Which Investments Have the Least Liquidity? [Answered and Explained]

If you want to find out which investments have the least liquidity, you are in the right place.

In this article, I am going to discuss 9 investment that have the least amount of liquidity and the reasons why. But before we do that, I'll cover some basics on liquidity, including what it is and why it's important.

Let's get into it!

The information contained in this post is for informational purposes only.  It is not a recommendation to buy or invest, and it is not financial, investment, legal, or tax advice.  You should seek the advice of a qualified professional before making any investment or other decisions relating to the topics covered by this article.

What is Liquidity?

Liquidity is a measure of how easy it is to convert an asset into cash without negatively affecting its market price.

A classic example of an asset that does not have a lot of liquidity is land. That's because it is going to take a lot of time and effort to sell that parcel of land to another buyer and get cash. If you are in a hurry to sell, then you may have to drastically cut your asking price to entice buyers to purchase quickly.

Even if you find a ready buyer, the sale of land can take a while and be costly because there are steps in the transaction that are time consuming and expensive (lining up financing, checking title, paying transaction taxes and broker fees, etc.)

Compare that to selling a share of Apple stock. It is highly liquid because you can sell it almost instantaneously for its market price at any time without any delay, mark downs, or (in many cases) fees.

Why Is Liquidity Important?

Liquidity is important to investors for the following reasons:

  • It gives them options when better opportunities arise
  • It provides a safety net if the investor experiences financial distress
  • It allows for smoother resolutions when life circumstances call for it (e.g., home purchase, divorce, etc.)

Businesses value liquid assets for similar reasons.

It's why healthy companies often hold large cash or cash-equivalent reserves. Those assets can be used to pay for higher yielding investments or to stimulate growth (e.g., R&D, new product launches, global expansion, etc.). They can also be used if the business begins to struggle (e.g., revenue can no longer meet debt obligations or cover operational expenses).

Finally, liquidity can play an important role in the broader economy.

For example, federal regulators look closely at liquidity levels when they measure the financial health of financial institutions, like banks. If a bank is holding a lot of high quality liquid assets, then the regulators have confidence that if the bank faces financial distress, it can sell those assets easily and without huge discounts.

When the financial system is healthy and less prone to banks going under (and more importantly when regulators and the public have greater confidence in the financial system), the entire economy rests on a firmer foundation.

Ok, now that we've covered the basics of liquidity and why it's important, let's dive into the meat of the article.

Which Investments Have the Least Liquidity?

Ok, onto the good stuff. Here are 9 investments that have low liquidity levels and some of the reasons behind this illiquidity.

1. Certificates of Deposit (CDs)

CDs are perhaps the classic (and most well known) example of an investment that is illiquid.

In fact, CDs as often referred to as “term deposits” or “time deposits” because they have set maturities. CD maturities can range from as short as 30 days to as long as 5 years, with shorter maturities generally paying less interest than longer maturities. This means that you are required to hold onto them for the stated maturity.

One of the main reasons why CDs are considered illiquid is that they usually carry a penalty if you want to get out of them. This penalty varies by bank, but it can wipe out some or all of interest you have earned and (in some rare cases, eat into your principal). It doesn't mean you can't get your money out at all – it just means you will feel some pain if you do.

Note: There are CDs out there that have eliminated these penalties. For example, Marcus (Goldman Sachs' online bank) offers a no penalty 7 month CD at the time of this writing.

2. Real Estate and Raw Land

Real estate and land are also well-known examples of investments that are not liquid.

We touched on the reasons why earlier, so I won't belabor the point. Basically, the reasons are (i) a limited (and mostly regional) buyer's market, (ii) a lengthy transaction timeline, and (iii) significant transaction expenses.

3. Investments in Retirement Accounts

Investments held in 401(k)s, IRAs, and other retirement vehicles are generally viewed as illiquid because you can't readily convert the investments in those vehicles into cash you can use.

Now, I shouldn't say you can't. Just like CDs, you can liquidate those assets, but it'll cost you. You will probably need to pay taxes and penalties unless you withdraw the funds after you have reached the required retirement age or you qualify for other legal exceptions.

Note: I want to clarify that you can trade out of investments within your 401k or IRA without issue. So you place an order to sell your interest in Mutual Fund XYZ and decide to keep it in cash or buy Mutual Fund ABC instead. The liquidity problem arises when you want take money out of your retirement account entirely.

4. Artwork and Other Collectibles

Many wealthy investors buy rare paintings and other collectibles, like classic cars, rare watches, coins, etc. in the hope that these investments will rise in value.

When bought right, these investments can pay handsome returns and offer great diversification. But they are highly illiquid investments.

In most cases, the collectors will need to contact an auction house and agree to a bidding process to sell these types of assets. There is, of course, no guarantee that anyone will buy the asset at the desired price, which means the investor may be stuck with the collectible or will need to reduce the minimum asking price (which is called the reserve).

5. Limited Partnership Interests

Going back to the world of real estate investing, you can passively invest in real estate through an arrangement called “real estate syndication.”

This is where a general partner (GP) who is usually an expert real estate investor finds a property and solicits investors to help him fund the purchase of that property. The purchasers then buy interests of a limited partnership (LP) which will fund the enterprise. The owners of the LP can then share in the profits of that investment.

If you work with a GP who can find great properties, you can make a ton of money by investing in LP shares. But the drawback is that those LP interests are usually highly illiquid because there is no large secondary marketplace for those types of shares. In fact, the LP agreement may prohibit the investor from selling the shares unless certain conditions are met.

Note: Online real estate crowdfunding has emerged as a popular investment strategy. In some cases, this is just real estate syndication by a different name. This means that your investment may be locked up for some period of time, so read the terms and conditions on the crowdfunding website (and offering memorandum) carefully before you take the plunge.

6. Private Equity Securities

If you are an accredited investor or meet other legal requirements, you can buy shares of private companies and hope that they go public or otherwise experience a profitable exit. However, similar to real estate LP arrangements, you are often prohibited from quick and easy liquidation of your ownership interests in these private companies.

7. Securities With Low Trading Volume

Even if you are investing in the stock market (which is generally a super-efficient marketplace with almost instantaneous execution), there could be certain securities that are difficult to unload.

I am talking about securities of smaller, lesser known companies that may have very thin trading volume. The same can hold true for certain options as well. There just may not be a buyer for your stock or option and that means you have no liquidity.

8. Stock that is Subject to “Lock Out”

If you are an executive of a publicly-traded company (or anyone else that is in possession of inside information about the company), you may be subject to a “lockup” or “lockout.” That simply means that the company is restricting you from trading in that security for a certain amount of time.

So if you happen to be holding some stock of that company, you cannot sell that stock during the lock-out. That's about as illiquid as you can get (at least during the restricted time period).

9. Your Own Business

Many people buy an existing business that runs itself (with management and employees in place) and play a very limited role in its operation. This is essentially an investment for cash flow.

There are lots of businesses like this. In fact, I have written an article on the best businesses that run themselves where I cover 12 practical examples.

While they can be tremendously profitable investments (with returns routinely in excess of 20%), they are not very liquid. As with any business, you are gong to be working with a limited set of potential buyers and a sale can often take months (with hefty commissions going to brokers).

Conclusion

So there you have it – 9 investments that have poor liquidity and the underlying reasons why. Hope this has been helpful and please feel free to check out my other articles on personal finance, investing, and business here.

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