The worst investments I’ve ever owned all share one thing in common—I couldn’t sell them. Whether we are talking fractional shares of expensive artwork or private investments in friends’ companies, I didn’t realize the paramount importance of liquidity until quite recently.
And I’m saying this as the Just Keep Buying guy. Trust me, I don’t sell investments often. But, sometimes, I have to. Sometimes it’s for a rebalance. Sometimes it’s to generate a tax loss. Either way, I need to sell.
But, what if I can’t sell them? What if there’s no secondary market for these assets? What’s the point of owning 9 square inches of a Basquiat if no one ever buys it? What’s the point of having private shares in a company if they keep doing down rounds?
Illiquidity can be brutal. I didn’t understand this as a younger investor. I assumed that having more asset classes was always better. Have a little bit of everything because diversification, right?
But now I’m paying the price for that decision. Owning un-diversified, illiquid assets is one of the worst things I’ve done as an investor. It’s worse than just losing money because when you lose money you know the end result. The uncertainty is gone. But owning illiquid assets, especially those that aren’t doing well, is investment purgatory.
I have private company shares that are worth more to me as a tax loss than their current value on my balance sheet. Of course, I don’t want these companies to fail. But locking up my money for a decade and watching them fail anyways would be the worst of both worlds. Though I’d still get my tax loss, I’d only get it after it’s been devalued by inflation for a decade. This is why I now despise illiquidity in my portfolio.
But not everyone agrees. Some see illiquidity as a feature, not a bug of a great investment. This seems to be the case when it comes to private equity and venture capital investments. As Silicon Valley Bank’s State of the Markets highlighted, top quartile funds typically don’t return capital for over 15 years:
This illustrates just how long it can take for these kinds of investments to play out. And, unless you’ve accepted this going in, then you shouldn’t even bother.
I didn’t realize this when I made all of my illiquid investments in 2021. Then again, if some of these investments had done well, today I’d probably be singing a very different tune. Unfortunately, they haven’t.
But it’s not just me who’s struggling with illiquidity. Dan Rasmussen recently gave an interview where he discussed the liquidity issues he’s seeing across private equity:
I think we’re in phase one where private equity can’t sell the assets that they have. So people are saying “Oh gosh, they can’t get distributions.” But they still think it’s worth exactly what the private equity firms are telling them.
The only logical conclusion from Rasmussen’s analysis is that prices must fall.
Unfortunately, private equity doesn’t have a great track record when it comes to marking their investments to market. Just consider the case of Blackstone’s Real Estate Investment Trust (BREIT) from September 2021 to September 2023:
One of these things is not like the others.
So, how does private equity get out of this jam? They have two options:
- Gradually re-price their investments to fair market value.
- Sell to unsuspecting investors at current prices.
Guess which one they’re going to go with?
You guessed it—sell to unsuspecting investors at current prices. Cue the Margin Call scene:
Why do you think the White House put out an executive order a few months ago to “democratize access” to alternative assets in 401(k) plans? Did Donald Trump wake up one day suddenly offended that grandma and grandpa couldn’t buy private equity like all of his rich buddies?
Please. I’ve never seen a more blatant use of “democratization” as a disguise for selling someone else’s bags. Private equity needs exit liquidity and everyday Americans have it.
Does this mean that every person who buys private equity in their 401(k) is going to lose money? Not necessarily. I can’t predict how this will play out. However, anytime an exclusive club opens its doors to the general public, it usually doesn’t end well.
I’m all for democratizing access when people are well-informed and know what they are getting themselves into. Unfortunately, I don’t feel like that’s the spirit of this current push for alternatives.
Why now? Why wasn’t Trump or anyone else advocating for main street to own alternatives a decade ago? I think we all know the answer.
In general, I’m not one to regulate what people invest in. I think most investors are smart enough to make their own decisions. They don’t need to be protected. This is definitely true when it comes to memecoins and crypto. By this point, people know what they are getting themselves into.
But retirement accounts feel different. These are meant for a specific purpose at a specific point in time far in the future. While owning private equity is not like owning a memecoin, I’m not so sure people will fully understand what these investments entail. They may not understand the lack of liquidity or the higher fees.
How do I know? Because I didn’t fully understand them when I made my private investments in 2021, just four years ago. And I’m someone who knows quite a bit about this stuff. If you had asked me in 2021 whether these private investments were illiquid, I would’ve told you “Yes.” I knew what illiquid meant from a theoretical perspective.
But I had never lived with illiquidity. I had never experienced it firsthand. That’s the lesson I learned the hard way. That’s what all of my most difficult investments have in common.
Of course, this advice may only apply to me. Despite being a long-term investor, I can be quite impatient sometimes. But it’s better to be honest with yourself than to make the same mistake again in the future.
Happy investing and thank you for reading!
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This is post 477. Any code I have related to this post can be found here with the same numbering: https://github.com/nmaggiulli/of-dollars-and-data
