December 2024
Here are some key takeaways from their conversation:
Watch previous episodes here:
Ep. 113 Replacing Income in Retirement
Ep. 112 New Trends in Investing
The title of the session today. Liquidity, blessing or curse? Hopefully it's somewhat thought provoking. And as all of you know, you know, most of you here are Morton Wealth clients. We obviously embrace illiquidity. We think there are big benefits to accessing certain investments in an illiquid fashion.
But many people don't really talk about liquidity. Most people just take it for granted that liquidity is a wonderful thing, right? If you had two investments and they were equal in all ways, but one was more liquid than the other, you would choose the more liquid one. And that makes sense more often than not. But I think if you look a little deeper and this kind of hearkens to Grant Williams' keynote speech, are you an investor or speculator?
Liquidity at extreme levels is not necessarily all it's cracked up to be. And there are obviously benefits, but there are some negative aspects of liquidity. And so we're going to dive into some of those negative aspects as well. So to set some context, when we think about liquidity, we really kind of break it down into two simple buckets.
The simplest bucket is the first. First of all, just what you need to live your life right? Spend it, spend your money, live your lifestyle, and maybe make some capital expenditures along the way. The second one is liquidity. When you think of an asset, how easy is it to buy or sell that asset? And specifically with stocks, we all know stocks are a very liquid market.
And that's where we're going to spend more time talking about again, the benefits of that but also potentially negative effects. So starting in that first bucket, Chris, putting your financial advisor hat on, can you talk about okay, can you talk about liquidity as it comes to how we think about it from a financial planning point of view and how to suit our lifestyle needs?
Yeah, I mean, I'm not used to sitting on this side of the stage. Normally I'm doing the questions, but an emergency fund is so crucial. I don't know, people hear about this all the time, but as part of a financial plan, understanding what your short term needs are really helps you maximize the investment potential of everything else.
And so an emergency fund is access to cash in case, you know, lightning bolt hits your house. Right. And most people should probably have somewhere between 3 and 6 months set aside in an emergency fund that they have access to. And that's liquid. Obviously, everybody's favorite answer is it also depends on your personal situation.
If you've got a stable income or a pension you can rely on, you might not need as much an emergency fund as somebody else. Also, if you're planning on making a large purchase within a couple of years, you probably need access to that moneys as part of an emergency fund.
And if your time horizon is, you know, more than 6 or 12 months out, you can take a tiny step out on the risk scale and invest it in some short term bonds. So you can, you know, earn a little bit more money. But the emergency fund helps you make better long term decisions.
Great. So now shifting gears a little bit to the second definition, talking about buying and selling an asset, namely let's say stocks at a liquid price. Can you talk about that? Meghan.
Can you actually access that money, sell the asset at a fair price, and also meaning low cost? So it doesn't cost too much to be able to actually get to it. And so the reason stocks are a great example is most stocks trade. I don't know if people have heard the term bid-ask spread, but the idea being that there's a a very small gap between where you can buy and sell it.
So you might be able to buy a stock for $10 and then sell it for 9.99. So one penny difference. And so that's that's not a huge cost, right. To actually go transact in that- very different than if you want to go sell your house. You buy a house, you change your mind, you're going to pay 5% commission extra fees like that.
So you hit on the term... decimalization, right? The ability to trade stocks theoretically at a penny wide bid-ask spread, a little bit of history. Can you talk about actually when that came into play?
Yeah. It hasn't been around forever.
In 2001 is when you actually started to be able to trade stocks like that based on a decimal or a penny. Before that, it was a fraction system. And so the the lowest fraction you could have was 1/16 of a dollar, which equates to about $0.06. So just even that right, the cost of it less liquid because the cost of that was then, you know, you bought it at ten, but you in 1994, it was the best you could hope to sell it for in, you know, at that at that price range.
