When Investing, Choose Liquidity…

…unless you really know what you’re doing.

For example, say that a coworker whose opinion you respect asked you to drink a glass full of blue liquid.  No doubt you would ask your coworker “What is it?” followed by “What will happen if I drink it?”.

What if you didn’t understand his answers to your questions?  And what if he’s still trying to convince you that the liquid is good for you, even though there is a property in the liquid that keeps it in your system for at least three months?  Would you still drink it?

If you’re like me, your suspicion would keep you from drinking it.  Especially if the liquid could not be expelled for at least a quarter of a year.

Although one’s body is more sacred than a portfolio of investments, you still may have put in years of effort to nurture that portfolio.  Your portfolio may also be a key support-system when you’re older.

So why is it that we’ll fiercely protect our bodies, but not our portfolios?

If you’re a person of means, you may encounter advanced investment opportunities designed to potentially create higher returns than what you may be able to receive with a portfolio of stocks and bonds–in particular, investments marketed towards accredited investors.   Some examples of advanced opportunities include:

  • Private Placements
  • Hedge Fund Investments
  • Leveraged ETF’s
  • Auction Rate Securities
  • Structured Products (including Mortgage-Backed Securities)

Investments like these that may propose to offer higher returns than what you would find with basic equities (like stocks) may also come with higher risk, higher complexity and a longer or more complex process of redemption — e.g., a property that dictates how quickly you can withdraw your money.  Limited redemptions are often established so that the investment’s underlying managers can execute their strategies without risk of sudden withdrawals, plus other reasons.

It’s key when presented with an advanced investment opportunity that you understand how that investment makes money.  Even if you’re working with an advisor that you know and trust, your advisor is supported in making his or her recommendation to you by taking cues from you on your tolerance for risk and suitability.

If you ultimately don’t understand how the investment makes money, then at minimum a key property to understand is how difficult it would be to get out of the investment — e.g. its liquidity.  Once you at least understand the mechanics of selling your investment, you may be able to sleep at night knowing  how you can exit the investment should it not perform as you expected.

Understanding an investment won’t guarantee that you won’t lose your principal.  But it will guarantee that you’ll be better prepared to react to the unexpected.

While you work with an advisor because you trust and respect his or her advice, a good advisor still needs for you to do your homework (and a great one will work with you to help you understand his or her recommendations).  If you’re not embarrassed to question what’s in a glass full of blue liquid, don’t feel embarrassed to ask questions about where your money is being invested.  If you are, it may be time to seek out a new advisor.