Happy New Year! Whew, the holidays are finally over! Things can finally get back to normal. I’ve been so busy lately with visiting family, taking care of kids, and completing holiday gifts that I’ve hardly had time to pump-out a blog post for the last couple of weeks.
A typical holiday (or school day-off) can be no picnic for your average financially independent SAHD… but I digress!
All this recent time-off reminded me of a great topic worthy of discussion — During the holidays, the good ‘ole stock-store closes up shop. In essence, stock market liquidity dries up for a few days … and yet no one is the worse for wear.
We’re often taught to believe that liquidity is one of the key advantages to stock market investing, but just how important is market liquidity?
Banking On Market Liquidity
Almost every one takes market liquidity for granted. The easy buying and selling of stocks, bonds, preferred shares, and other assets is one of the key features of owning such investments. The markets are almost always open for trading during the weekdays, and it’s liquidity that helps make stock investing easy and feel pretty safe.
Liquidity means you get the ability to move in-and-out of any investments quickly and at very little cost. It’s so much easier than say trying to find a buyer for rental property, or selling a small business.
Liquidity is a feature that investors love, but does that liquidity (or lack of it) cause investors to make poor decisions? It wasn’t so long ago that the New York Stock exchange closed for almost an entire week following the 9-11 terrorist attacks. When the markets finally opened again, there was a huge selloff…
What if you could only buy and sell investments only one single day a year? Would that change how you invest?
What about once every ten years?
Pardon me for saying so, but I believe a liquidity constraint would give most investors serious pause. Ten years is a LONG time to wait, and A LOT of things could go wrong over the span of a decade. If this were the case, most investors would need to take a long hard look at their portfolio and decide if their investments are going to be stable enough to be held for ten years.
First, an undiversified investment could easily go bankrupt in 10 years. Industries change quickly these days, and technological disruption is happening faster than ever. A company doing well today could be a big loser in ten long years. If you could only trade once a decade, you’d look for a very diversified company with exceedingly strong moats (perhaps like Boeing or Google). Or, you’d simply invest in index funds that swap to whatever the largest business of the day is.
Second, many retirees (early, late, or anywhere in-between) often plan to take capital gains to fund their lifestyle. With stock prices being high, dividend yields are quite low. Those low yields almost force retired investors to sell in order to harvest capital appreciation and generate income.
If the stock market was only open once every ten years those retiree investors would either need to focus on Dividend Growth Investments or find other assets (like real estate) that might provide high-income but lower capital appreciation.
I think we’d see far less of this “pile into growth at any cost” style of investing that seems quite popular today. When you can’t trade as frequently, suddenly the human brain has this big mental shift and other things start to matter a lot more.
Suddenly investing becomes about a lot more than waiting around for a greater fool willing to pay a higher price than you did.
Buffett Doesn’t Care About Liquidity
Obviously the market isn’t going to stay closed and open just once every ten years, because Wall Street loves profiting from investors diving in and out of investments. That’s how they generate the fees that pay for those expensive New York penthouses!
But this whole thought exercise really got me thinking — maybe we should start to think of stock investing in terms of ten year increments. Maybe those other things really do matter more than liquidity.
After all, it was super investor Warren Buffett that once said,
“Only buy something that you’d be perfectly happy to hold if the market shut down for 10 years.”
Buffett doesn’t care about liquidity, so why should you? Obviously Buffett is an expert investor, but he didn’t get that way trading in and out of stocks. He holds investments for extremely long periods of time — he’s held shares in Coca Cola since 1998, and has owned many companies outright, like See’s Candy’s (purchased in 1972) even longer.
Now that’s REAL long term investing.
It just goes to show that liquidity isn’t as important as you’d think to achieving good returns from your investments. Compounding money doesn’t have to mean timing the markets and buying and selling investments to realize profitable gains.
So What Matters?
If we plan to be long term investors and not traders, what is it that really matters to our succeed as a long term investors? Clearly liquidity isn’t quite all it’s cracked up to be.
I’ve said it once and I’ll said it again:
Low Fees — Trading fees and fund fees can seriously eat into long-term returns. Wall Street and its advisors are just vampires feeding off you. You want fees to be as low as humanly possible. For example, Fidelity recently started a Zero-Fee Total Stock Market Index fund. Zero is pretty damn low. If you buy bonds, stocks, or other investments, try to do so in a manner where fees are tiny.
Moats And A Margin Of Safety — I’ve written about margin of safety and moats before. This is a very important topic to succeeding as a long-term investor. Some companies just have incredible moats. They’re integrated into our society, culture, and identity as human beings — either on accident or on purpose. These investments have considerable staying power that is going to fuel their stock for decades to come. Buying these investments with a margin of safety almost guarantees investing success over a long periods of time.
Good Returns On Incremental Capital / Internal Compounding — It’s one thing to invest in something that’s doing well today, but it’s an entirely different task to invest into a company that can reinvest well for the future. In other words, the investment must be able to earn good returns on capital retained. This is what I call “internal compounding“, and you’d be surprised how rare it is to find investments that are good at it. Many Fortune 500 companies simply throw away billions on failed attempts to compound shareholder money.
Market Share / Low Change Industries — Without a doubt the world is going change in the next ten years. I have no way of predicting how it’s going to change, but I don’t really need to either. Some industries just aren’t going to see a giant upheaval in the next decade. Ten years from now, people will probably still be getting loans to either buy homes or rental properties. They’ll probably still need credit to buy cars, fly on airplanes, eat at restaurants, and entertain themselves. Sure, the cars may change, the planes may change, popular cuisines may change, even the ways we entertain ourselves will probably change, but these core human activities are unlikely to disappear anytime soon.
In all likelihood, the players that hold the largest market share today will probably have a place in that different future. It’s not guaranteed, but the probability for success is considerably higher than investing in startups that are “going to change the world”.
Don’t Pretend You Can Predict The Future — Many investors fall into the trap of believing they can predict the next Amazon, Apple, or other investment that will grow to the moon. Perhaps it’s a love of new technology or a desire to see a particular change come to fruition. Whatever the case, more often than not they’re completely wrong.
Trying to invest in only the fastest growing companies isn’t a recipe for success either. Sometimes investors overpaying for growth can actually hurt investing returns. The tortoise still occasionally outruns the hare in the long race.
It’s no secret that the last couple of weeks have seen significant stock market volatility. This volatility represents stock market liquidity at work. Sometimes that liquidity means stocks fall quickly when more sellers exist than buyers. Other days, stocks rise when more buyers appear than sellers.
Despite the volatility, it’s a new year and I have absolutely no idea which direction the markets are going to head in 2019. But I do know this — it’s Mr. Market doing what he does best! He offers up fresh new prices every day. Sometimes those prices even make sense.
Mostly though, Mr. Market can simply be ignored. His liquidity is less important than we’re frequently led to believe. Investors can achieve good returns without trying to take advantage of liquidity.
Simply put, long-term investors are better served by putting their money to work and then pretending the market is closed for the next decade. Doing nothing for a decade is a powerful investing advantage!
Not only does this keep fees low, but it keeps investors mentally focused on timeless investing principles that will continue to work in the decades to come.