Investing in Liquidity
It’s no secret that we are in uncertain economic times. While the stock market continues to reach record levels, the real economy is struggling to get going as supply chain issues, labor shortages and uncertainty continue to disrupt business activities.
Fears remain whether high-flying asset prices will ever fall to reasonable valuations again or if they will keep going.
During this uncertainty, it is important to be nimble with our capital as investment conditions change. Therefore, we must consider the liquidity of our investments as well as where and how we hold our dry powder so that we can easily adjust when necessary.
Importance of Liquidity
The importance of how easily you can convert assets into cash in order to move capital around during economic uncertainty cannot be understated.
In economic downturns, certain assets may lose more value than others. In this instance, you may want to take advantage of these lower prices by selling some other assets or you may want to cut your losses and move on.
Aside from investing, income streams may be impacted during tough times, and you may need to tap into liquid portions of your investment portfolio for daily needs or emergencies.
Apart from holding cash, stocks and bonds will provide the most liquidity versus other asset classes. However, they also carry the most risk and volatility when markets are unstable.
On the other side of the spectrum, business assets that fall under property, plant, and equipment on the balance sheet will probably not be easily converted to cash in times of crisis.
The same can be said for real estate investments that could potentially lose value if asset prices fall. Unless you run into a follower of Warren Buffett who prefers to buy assets when others are fearful or there is panic in the market, you could be stuck holding a falling knife.
Liquidity is a piece of our investment portfolio that tends to slip under the radar. Having a balanced portfolio of different asset classes will help ensure that you have access to cash when you need it most.
Storing Dry Powder
One of the hardest things to do in investing is to do nothing. Our emotions tell us we need to always be shuffling our portfolio and adding to investments at any chance we get.
Especially for value investors, sometimes it just isn’t the time to buy because everything is so expensive. This is the time to build up dry powder and wait patiently for an opportunity.
Usually, investors will build up dry powder in cash because it is liquid and easy to accumulate. But in times of inflation, you must consider if the loss of purchasing power makes sense for you.
If you hold onto something for dry powder, you want it to appreciate against what you are trying to buy in the future.
Inflation numbers have been running hot recently which makes the idea of holding your dry powder in cash a scary thought.
But if you are only planning on holding cash for a short amount of time, it may not be worth the risk or trouble to move into other short-term assets. However, there are options to consider if you are worried about losing purchasing power in the short term.
One way to do this by investing in short-term treasury ETFs such as the Vanguard Short-Term Treasury ETF(VGSH) or the Short-Term U.S. Treasury ETF (SCHO).
Both ETFs track an index of short-term U.S. Treasury bonds with one to three-year maturities. These ETFs feature low fees and plenty of liquidity to take your funds out efficiently.
Storing your dry powder in one of these short-term treasury ETFs is among one of the safest ways to protect your capital in the short term. Just don’t expect to get rich holding them.