What is Liquidity risk?
The risk that when you want to sell an investment, there will be no buyers interested in paying what you believe is a fair price for it.
How this risk plays out in the real world
Following are articles that concern the issue of liquidity and not a specific corporation’s stock that is difficult to sell.
Sep 13, 2017: Bitcoin slides on ‘fraud’ warning from JPMorgan’s Dimon
Feb 01, 2016: The Reckoning: Private investors have plowed $362 billion into startups in the past five year. Now tech IPO’s are in trouble. Good luck getting out.
Dec 12, 2015: Third Avenue junk fund blowup exposes risks of unsellable assets
Oct 17, 2014: Twitpic fails to find a buyer, will shut down
Oct 01, 2014: Gross Exposes $42 Trillion Bond Market’s Key Flaw in Exit
Sep 06, 2014: The Bond Bubble Will Pop, It’s Just a Matter of Time
Mar 10, 2013: Homes damaged by Superstorm Sandy hit the market for bargain prices
Connection to other risks
This risk is connected with Systemic risk because when a financial system begins crashing, when investors are overcome with fear, they will rush to sell what they hold. With others doing the same thing, there’s a good chance that there will not be nearly as many buyers ready to absorb the assets being sold.
Read the glossary definition of Liquidity risk.
How investors can manage Liquidity risk
- Don’t buy penny stocks, tiny companies whose shares trade hands among investors infrequently.
- In general don’t make an investment before confirming that there is an active market of buyers and sellers for it. It is that market that you will one day sell the investment into when you no longer want to own it.
A final word
Investors don’t set out to purchase investments that will be difficult to sell. During the course of their ownership an event may happen which causes the investment community to change its views. For example, Superstorm Sandy flooded homes near the coast from New Jersey to New York’s Long Island. Over night, those “flood homes” became impossible to sell for anywhere near the value they would have fetched before the storm.