Liquidity risk
A price on a screen is not a promise that anyone will pay it.
The price versus what you actually get
The last price shows what someone paid for a small quantity. It says nothing about the price you would get if you sold ten times that amount.
For a large stock, the difference is negligible. For a small stock, a corporate bond, or a property, it can be several percent.
That is why a portfolio valuation always comes out slightly optimistic: it assumes every position could be sold at the last price, which is never true for all of them at once.
When it disappears
Liquidity is most plentiful when you do not need it and scarcest when you do. In a panic, buyers vanish and spreads widen in an instant.
This hits hardest the assets that looked safe: corporate bonds, real estate funds, and anything that trades only a little each day.
Some funds have suspended withdrawals during crises for exactly this reason — they could not sell their assets fast enough to pay their investors.
How to judge it
Look at the average daily volume. If your position makes up a large share of it, getting out will cost you.
Look at the spread between the buying and selling price. A wide spread means an immediate cost, and a warning that liquidity is thin.
And read the withdrawal terms of any fund that does not trade on an exchange. The words "in exceptional circumstances" deserve your attention before you need them.
Key terms in this lesson
- Liquidity risk
- The risk of not being able to sell quickly without accepting a noticeably worse price.
- Volume
- How many units trade on an average day. A direct indicator of liquidity.
- Gating
- When a fund temporarily halts withdrawals because it cannot sell its own assets.
Quick check
Why is liquidity the risk that shows up exactly when you need it most?
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