And so what we saw from that though was and this does harken back to what Grant was talking about earlier. He mentioned hold periods of stocks, the average hold period for a stock, I think, back in 1950 used to be I think it was eight years. And then now it's closer to well, he said five months.
Just the idea being that again, more speculation has come from this because it's so easy to do it. Right. Because they're so much more liquid than they used to be. There's a lot more trading that happens.
So yeah, on the surface liquidity is wonderful. But the flip side is a little bit more friction to selling. When stocks were trading at a 16th or an eighth, theoretically reinforced more of an investor mindset.
That made them think about it more. Right of do I want to own this or yeah...
Let's talk about the curse of liquidity. Chris, can you talk a little bit about the mindset and theoretically why bad outcomes come from a little more liquid portfolio?
Well, because we have emotions, and 90% of the decisions that we make are based off of how we feel. I don't know if that number is actually accurate. I just said it. But really, I mean, you hit on this with, the podcast that you were on with Grant Williams, Grant Williams talked about it today. Being a speculator versus an investor.
There's good things to both of those mindsets and strategies. But liquidity is more of a curse. I think this notion that, oh, I can click a couple of buttons and sell my stocks today, I mean, that just reinforces very bad behavior. And I think it's more of a negative than anything. And the reality is like, if you're investing in your life or your career or business in order to be successful, well, you have to do a lot of very small actions every single day over a long period of time in order to be successful.
Investing is no different. You have to have that long-term mindset. And I'm coming at this not only from somebody who tries to help people and give advice for a living, but in my prior career I was retired first playing golf for a living. I joke because now I'm going to have to work the rest of my life, but I only got good because of those small actions that I had to do every day and have a long-term mindset in terms of how I was going to get better.
And I believe that investing and allocating your dollars, we need to have more of that mindset as opposed to, oh, I can click a couple of buttons and sell something.
I love that analogy of comparing investing to investing in other aspects of your life, whether it's career, your health regimen. I mean, that stuff takes discipline, right? It's not a speculative mindset. You got to stick to it.
Like literally. The opposite of that, I think, is probably the meme stock craze. And we were looking at GameStop, AMC, and even some of the more esoteric cryptocurrencies where it's just pure speculation. There's nothing long term or fundamental about about some of these things.
So that relates to just even the word ownership. When you think about having an ownership mindset, it's something we talk a lot about when we make investment decisions. Can you talk a little bit about that ownership mindset, how we think about it?
Yeah, unfortunately, I think our industry promotes very much more of a renting mindset. So instead of you're going to, oh, you're going to buy this, you're going to own it long term. Think about like price target. So you know, Goldman Sachs came out and you bought this stock here. But the price targets here, they think that's where it's going to go.
So literally you are thinking about selling it the moment you buy it. And so that almost is like the definition of a renting mindset versus a an ownership mindset. And it's really counter to long term fundamentals, sound investing, having this constant thinking about when are you going to get out and at what price.
Yeah. Again, the nature of a liquid market with a price target by the very nature of that, you're thinking of selling the moment you buy. That's counterintuitive. Just harkening back to the two sessions that you led, the real estate panel, the lending panel you were on. When these groups make investments, they don't have a price target, right?
They're buying a piece of real estate with the goal of creating wealth and value over time and getting cash flow along the way. Very different than a price target mentality, right?
I've made some mistakes around that. In the past, I've thought that I was an investor, but I was a speculator. I'm glad my wife's not here because I don't think she knows the story in real detail. But back in like, no, she left.
It's being recorded.
Back in 2019. A doctor friend of mine, I say that because he's a radiologist. He just looks at charts every day. He called me up and he said, hey, a friend of mine just took this medicine or had this procedure and this trial thing, and it's helping with, you know, he's losing his eyesight. And it worked like, can you see if this company's public.
And I was like, oh, yeah, I looked it up. It was public. I had no earnings. Negative cash flow was trading at pennies. I was like, let's buy some. Right. So I ended up accumulating about 80,000 shares of this penny stock because I kept going down and down. You fast forward a couple months later in mid 2019 and surprise my wife is pregnant.
