141: The Dark Side of Liquidity: Why Too Much of a Good Thing can be Harmful

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Today, we’re going to discuss asset class liquidity and why it may not always be such a great thing. 😔😔

Have you ever considered investing in an illiquid asset, like multifamily apartments?

Well, they might just be a better choice when it comes to protecting against market volatility and avoiding those huge price drops.

Let’s dive in and explore why.

What’s Liquidity?

Before we jump into the nitty-gritty of asset liquidity, let’s take a moment to define what it actually means.

Simply put, liquidity refers to how easily and quickly an asset can be converted into cash without affecting its price. 💸

Some examples of liquid assets are stocks, bonds, and currencies – basically, anything that can be sold quickly with minimal price impact.

Now, while liquidity is generally viewed as a positive trait, there are some potential downsides to keep in mind. 

One of the biggest drawbacks 👎🏻 is that during times of market volatility, liquid assets tend to be hit the hardest.

Why is that? Well, when investors get nervous or fearful, they often start selling off their liquid assets in order to raise cash. This creates a domino effect, where more and more people start selling, leading to a rapid decline in prices.

An example of the concept of asset class liquidity can be seen in the popular TV show “Shark Tank.” 🦈

In this show, entrepreneurs pitch their businesses to a panel of investors (the sharks) in hopes of securing funding. The sharks are always looking for businesses that have strong liquidity, meaning they have the ability to quickly convert their assets into cash if needed. 

This is because the sharks want to be able to easily sell their stake in the company if they need to.

However, sometimes the sharks will invest in businesses that have illiquid assets, such as real estate or inventory if they believe in the long-term potential of the business and are willing to hold onto their investment for a longer period of time. 😕😕

So, while liquidity can be a great thing in normal market conditions, it’s important to remember that it can also make assets more vulnerable to sudden price drops during periods of uncertainty.

Illiquid Assets

Next, let’s examine why illiquid assets like 🏢 multifamily apartments might actually be a better option during periods of market volatility.

The main reason is that it’s much harder to sell an illiquid asset quickly, which can actually work to an investor’s advantage in turbulent times. 

👉 For example, let’s say there’s a sudden drop in demand for multifamily apartments due to market volatility.

Because it’s harder to sell these assets quickly, investors are less likely to panic and sell off their properties at a loss. This can help to protect the asset’s value and provide a sense of stability in an otherwise uncertain market.

On top of that, multifamily apartments generate a steady stream of rental income 💰, which provides a cushion against market volatility.

This income stream can be especially attractive during periods of low-interest rates when investors are looking for alternative sources of income.

Another advantage of investing in multifamily apartments is that they’re a tangible asset that provides shelter, which means they’re less likely to lose their value completely in a market downturn.

In contrast, liquid assets like stocks and bonds can lose their entire value in a market crash. 

Multifamily apartments also have a low correlation with other asset classes like stocks and bonds, which makes them a valuable addition to a diversified portfolio.

This means that during periods of market volatility, different asset classes tend to move in different directions, which can help to smooth out the overall returns of a portfolio.

So, while liquidity might be seen as a desirable trait in many circumstances, it’s important to consider the potential benefits of investing in illiquid assets like multifamily apartments during periods of market volatility.

The Big Picture

So, while liquidity might seem like a desirable trait, it’s important to consider the potential benefits of investing in illiquid assets like 🏢 multifamily apartments during periods of market volatility. And that’s why, as a real estate investor, you might want to consider taking a closer look at the world of illiquid assets. 🙌🏻

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