portfolio should be diversified.

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DO NOT SHOP EMOTIONALLY

The fact that we are biological beings does not mean we should not make logical decisions. Do not fall prey to ‘retail therapy’. Retail therapy is a term that is used to describe the action of shopping to improve one’s mood. It is also referred to as “comfort buys”, often acquainted with individuals who buy during periods of depression and stress. You are allowed to get emotional and you are also allowed to deal with that emotion, but talking to a sales representative or clerk just to make you feel better is not healthy.

Their job is to make sales, not your welfare. This is not intended to paint anyone in any sort of way but rather, to educate you. Instead of making that trip to the store or browsing that online catalogue, it would be better for you to call up a trusted friend or family member and talk with them. You’ll thank me for it.

DO NOT SIGN A CONTRACT YOU DO NOT FULLY UNDERSTAND

A contract is an agreement between two people that is legally binding. Four essential elements that make a document legally binding are; an offer, an acceptance, an intention to form a partnership, and a consideration that usually involves money. It can be oral or written. When it is oral unless recorded, there is no solid proof that an agreement was made, but, once it is written there is enough proof.

So before you go ahead and sign that piece of document, you must be fully aware of the terms and conditions of your agreement. Yes, a contract may, however, be considered invalid for specific reasons, but the bottom line is that you should avoid any situation that would put you in any money problem. It is more rewarding to get professional advice than implicate yourself unknowingly.

With all that’s been said, the crux of the matter is that you must be intentional with your money. Only then, can you plan, only then can you learn from your mistake, only then can you track your money movements, be deliberate, make decisions and take actions with a purpose. Develop a relationship with it (a healthy one of course), get to know your money, go on money dates and your financial health will bless you for it.

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MSME

FG says 174,574 successfully register for N75 billion MSME survival fund in 48 hours

174,574 persons have successfully registered for schemes under the Nigeria Economic Sustainability Plan.

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FG releases new details on MSMEs support scheme, budgets N200 billion for loans, FG says 174,574 successfully register for N75 billion MSME survival fund in 48 hours

The Federal Government has disclosed that a total of 174,574 persons successfully registered for the N75bn National MSME Survival Fund and the Guaranteed Off-take Stimulus schemes under the Nigeria Economic Sustainability Plan, within 48 hours.

The disclosure was made by the Minister of Industry, Trade and Investment, Ambassador Mariam Katagum, during a media briefing on the update of the schemes, on Thursday, September 24, 2020.

Mariam Katagum, in her statement, said: “As at 8.30 am this (Thursday) morning, total successful registrations stood at 174,574 with the following states having the highest applications as follows: Kano, 19,895; Kaduna, 13,575; Lagos, 13,640; Katsina: 8,383; Federal Capital Territory, 8,085.”

She stated that the registration for the MSME Survival Fund commenced on September 21, 2020, at 11 pm, and within 24 hours, approximately 138,000 individuals had logged on, created profiles and completed the first stage of registration with Kano, Kaduna and Lagos as lead states.

(READ MORE: Nigeria’s external reserves up by 7% in 21 days, currency speculators to lose over N10 billion)

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Going further, Katagum said, “All successful applicants received SMS and email verification with a list of requirements for the second stage of application which would commence on October 1, 2020. Applicants will be required to upload details supporting their applications which will be verified and if successful, approved for disbursements.”

The minister further disclosed the states that recorded the highest numbers of applications within the first 24 hours of registration; these are Kano, which recorded 16,880: Kaduna, 11,438; Lagos, 10, 530; Katsina, 7,354; and Bauchi, 6,622.

Explore the Nairametrics Research Website for Economic and Financial Data

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She also stated that registration for other tracks would start next with the hospitality industry coming on September 25, 2020, by 10 am; payroll support (others), September 28, 2020, 10 am; while artisan/transport grants would start on October 1, 2020.

Nairametrics had two days ago reported the opening of the portal for its N75 billion Micro, Small and Medium (MSMEs) Survival Fund and Guaranteed Off-take schemes with effect from 10 pm on Monday, September 21, 2020.

READ: Delivering mass housing as a path to Nigeria’s economic recovery

These two MSMEs initiatives namely MSMEs Survival Fund with payroll support track and the Guaranteed Offtake Scheme which are at the core of FG’s N2.3 stimulus package in the Economic Sustainability Plan, were introduced by it as part of the efforts to help businesses overcome challenges posed by the Covid-19 pandemic.

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