That was not planned. You have a plan and God laughs. Then you get to the end of 2019. It's like, oh man, we need a house. So I had to sell that penny stock to have liquidity to put an offer on a house. And so I wasn't really that prepared with my planning, although it was fine, I forgot about it, completely ignored it.
A couple years later, I'm with Jeff in 2021, 2021, and we're just kind of reading the headlines on CNBC and I see this name that's vaguely familiar in the headline, and I look it up and it was trading at $18 a share, and I had 80,000 shares at one point in time, no longer. But if I would have, you know, maybe been an investor or had an emergency fund that can get through some of those decisions, I might have not had a mortgage, so it would have been nice.
I feel like this turned into a therapy session.
While we're at it, you made, like, a little sarcastic remark about radiologists just reading charts. My father's in the audience. He was a radiologist. I my brother, my older brother is a radiologist doctor.
Dr. Sarti, sorry, I thought I was just teasing his brother. I didn't realize I was teasing you as well. I apologize.
Circling back to the start of the conversation, we had two buckets, right? One bucket. When we think of liquidity, liquidity needs to suit your lifestyle. The second, the ability to buy and sell an asset at a moment's notice to help pay for that lifestyle. Those are two different things. But I think part of the issue and part of the problem at hand, is most people confuse the two.
And one of them is specifically talking about stocks and liquidity. Of course, most people think of their liquid bucket for their expenditures as their cash, and maybe they're safe bonds, but then they think of their stocks as the next stage of liquidity. If they run out of that cash, no problem. I'll just sell my stock portfolio and raise that cash.
I like stocks even though they it's a question of, you know, can versus should. So you can sell your stocks. You can click a button and sell your your net worth. But should you. Probably not. And it does come down to the volatility of that asset class and the idea of like oh I could access it, but are you going to access it during the right period of time?
So we there's many periods I know we've had a really good run in stocks, but there have been many long term periods going back in history where stocks were flat or negative. And you know what's long term. Me and you talked about this actually in your recent perspective writer, which I read, by the way. But it was ten year periods going back there.
There have been multiple ten year period. And that that's like long term. So ten years is really what you should think long term. But even more than ten years, because again, you have these negative loss periods for stocks over that time frame. So the idea of like I might have to sell at the wrong time, even though you know, you needed it, but you needed the cash, had to tap into it, and you got out when it was cheap.
If you'd held it, it would have been worth more. So you don't want to have to make that decision. That shouldn't be part of the liquidity planning.
But people don't really make this decision during their lives, right? I mean, I get to work with many of you here in this room, and you have, you need money to go buy something. You don't want to sell that thing that has all the gains because you don't want to pay the taxes on it. So that's already illiquid now because you hate taxes so much. And so the proper plant like stocks are just not as liquid as people.
Think on that point. It's both the downside and the upside. Right. So often people need liquidity because something ill fortune happened right. Maybe it's in the economy. Maybe we hit a recession. Maybe you lost your job. Could be a variety of things at that point in time. Making your point stocks might be down. So now you're selling an asset that's theoretically down.
On the flip side, over time stocks do go up. Right. And then built-in gains continue over time. And to your point Chris. Now you're actually making a rational decision sometimes where you're like, I don't want to sell that stock. I don't want to incur those gains. But sometimes you're forced to sell those stock.
Yeah. So that's this illusion that we have around... Oh it's liquid I can sell it. But when push comes to shove, taxes or account types play. You know a big role in that illiquidity.
All right. So now the flip side of liquidity is illiquidity, Meghan you smiled even before I even got the word illiquidity out of my mouth. You love liquidity. Why do you love the liquidity so much?
I think there's there's a number of real benefits to it. One being that it does reinforce the ownership mindset that we're talking about. Right. Even back to the business owner, a business owner isn't investing in their business day after day and then thinking about, oh, I think it's up 2% today or down 5% today.
