A diversified portfolio is important for today's investors. Both liquid and illiquid assets should be considered to balance one's portfolio. Learn more about illiquid assets and the benefits to owning them.
What are Illiquid Assets?
Illiquid assets are investments or properties that are not easily sold or exchanged for cash. They typically lack a well-established market for buying and selling, making them harder to convert into cash quickly. These assets often have a longer holding period and require more time and effort to sell compared to liquid assets.
Common Examples of Illiquid Assets:
- Real Estate – Properties can take time to sell, and the market for specific properties can be limited.
- Private Equity – Investments in private companies or startups that are not publicly traded.
- Venture Capital – Investments in early-stage startups that are not yet publicly listed.
- Collectibles – Items like rare art, vintage cars, jewelry, or wine, which may be difficult to sell quickly.
- Hedge Fund Investments – Some hedge funds have long lock-up periods, making them difficult to liquidate before a specified time.
Why Should Investors Consider Holding Illiquid Assets in Addition to Liquid Assets?
Holding a mix of liquid and illiquid assets can offer several important benefits to investors:
1. Diversification
- Risk Reduction: Illiquid assets typically behave differently from liquid assets, such as stocks and bonds, which are more influenced by short-term market trends. Adding illiquid assets can reduce overall portfolio volatility and risk by diversifying across asset classes that react differently in various market conditions.
2. Higher Potential Returns
- Illiquidity Premium: Illiquid assets often offer higher returns to compensate for their lack of liquidity. For example, private equity or venture capital investments may deliver substantial gains if the underlying companies grow successfully over time. Illiquid assets can provide investors with the opportunity to earn above-average returns that they might not get with more liquid investments.
3. Protection Against Market Volatility
- Less Sensitivity to Market Fluctuations: Liquid assets, like stocks, can be very volatile, especially in short-term market downturns. Illiquid assets, however, tend to be less reactive to daily market fluctuations. For example, real estate or private equity may not be as heavily impacted by market swings, providing a buffer during times of high volatility.
4. Long-Term Growth
- Capital Appreciation Over Time: Illiquid assets often require a longer investment horizon, but they can provide significant capital appreciation over time. For instance, real estate properties or private equity investments can generate solid returns if held for an extended period. Investors with a long-term outlook may benefit from the potential growth of these assets.
5. Inflation Hedge
- Tangible Asset Appreciation: Certain illiquid assets, like real estate or commodities, tend to appreciate with inflation, helping preserve purchasing power. In times of rising inflation, assets like property or land can become more valuable, while liquid assets such as cash or bonds can decline in value.
6. Exclusive Opportunities
- Access to Unique Markets: Illiquid assets can provide access to niche markets or sectors not available through traditional liquid investments. For example, private equity or venture capital allows investors to tap into early-stage companies or innovative sectors, which can yield exceptional returns if successful.
7. Capital Preservation
- Long-Term Security: Illiquid assets, especially tangible ones like real estate or collectibles, tend to hold their value better over the long run. Unlike stocks, which may fluctuate wildly in the short term, these assets often serve as stores of value, especially during periods of financial uncertainty or market downturns.
8. Tax Benefits
- Potential Tax Advantages: Certain illiquid assets come with tax benefits, such as depreciation on real estate or favorable capital gains treatment on long-term investments. These benefits can help investors minimize their tax burdens and retain more of their investment returns.
9. Lower Emotional Trading
- Long-Term Focus: Since illiquid assets cannot be quickly sold or traded, investors are less likely to make impulsive decisions based on short-term market noise. This can help maintain a more disciplined, long-term investment strategy focused on fundamentals rather than trying to time the market.
Conclusion:
Investment in illiquid assets is not for everyone as they carry a unique set of risks, but by holding a mix of both illiquid and liquid assets, investors can potentially create a more balanced and resilient portfolio. While liquid assets offer flexibility and easy access to funds, illiquid assets can complement them by offering stability, capital appreciation, and unique investment opportunities that may not be accessible in more traditional markets.
For more guidance on illiquid assets, contact your McKinley Carter advisor or other trusted professional.