Investment can be illiquid

investment-can-be-illiquid

Based on the fact that people in general prefer the more liquid investments, the law of supply and demand will mean that in general, the more liquid is an investment, the lower is the return that an investor can expect to get. Thus, current account (which is highly liquid) provides zero return, while savings account has a lower return than fused deposit which in turn has a lower return than “tontine” since each type of investment is in turn less liquid than the previous one. How should one classify share investment in terms of liquidity? At hrst glance, one would think that share investment can be classified as a fairly liquid investment since shares can be sold and cash be collected within a few days. But in reality, shares can be a very illiquid investment, particularly in the Malaysian/Singaporean context.

The most important reason why shares are illiquid investments is that most investors let themselves be caught in a psychological trap… Nobody that I know (including myself) likes to sell a share at a prim that is below his purchase price. Most people find it extremely dilliettlt to “cut losses” and sell out when the market turns down. The instinctive reaction is to hold on and hope that the market will turn better, But since the bear market can last anything up to two years, an investor hoping for higher prices may have to wait as long as three or four years before he can dispose of his investment at a profit. In the mean time, his investment is totally locked up.

Secondly, for one reason or another, one often finds that one may not be able to sell the shares when one wants to sell. Quite regularly, a share can become suspended, either voluntarily or involuntarily be» cause of bankruptcy and such like. Sometimes, the suspension can continue for months or years. The more speculative the share, the greater is the probability of it being suspended. Even if a share is not suspended, it cannot be traded because the investor has sent it away for registration or splitting which can take weeks if not months.Thirdly, the buying and selling of shares involves costs quite unlike, say, putting money into or withdrawing money from savings accounts The most obvious of such costs is brokerage. But much worse than brokerage is the cost known as “ask-bid spread” that is, the difference between the buyer’s and seller’s price. Even in normal circumstances,

the ask-bid spread is seldom less than 2 per cent. Combined with brokerage. each time an investor buys or sells, he loses 3 per cent of the value of the share. Considering that future stock market return is likely to be around 10 per cent per year on average, there is very little margin for trading. If he buys and sells his shares more than twice a year, all the likely return would be wiped out. The ask-bid spread can be extremely large during a time when the market is falling sharply when a 10 per cent spread is possible. In such a situation, even if he wants to sell, he is not able to and the share becomes an illiquid investment.

For these reasons therefore, shares, under the normal circumstances, cannot be regarded as a very liquid investment. Since it is not very liquid, it is to be expected that share investment ought to provide a higher return than, say, fixed deposit.

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