Stock liquidity: It’s a double-edged sword
The great 20th-century playwright Tennessee Williams once remarked, “If I got rid of my demons, I’d lose my angels.” For those not keen on literary bromides, the translation in 21st-century vernacular might be: The good news is also the bad news. Either sums up the double-edged sword of stock liquidity. The good news is that investors can obtain an instantaneous stock quote and sell their shares with the click of a mouse. That is also the bad news.
Ben Graham was the first to write about the antithetical characteristics of liquidity in his classic “The Intelligent Investor.” He compared the benefits of owning non-liquid investments to those of liquid securities during the worst of the 1931-33 depression. Graham observed that there was a kind of “psychological advantage in owning business interests which had no quoted market.” He argued that those with illiquid investments could convince themselves that their investments had kept their full value — since there were no daily market quotations to prove otherwise. On the other hand, owners of stocks and bonds subject to daily quotations obtained a sense that they were “growing distinctly poorer” each day. For those of us who still feel the sting of the 2008 decline, Graham’s words resonate.
Warren Buffett, a student of Graham’s and his eventual collaborator on the fourth edition of “The Intelligent Investor,” is the modern-day personification of the intelligent investor. In his 2013 annual letter to shareholders, Buffett provides an example of two very successful illiquid investments he made in real estate. “Those people who can sit quietly for decades when they own a farm or apartment house … often become frenetic” when exposed to daily stock quotes and commentary. He concludes, “For these investors, liquidity is transformed from the unqualified benefit it should be to a curse.”
What, then, should our response be to the kind of volatility we have experienced in the past week or, even more to the point, in 2008? We should consider the good news and the bad news.
As an example, in April 2007 I purchased shares of Starbucks at $31 after a 30 percent decline in the stock price. The market rout of 2008 took down the price much further, to around $8 per share. Graham and Buffett would argue that when the shares of a great company decline, investors must ask themselves if the company and the brand are still sound. If so, then buying the shares too early, as I did, is not disastrous. I held firmly onto my shares and have reaped a total return of 2.5 times greater than the S&P 500 over the subsequent eight-plus years. If I had sold my Starbucks “demons” at $8 per share, I would have lost my outperforming “angel.” And that, my friends, would be bad news.
Nancy Tengler spent two decades as is a professional investor. She is the author of “The Women’s Guide to Successful Investing,” a financial-news commentator and university professor. Reach Tengler at nancy.tengler@cox.net.