The stock market crash of October 29, 1929 (aka Black Tuesday) is largely credited with triggering the Great Depression. Another leading contributor to the worldwide financial collapse was the runs on banks as depositors scrambled to withdraw their funds for fear of bank closures. Ironically, it was these very runs that contributed to many bank failures.
The FDIC was created to prevent future runs by insuring accounts for up to $100,000 to give depositors the comfort of knowing their funds were in good hands and that there was no need to liquidate their accounts in an economic downturn.
Black Tuesday and the bank runs leading up to the Great Depression were two glaring examples of liquidity dangers. What is liquidity?
Liquidity is the ease by which an account or investment can be cashed out (liquidated). On the liquidity scale, stocks and basic bank accounts are highly liquid – with the ability to cash out almost instantly. On the other end of the liquidity, spectrum are investments in tangible assets like real estate and private investments (private equity, venture capital, and private funds) that are illiquid.
Despite a hot market, sellers still have to go through the motions of selling a property. Private investments are even less liquid, with many having transfer restrictions and long lockup periods of five to seven years and beyond.
In my opinion and experience, the main difference between unsophisticated investors and ultra-wealthy investors is patience. Unsophisticated investors want everything now in their private lives and their investing. They’ll go into debt to buy cars, toys, and homes they can’t afford to live in the now. With investing, it’s the same. They’re continually chasing the exciting – looking to hit a home run every time. They’ll scan social media and constantly look for memes for the next big stock.
While the mass of unsophisticated investors gravitate towards liquid investments like stocks and crypto to chase the next big thing, the minority of wealthy investors are more patient when it comes to investing, which trickles down to their lifestyles. They’re willing to sacrifice luxuries now for financial freedom in the future.
Instead of going into debt, they’ll stash away their savings into investments, but their investments aren’t like what the masses prefer. They don’t speculate or gamble. They prefer assets where patience pays off. Not surprisingly, these assets are also illiquid.
The ultra-wealthy, in my experience, have little interest in liquid investments. Increasing their yearly earnings through compounding can take a more nuanced approach to illiquid vs. liquid assets. Because they receive continuous cash flow, the need for liquidity becomes less and less pronounced. Consequently, they not only grow to tolerate, but prefer illiquidity because illiquidity also acts as a buffer from the madness of the crowds.
They prefer secure investments in assets such as real estate or private investments with a defined exit and tangible returns.
Investing in assets insulated from the crowds and defined exits allows the wealthy to project their returns and put their minds at ease, knowing that a run in the public market isn’t likely to affect their illiquid holdings.
In the wealthy investor’s mind, unsophisticated investors can have their liquidity. Speculating and chasing rainbows is a fool’s errand. They prefer proven and illiquid assets that will reward them handsomely at defined points in the future, given the time to bake.