When I first retired from the military and was starting this company, I worked for a company doing consulting in the oil field. During that time, the company offered stock for purchase to employees and subcontractors that worked for it. The company was not publicly traded. After a year or so, one of the other contractors put out the word that he was looking to sell some shares to pursue other opportunities.
A month or two later I received another broadcast email offering the stock at a significant discount. I don't know if he ever sold it or not. I do know that he didn't think about liquidity risk.
What is liquidity risk?
According to the course work I did for the CFP® program it is:
The degree of uncertainty associated with the time it takes to sell an investment with a minimum of capital loss from the current market price
In other words, "Can I get my money now and do I have to worry about paying so that I can get it?"
Military Officers Should Consider Liquidity Risk in These Investments
Almost all investments will have some level of liquidity risk with the exception of the cash in your savings account. But you should think carefully when encountering the follow investment options.
- Your House and Mortgage. Virtually everyone I talk to has the dream of paying off the mortgage. Realize that when you do, you are putting your cash into a very illiquid asset. We all know it can take months to sell a house and you're most likely going to pay a realtor a significant commission to sell it for you. Beyond that, you can't sell a portion of a house to generate cash. Having your mortgage paid off is a good thing. Think about liquidity if you're considering it.
- Annuities. Almost all annuities have a surrender charge for a number of years. This will mean that if you take funds out during the surrender period, you won't get all of your money. You may be able to get a portion out without a surrender charge, but that's the point. Money is liquid if you can't get it when you want it.
- Non-Traded REITs. If you purchase a Non-Traded REIT you have very limited opportunities to sell it (if you can find a buyer). In fact you may be tied up in the REIT until it closes. This isn't an issues with REITs that are publicly traded.
- Limited Partnerships. Common in the oil and gas industry and real estate. There may not be an existing market to sell them. You may have to find a buyer on your own.
- Closely Held Corporations. This is the situation I described at the start of this blog. You may not be able to find a buyer at the appropriate valuation.
- Retirement Accounts (401(k), TSP, IRA, etc). When you invest in a retirement account, in most cases you can't get to the funds until you turn 59 1/2 without paying a penalty. That's not liquid.
What to Do?
As a military officer you know that risk isn't always a bad thing. Retirement accounts have liquidity risk (at least for a while), but they're the right tool to invest for you retirement. You can accept the risk because it supports your plan.
You need to mitigate risk. When I used to fly fighters, we had risk in virtually everything we did in the air. That's the case with most military activities. But we looked at ways to mitigate that risk. Same thing here. Mitigate the risk by having liquid assets in addition to your illiquid assets. In fact, I would say one of the first things you should do is establish a reserve of liquid assets, just in case. We normally call this an emergency fund.
Bottom line: Include liquidity risk in your investment evaluation so you don't end up asset rich and cash poor. Or...we can help you with it.
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