There are some very good investments that tie up your money and make it difficult to retrieve without large penalties or long waiting periods. Many of these investments are simply not geared to a format that can offer daily liquidity. Think of your house. It is a major investment and probably one you are proud of. Still, it is not one in which you have anything like daily liquidity. Typically, it would take months to place this asset on the market, find a buyer, and close the deal.
Investments that you may be sold by investment professionals that typically offer less liquidity include hedge funds, private real estate funds, annuities, limited partnerships, etc. You need to evaluate closely what your expected returns in this illiquid asset are versus the risks, what are other options you may have, and what percentage of your assets are you willing to tie up for the long run.
For instance, a private real estate deal (AKA a non-traded REIT) should be considered against various publicly traded real estate exposure (REITS, ETFs of REITS, closed end funds of REITS, home builder stocks, etc.). Do you expect that investment to do better than all the publicly trade options? How much better? In return for that expected performance, are you willing to give up the ability to change your mind and seize a better opportunity if it presents itself tomorrow, in a month, in two years? Have you read the risk disclosures of this private deal carefully and do you understand them?
Annuities include surrender charges (penalties for getting your money back) that can go on for over 10-15 years. Think of the changes that have occurred in that time period both in your life and in the investment world during that time period. Fifteen years ago people believed that tech stocks went up 25% a year routinely. Ten years ago people believed real estate always goes up and you can’t lose money. Fifteen years from now who knows what the investment landscape will look like? To decide what to do with your money today is tough enough. To decide where it should be ten years from now is …impossible. Annuities with no commissions attached generally have no surrender charges. Annuities with very large commissions generally have very long surrender charges. Buyer beware! Who is benefiting from you giving up the freedom to move your money as you see fit, you or the insurance agent and insurance company?
Still, there can be good reasons to tie up some of your money in illiquid investments. Annuities are good vehicles for dealing with longevity risk (the risk of having a very long life and needing income for a long time). The question is what percentage of your assets can be tied up for the long haul? My answer is simple-tie up relatively little of your assets for very long periods as there are too many “unknown unknowns” in life. The number should be based on your individual circumstances. Twist my arm for an answer and…..nobody should have more than 30% of their investable assets in illiquid investments! You won’t have big regrets later if you keep your options open in dealing with the future.
By Ted Schwartz, CFP©