That's not part of the process. So it takes that out of the equation. The fact that you, to be blunt, cannot sell. It takes away that part of almost that mental space that it's taking up for you of like, should I sell it? What should I do with this? You've made the decision up front. Hopefully you spent the time and did the right analysis to say this was the investment I want to make.
And now every single day. You don't have to remake that decision. Essentially. There's also a real structural benefit to it. And this is where I was smiling more because I, I geek out on structure. But look, if you're going to go and pool your money with other investors the way we do in funds and go invest to, to be able to put more dollars to work and invest in some of these really interesting strategies, you need there to be structural controls in place that make it so that there can't be a run on the bank.
Like, I don't want to be in a pool with a bunch of investors that they can all raise their hand to get liquidity in, the manager has to go sell fire sale something at the wrong time just to pay those people out. That doesn't make a lot of sense. So having those structural controls in place I think makes a lot of sense.
The last one is just returns. So because people value, liquidity, they're willing to pay a premium for it. So they're willing to pay more and theoretically make less for that. So that translates into what we call the illiquidity premium. We talked about it on the private lending panel, but you should expect to make higher returns from being willing to lock up your money.
Chris you know, if you look at the different types of accounts that you have, your short and long term goals, you can realize that even IRA accounts are illiquid themselves. Excuse me. And so you're not going to just go and take $1 million out of your 401k or your IRA because you don't want to pay the taxes again.
So you can embrace illiquidity in certain assets in certain accounts to really maximize your returns and what you're looking out for. The other flip side is that if you're worried if your net worth is above the estate tax limit and you're potentially worried about paying estate taxes, illiquid investments that you don't control, that you don't have access to, actually receive a little bit of a discount when you pass away and they value your estate.
An example that's like, let's say I've got $1 million in a multifamily real estate deal that somebody else controls and makes decisions on, and I'm just a limited partner that might be discounted anywhere from 20 to 35% in value. So when they look at your overall net worth, it's no longer $1 million. It's, you know, anywhere from 7 to 800,000.
And so looking at your personal situation to kind of figure out what you're looking to try to do or minimize taxes and how much illiquidity you can take on, I think some people can take on a lot more liquidity than they realize.
Agree. Totally agree. So much of this comes down to mindset. At Morton Wealth, we talk again so much about investor mindset and liquidity. Again it goes back to Grant's keynote. Perfect timing. Investor versus speculator comes into play most in our industry.
And we think that in so many ways is backwards. Of course, liquidity is wonderful and you should have a certain amount, but to have the majority of your net worth, where you can buy and sell at a click of a button. That's not necessarily a good thing. You can actually act in haste when your emotions are at their highest.
Very different than illiquidity, which we talk again about ownership mindset. Again, going back to your panels when we get into these illiquid investments, man, I mean, you're not thinking about a price target. You're not distracted by those price targets. So hopefully again a lot of you in the room experienced that. And I know plenty of you, have shared with us, shared with your advisor that after you've been with Morton for a few years, that you no longer look in your portfolio on a daily or monthly basis, maybe it's only a few times a year when you're meeting with us.
Love that. That is music to our ears. You should not be looking. It's unhealthy investor behavior to be looking at your investment portfolio, that liquid portfolio on a daily basis. Those zig zags just don't matter. So with that, we're a minute early.
Thank you everyone.
Disclosures: The information presented herein is for discussion and illustrativepurposes only and is not intended to constitute financial advice or investmentrecommendation. The views and opinions expressed by the speakers are as of thedate of the recording and are subject to change. These views are not intendedas a recommendation and should not be relied on as financial, tax or legaladvice. It should not be assumed that Morton will make recommendations in thefuture that are consistent with the views expressed herein. Morton makes norepresentations as to the actual composition or performance of any asset class.Past performance is no guarantee of future results. You should consult withyour finance professional or accountant before implementing any transactions and/orstrategies concerning your finances
