Liquid: the ideal state of an investment

posted: December 9, 2023

tl;dr: Money flows easily with liquid investments whereas illiquid ones are frozen solid in place...

For investments or other assets, liquidity can be defined as “the speed at which it can be converted into cash,” where cash is the local currency: the United States dollar, in my case. Liquidity is a wonderful and often under-appreciated concept, and is taken for granted far too often.

Two situations that illustrate how liquidity can vary across different investments and assets are when I cashed out the last of my Westell stock, and when my wife and I sold the house that we owned in Naperville, Illinois. Stock that you receive when you work for a company often is illiquid due to various restrictions placed upon it, but here I am speaking of the time that it takes to liquidate (sell) stock in a publicly traded company that is sitting in a brokerage account with no restrictions on it.

When I left Westell I had little faith in the management team that took over, so I wanted to sell all my remaining stock. The day finally arrived where I was first able to do so, and fortunately the stock had risen due to some positive financial results that had been recently announced. It would end up being the peak in the stock price under this management team. The daily volume of Westell stock traded on the NASDAQ at the time was tiny, so even though the amount of stock I had to sell was modest, it still represented approximately ten days worth of average daily volume. I didn’t want to sell so fast that the stock price took a nosedive, so rather than place my sell order through the brokerage firm’s website, I called and spoke to a broker. I set a minimum sale price a little below where the stock currently was priced, and gave the broker complete flexibility to spread the sale orders out over time. Given the low daily volume, I was expecting it would take a couple of weeks or perhaps more to sell all my stock. I was stunned when, within an hour, I received trade confirmation emails that, when totaled, told me that my entire position had been liquidated and converted into cash. Perhaps there was a buyer or two on the other side who wanted to take a sizable position without unduly causing the stock price to rise.

The Illinois house took much longer to sell. We placed it on the market at a bad time of year, in September, after the summer house selling season was over. It sat on the market through the fall and a brutally cold Midwest winter until it finally attracted an offer in the spring. Once we had agreed upon a price with the buyer there still was a month-long closing process that involved further negotiation and remediation over the house inspection. It was a long, arduous process, and we felt both exhaustion and relief when it was finally over and the cash was sitting in our bank account.

A black-and-white photo of a man wearing glasses, a dress shirt, tie, and slacks, smiling at the camera while seated next to a computer terminal on a table in a computer room, with large computing machines in cabinets in the background

Charles Schwab was a pioneer in using computers to increase the liquidity of stocks and bonds

For all the criticism aimed at the U.S. financial system, the liquidity it has enabled is a triumphant achievement which benefits investors greatly. The phone call to a human broker that I described above used to be the way that all stock and bond trades were transacted. The broker earned a non-trivial commission fee for handling the transaction. Stocks were priced in fractions of a dollar, not down to the penny or ten-thousandth of a penny. Then Charles Schwab and other discount brokerage firms pioneered the “telebroker”, an automated phone system that took trading orders via touchtone phone. Then, of course, came the World Wide Web and brokerage firm websites, which is how I execute most of my trades today. I haven’t taken the leap into using brokerage firm mobile apps, although many have. The speed and ease with which investments can be liquidated has never been greater.

Now there are some caveats, with the main one being that you are incurring counterparty risk when working with a brokerage firm. You don’t really own the stocks and bonds which appear on your monthly statement; there are no stock certificates or bonds sitting in the brokerage firm’s vault with your name on them. Your ownership position in a stock may be balanced out by other of the brokerage firm’s customers who have sold the stock short. Hopefully the brokerage firm, if it is a legitimate firm, holds title to enough stock to cover the net ownership position across its entire customer base. Bernie Madoff’s customers found out the hard way that this is not always the case. Madoff’s firm did not actually own the stocks that appeared on their customers’ statements, so when too many customers wanted to liquidate, there was nothing to sell and the Madoff’s Ponzi scheme collapsed.

Stocks and bonds in a brokerage account are highly liquid, whereas other investments and assets are much less liquid. If you own a private business, it can take years to sell it. Private company stock is incredibly illiquid. Even if you work for a company with a publicly traded stock, the stock or options you receive typically are less liquid due to restrictions placed upon them and blackout periods in which stock transactions are prohibited. There may also be a legal requirement to file stock transaction plans in advance and get them approved.

Real estate can take years to sell if the property is especially unique. Physical gold is fairly liquid and can be easily converted into cash at the local pawn shop, but if you want to receive the best price it can take days to do a transaction with a national dealer. It takes a while to sell a used vehicle privately, although the rise of used car dealerships such as Carvana and CarMax makes this easier and faster. If the vehicle is atypical, such as a collectible car, it might have to be put up for auction in order to liquidate it. The Barrett-Jackson auto auction happens but once a year in Scottsdale, Arizona.

Having owned highly liquid and illiquid investments in my life, I greatly appreciate liquidity.