If there’s one thing you hear constantly in finance and investing, it’s stay liquid. That bit of advice is so common that most investors, from the smallest to the largest, tend not to question it. But what if it’s misleading or downright wrong?
Liquidity refers to how easily you can convert an investment into cash. A publicly listed stock like Proctor & Gamble can be sold at the push of a button – that’s quintessential liquidity. However, liquidating a real estate investment can take months, which means real estate is relatively illiquid. No one wants to be left holding an investment they can’t sell, so it seems to make good sense that everyone says stay liquid. And owning a portfolio of liquid securities like Proctor & Gamble is a great strategy if there’s someone who wants to buy what you want to sell and vice versa.
But what happens when there isn’t a buyer for every seller?
When something unsettling hits the news, a critical mass of people gets scared and some buyers become sellers and some long-term investors start thinking short-term. Prices drop and as prices go south it scares others who become uneasy as they watch the market change. They, too, become sellers. Many of these people weren’t consciously aware that they had a stop, a number below which they would feel so scared or so threatened in their financial wellbeing that they would decide to sell. They may not have a stop consciously in mind, but they have it nonetheless. Therefore, when the price gets too low for them to tolerate, they sell. The point is that everyone has a stop, regardless of whether they know it or not.