Liquidity
Quick – what’s the first thing that comes to mind when you hear the words Harvard University? Is it “Ivy League college?” “Prestigious institution?” A finishing school for aspiring doctors and lawyers?
Harvard is certainly all that. But the university – or more specifically, its endowment – is also an excellent cautionary tale for investors. Specifically, on the importance of liquidity.
Come back with me to 2008 when the world was in the grips of a financial crisis. Even an institution like Harvard wasn’t immune. While it still trained some of the brightest minds in America, Harvard's $36.9 billion endowment was feeling strained.1 Like many universities, Harvard’s endowment plays a key role in funding its operations. But in 2008, it was rapidly losing money.1
Part of the problem was that Harvard Management Company – the organization that manages the endowment – had invested heavily in complex things like private equity partnerships, real estate, and commodities.1 Like the stock market, these investments were losing value. But it was extremely difficult to sell these investments, because most were illiquid.
What is liquidity? Put simply, liquidity is the ability to quickly convert an asset into cash without drastically affecting its price. Technically, cash is the most liquid asset there is, because it can be used immediately and under almost any circumstance. Other assets have varying degrees of liquidity. Stocks are fairly liquid since they can often be sold easily. More tangible objects, like a car or even a prized baseball card, are far less liquid, because it might take longer to find an interested buyer. Items like these might also be harder to sell for their full value. Real estate, meanwhile, is one of the least liquid assets of all – ever try selling a house before?
So, at a time when Harvard desperately needed cash, they were unable to sell many of their losing investments. To make matters worse, many of those they could sell had to be sold at a discount.1 It’s partly why their endowment dropped by $11 billion.2
Now, I don’t write all this to pick on Harvard.For one thing, it’s important to remember the
endowment is run by Harvard Management Company, not Harvard University itself. Furthermore, many institutions and endowments experienced similar drops at the time. I write to illustrate a key point: When it comes to finances, liquidity is crucial.
Why is liquidity so important? Well, whether you’re investing for the long-term or the short, you never know when market volatility, economic downturns, or even unexpected expenses may strike. Take expenses, for example. What if your house is damaged by a storm and needs
repairs? What if your car gets stolen? What if you have sudden medical expenses to pay? All those things require cash.It may be that you have enough in savings to cover these expenses – but you may not. This is especially true for retirees, who often have most of their savings earmarked for specific purposes. Or what if the economy goes south and some of your investments don’t make sense anymore?
In life, we should always expect the unexpected. It’s why you should always keep a first-aid kit
in your car or a flashlight in your house. And it’s why you should always factor in the
importance of liquidity when it comes to investing for your future. Sometimes, even experienced financial professionals and prestigious institutions forget this basic fact.
Understand that I’m not saying all illiquid investments are bad. I’m not saying you should make a habit of selling your investments anytime you could use some cash. What I am saying is that there may come a time when you need to convert an asset to cash quickly.
And that’s why you think carefully about liquidity.
Sincerely,
David M. Gallagher
Wealth Manager
1 Bernard Condon and Nathan Vardi, “Harvard: the Inside Story of Its Finance Meltdown,” Forbes, February 26, 2009. https://www.forbes.com/forbes/2009/0316/080_harvard_finance_meltdown.html#1d116fdb51dd
2 Peter F. Zhu, “Harvard Endowment, Largest in Higher Education, Plummets by 27%,” The Crimson, September 10, 2009. https://www.thecrimson.com/article/2009/9/10/harvard-endowment-largest-in-higher-education/
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results
Securities offered through LPL Financial, member FINRA/SIPC.
