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ONE OF THE BEST features of the stock market is liquidity—but it’s also one of the worst.
Whenever the market is open, we can find out precisely what our investments are worth and, if we’re so inclined, we can turn our stocks into cash with the click of a button. But this convenience comes with a major disadvantage: Yes, we can buy at any time—but we can also sell. This tempts some to bail out at the worst possible moment, when the market is down sharply.
Contrast this with investments in real estate. It’s difficult to buy and sell. But that may be a blessing in disguise.
Without so-called price discovery, we can’t constantly check the value of our real estate. That means that, most of the time, we aren’t unduly worried about the price of our real estate investments. Values may have declined, but we’d have only the foggiest notion because the prices aren’t flashing across our TV screen.
A friend recently told me about one of his real estate investments in India. He said that it had gone up 20-fold, equal to 1,900%, over 20 years. He’d earned a compound annual growth rate of 16.2%. We compared that to the S&P 500 for the same period and found it had a return of 7.5% a year from 2002 to 2022.
We also looked at the Nasdaq Composite. It had a return of 10.9% over the period, which includes this year’s bear market. My friend’s real estate investment had handily beaten the U.S. stock market’s return.
Then I tried a thought experiment. I asked him to imagine that he’d been able to see the current price of his real estate investment day and night. Would he have been able to hold on for the past 20 years if its value was dramatically affected by interest rate changes, inflation spikes and the COVID-19 pandemic? He wasn’t sure.
Now that he lives in the U.S., my friend wants to sell his real estate investment and bring the money to the States. Did I mention that real estate is illiquid? Let’s just say there are so many hoops to jump through that he’s decided to hold off selling for now.
Contrast that to investing in the stock market. We can invest in the stock market regularly, such as every two weeks when we get our paycheck. We can sell at any time when we need money. The cost of this convenience with the stock market is accepting major short-term price changes—and big swings in our net worth.
We should know going in that there will be wild fluctuations in stock prices, and that they aren’t necessarily related to the fundamental value of our holdings. This kind of volatility is the price of admission to stock investing.
Volatility is not a fine or a penalty. Rather, it’s the fee we pay for the added convenience of being able to buy and sell stocks in an instant. Each investor has to decide whether it’s worth paying that price.
It’s easy to say that we can tolerate a 30% stock decline when looking at a spreadsheet. Actually seeing our retirement account suffer such a drop can cause us to lose sleep—or, worse yet, sell out at the bottom.
As investors, we must decide whether we want the convenience and liquidity of stocks, even though the cost is massive fluctuations in our net worth. Or do we prefer the stability of real estate, where prices are opaque and selling is hard? Maybe the answer is to own them in combination, like the yin and yang of investing.
Gaurav Kumar is a CPA and professor of accounting. He enjoys talking about finance and teaching financial literacy to high school students, and is an avid reader of books on personal finance and stock market investing. Check out Gaurav’s blog and follow him on Twitter @GauravKInvestor.
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Maybe I am in my eighties and much older than Gaurav Kumar, but I see liquidity as a positive. Investing in real estate is like running a business and lack of price discovery is a negative at least for me. The temptation to sell at the wrong moment may be a problem for the inexperienced, but not for the experienced old folks like me. Also the old folks are likely to have sufficient assets that they are not worried about the market swings. Inspite of the current inflation and market downturn I have confidence in the markets to grow in the long term.