Register For Our Mailing List

Register to receive our free weekly newsletter including editorials.

Home / 55

Beware of the curse of liquidity

Stock markets have been bouncing around recently, as conflicting reports arrive about the situation in Ukraine and the effect of possible sanctions. The optimists are seeing any dip in the market as a great opportunity to jump in and buy, while the most extreme of the pessimists are forecasting we are on the brink of another major war.

Having observed the behaviour of markets for more than 50 years, I’ve long given up making forecasts. There has never been a time when the pessimists weren’t with us, but most of them remind me of a stopped clock – right twice a day.

I will certainly be looking at buying opportunities if the market falls, but it is vital for anybody considering investing in shares to understand that volatility is the price we pay for liquidity. Only shares offer the opportunity to buy and sell in small parcels with minimal cost, and have the proceeds in your bank account in five days.

To help individuals understand the way stock markets work, investment guru Warren Buffett used his recent annual newsletter to tell the story of a farm he has owned since 1986. Unless you are a short term trader, in other words a gambler, Buffett believes you should treat your share portfolio in exactly the same way as you would your real estate investments.

“Those people who can sit quietly for decades when they own a farm or apartment too often become frenetic when they are exposed to a string of stock quotations,” Buffett said. “For these investors, liquidity is transferred from the unqualified benefit it should be, to a curse.” He argues that the goal of the ordinary investor should not be to pick winners: they should simply hold a diversified portfolio and stick with it.

Buffett compared the fluctuations in the share market as akin to an erratic neighbour leaning over the fence screaming out offers for his land every day.

“Imagine a moody fellow with a farm bordering on my property who yelled out a price every day at which he would either buy my farm or sell me his – and those prices varied widely over short periods of time depending on his mental state. If his bid today was ridiculously low, I could buy his farm … if it was ridiculously high I could either sell to him or just go on farming.”

Let’s translate that to our local market. Let’s say you owned a blue chip share XYZ Limited that was selling at $40. The company is highly profitable, paying increasing dividends, is well managed, and is a market leader. Suddenly, due to the possibility of war in Ukraine, Wall Street tumbles, traders all around the world panic and sell, and our market drops 3%. Of course, shares in XYZ will fall too, and you may wake up to find your $40 share is now worth $39.

As far as XYZ is concerned, nothing has changed. The business is as strong as ever, and 99.5% of investors are happy to sit tight and enjoy the growing income stream. Only a desperate few panic and sell and take a loss, just because the market in general reacted to events that happened thousands of miles away.

No investment offers the growth potential, ease of ownership, or tax concessions of shares. Buffett’s phrase ‘the curse of liquidity’ is a new one to me, but it sums up markets perfectly. Every investment decision you make will have advantages and disadvantages. The downside of liquidity is that you can be tempted to sell just because you can.

 

Noel Whittaker is the author of Making Money Made Simple and numerous other books on personal finance. His advice is general in nature and readers should seek their own professional advice before making any financial decisions. Email: noelwhit@gmail.com

2 Comments
Roert
March 29, 2014

I am more nervous when in excessive profit (without a solid foundation ) and tend to take the initial cash out, leaving the accumulated profits to continue compounding (if that is their destiny).

Around 150% profit (cash costs + 150% ) is around where I consider over-valued shares should "fly by themselves" (none of my cash in it).

Obviously, if the value is still there, strong P/E, solid yield and growth (potential and current) and modest gearing/debt, I will continue with the investment (cash involved ) and may take extra opportunities to buy more.

If the reverse happens and the price decreases (under my costs ), I re-assess the investment at (roughly) every 20% drop, as to whether I ride out the dip, or invest more at a discount .. not every investment will be added to, but the option is considered.

I normally only completely exit when i am forced to (take-over or liquidation, etc.) or the investment takes a direction I am not comfortable with (MYR compounding its issues by merging with DJS is an example ... although i will wait for a suitable exit price).

in the exampled farm scenario :- if the neighbours farm went bad (infertile ground ) while i owned it i would be more likely to consider turning it into a shopping center or warehouse space , than cry and sell cheaply .

Gary Whittles
March 29, 2014

I agree we should stay invested - the problem is, when the market falls 20%, there's always some expert who gives great reasons why the market will fall another 30%. Most retirees can tolerate a 20% correction but a halving of their wealth leads to too many sleepless nights. Especially when the ability to return to work is nil.

