Money Matters:
Why liquidity and diversification is important in your investment plan
This is part 2 in this month's Money Matters with guest columnist Jake Pence. You can read part one What's the best way to invest in your future here.
by Jake Pence, Guest Columnist
Next, picking up where we left off, we need to talk about liquidity.
To keep it simple, liquidity is how easily an asset can be bought and/or sold. Another way to think about liquidity is how easily the asset can be turned into cash. The stock market has a clear advantage in terms of liquidity, but it still warrants a discussion.
Stocks are very liquid. In fact, stocks are so liquid that last summer, I was able to sell Amazon for $1,800/share, Tesla for $250/share, and Zoom for $85/share without Robinhood tapping me on the shoulder and saying, “You might not want to do that …”
Those companies now trade for $3,300/share, $1,700/share, and $275/share, respectively, and I still live in my parent’s basement.
I don’t tell that story to downplay liquidity because having quick access to your capital is advantageous in many scenarious; however, I tell that story to highlight how liquidity makes it easy for an investor to make emotional, rash, and in my case, downright stupid decisions. At that time, I did not have the trading savvy or financial discipline to hold a stock for more than a year.
All in all, if you value having easy access to your capital and have the financial discipline to manage that liquidity, then the stock market will better suit you.
Real estate, on the other hand, is a relatively illiquid investment. Whenever you want to pull money out via a refinance or cash out of the investment via a sale, then there is going to be a process that you must follow. The process will likely take a few months. Depending on the transaction, you could fall on either side of that timeline; however, it doesn’t take seconds like it does with stocks. If you don’t need your capital in the short-term, then real estate investing will be a great option for you.
Another important criteria is asset diversification. Diversification is the act of placing your investments in a variety of asset types, industries, etc. so that your exposure to any one asset type is limited.
Diversification is extremely important in an investment portfolio because if you’re only invested in airline stocks and then a global pandemic halts all air travel … well, you’re in trouble.
It is easier to diversify your portfolio within the stock market than it is real estate. You can still diversify your real estate portfolio, but it will take more than a few hours on Yahoo Finance to do so.
To make diversification even easier for stock market investors, you could buy a mutual fund that is already diversified. In real estate, you can diversify your portfolio by purchasing different asset types (apartments, self-storage, single-family-homes, etc.) in different locations (Illinois, Indiana, Tennessee, etc.). This will take more time, capital, and energy; however, it can and should be done.
I firmly believe that a well-balanced portfolio should include both stocks and real estate.
If your entire portfolio is in stocks, then you are heavily reliant upon company executives, Wall Street, and government decision makers for your financial future. If your entire portfolio is in real estate, then the cyclical nature of real estate markets will present challenges. Overall, a combination of Wall Street and Main Street investing will create a balanced portfolio.
In my next installment I will briefly discuss taxes and how investing can potentially lower your tax annual liability.
About the author:
• Jake Pence is the President of Blue Chip Real Estate and a consultant for Fairlawn Capital, Inc.. A 2019 graduate from the Gies College of Business at the University of Illinois, he is a 2016 graduate from St. Joseph-Ogden High School where he was a three-sport athlete for the Spartans. You can view his latest acquisitions and advice on his YouTube channel here.
