Investing
Liquidity Thins Out Exactly When It Is Needed
The ease of selling an asset depends on other participants wanting to buy, which means liquidity is a property of market conditions rather than of the asset itself.
An investment is liquid when it can be sold quickly at close to the quoted price. That condition depends on other people, and it is least reliable when most people want the same thing.
Liquidity is supplied by counterparties
A price on a screen represents someone's willingness to trade at that level for a certain size. Beyond that size, the next available price is worse.
Market makers and other participants supply this willingness commercially, and they widen their prices or withdraw when uncertainty rises, because holding inventory becomes riskier.
So the depth available in calm conditions is not a fixed property of the security. It is a service that is priced, and the price moves.
Correlated selling removes the other side
When many holders decide to sell simultaneously, the buyers who would normally absorb that flow are fewer, because the reasons prompting the selling are widely shared.
The result is that the same order that would have executed near the quoted price on an ordinary day executes materially away from it.
This is why liquidity is described as disappearing rather than declining. The change is not gradual, because it depends on collective behaviour rather than on individual decisions.
Fund structures can transmit the problem
An open-ended fund creates and cancels units on demand, so redemptions require the manager to sell underlying holdings if cash reserves are insufficient.
Where the underlying assets trade less readily than the fund's dealing terms imply, there is a mismatch, and heavy redemptions force sales into a market that cannot absorb them.
Suspension and deferral mechanisms exist precisely for this mismatch, and the rules on when they may be used vary by jurisdiction and change over time.
Property and private assets face this structurally
Assets that transact rarely and individually, such as buildings or unlisted holdings, have no continuous market, so there is no price until a sale is negotiated.
Valuations for such assets are estimates between transactions, which means the reported value can be stable while the realisable value is not.
The gap between the two typically becomes visible only when a sale is attempted, which is usually at the moment when a fund or holder most needs the money.
The practical implication is about matching, not avoidance
Illiquidity is not a flaw to be eliminated; assets that are harder to sell exist for reasons and are held by investors with no near-term need for the money.
The difficulty arises when money that might be needed at short notice is held in something whose sale price depends on conditions at that moment.
Matching the expected holding period to the liquidity of the holding is the structural response, and it is a question about the money's purpose rather than about the asset's merits.
Questions readers ask
Does this mean I should sell before a fall?
Only if you can identify falls in advance, which the evidence suggests almost nobody does consistently. The practical response is choosing an allocation whose falls you can sit through.
Why do average returns overstate what I got?
Because averaging percentages ignores that each return applies to a different balance. The compound return accounts for that and is always lower when returns vary.