 

Leave a Comment:

     

RELATED ARTICLES

Long-term investing: the destination is better than the journey

Long-term investors fail to reap their natural advantage

The defined contribution obsession with liquidity

banner

Most viewed in recent weeks

Super changes, the Budget and 2021 versus 2022

Josh Frydenberg's third budget contained changes to superannuation and other rules but their effective date is expected to be 1 July 2022. Take care not to confuse them with changes due on 1 July 2021.

Noel's share winners and loser plus budget reality check

Among the share success stories is a poor personal experience as Telstra's service needs improving. Plus why the new budget announcements on downsizing and buying a home don't deserve the super hype.

Grantham interview on the coming day of reckoning

Jeremy Grantham has seen it all before, with bubbles every 15 years or so. The higher you go, the longer and greater the fall. You can have a high-priced asset or a high-yielding asset, but not both at the same time.

Whoyagonnacall? 10 unspoken risks buying off-the-plan

All new apartment buildings have defects, and inexperienced owners assume someone else will fix them. But developers and builders will not volunteer to spend time and money unless someone fights them. Part 1

Buffett says stock picking is too hard for most investors

Warren Buffett explained why he believes most investors should not pick stocks but simply own an S&P 500 index fund. "There's a lot more to picking stocks than figuring out what’s going to be a wonderful industry."

Should investors brace for uncomfortably high inflation?

The global recession came quickly and deeply but it has given way to a strong rebound. What are the lessons for investors, how should a portfolio change and what role will inflation play?

Latest Updates

Exchange traded products

ETFs are the Marvel of listed galaxies, even with star WAR

Until 2018, LICs and LITs dominated ETFs, much like the Star Wars franchise was the most lucrative in the world until Marvel came along. Now ETFs are double their rivals, just as Marvel conquered Star Wars.

Shares

Four leading tech stocks now look cheap

There are few opportunities to buy tech heavyweights at attractive prices. In Morningstar’s view, four global leaders are trading at decent discounts to their fair values, indicating potential for upside.

Shares

Why copper prices are at all-time highs

Known as Dr Copper for the uncanny way its price anticipates future economic activity, copper has hit all-time highs. What are the forces at play and strategies to benefit from the electric metal’s strength?

Economy

Baby bust: will infertility shape Australia's future?

In 1961, Australian women had 3.5 children on average but by 2018, this figure stood at just 1.7. Falling fertility creates a shift in demographics and the ratio of retirees to working-age people.

SMSF strategies

The Ultimate SMSF EOFY Checklist 2021

The end of FY2021 means rules and regulations to check for members of public super funds and SMSFs. Take advantage of opportunities but also avoid a knock on the door. Here are 25 items to check.

Economy

How long will the bad inflation news last?

The answer to whether the US inflation increase will prove temporary or permanent depends on the rates of growth of the quantity of money. It needs to be brought down to about 0.3% a month, and that's a problem.

Economy

The ‘cosmic’ forces leading the US to Modern Monetary Theory

If the world’s largest economy adopted a true MMT framework, the investment implications would be enormous. Economic growth would be materially greater but inflation and interest rates would also be much higher.

Sponsors

Alliances

© 2021 Morningstar, Inc. All rights reserved.

Disclaimer
The data, research and opinions provided here are for information purposes; are not an offer to buy or sell a security; and are not warranted to be correct, complete or accurate. Morningstar, its affiliates, and third-party content providers are not responsible for any investment decisions, damages or losses resulting from, or related to, the data and analyses or their use. Any general advice or ‘regulated financial advice’ under New Zealand law has been prepared by Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892) and/or Morningstar Research Ltd, subsidiaries of Morningstar, Inc, without reference to your objectives, financial situation or needs. For more information refer to our Financial Services Guide (AU) and Financial Advice Provider Disclosure Statement (NZ). You should consider the advice in light of these matters and if applicable, the relevant Product Disclosure Statement before making any decision to invest. Past performance does not necessarily indicate a financial product’s future performance. To obtain advice tailored to your situation, contact a professional financial adviser. Articles are current as at date of publication.
This website contains information and opinions provided by third parties. Inclusion of this information does not necessarily represent Morningstar’s positions, strategies or opinions and should not be considered an endorsement by Morningstar.

Website Development by Master Publisher.