Pros and Cons of Investing in Illiquid Securities

Table of Contents

• Introduction

• What are illiquid securities?

• Types of illiquid securities

• Pros of investing in illiquid securities

• Cons of investing in illiquid securities

• Factors to consider before investing

• How illiquid securities fit into your portfolio?

• Final Thoughts

• FAQs

Introduction

Stock market investments need wise and smart choices. The segment of illiquid securities is one that investors overlook. These are not short-term sellable like common stocks or bonds. One has to wait for some time before there is a buyer, and selling is on a discounted basis. 

However, such investments promise good returns in the long term. It is important to note the pros as well as the cons before investing. 

Furthermore, this guide will help you learn the pros and cons of illiquid securities. It’s beneficial for anyone looking for tips on investing in the stock market in India or who want to learn the best shares to buy now India. Taking wise decisions can protect your money and augment your wealth in the future.

What are illiquid securities?

Illiquid securities are assets that you cannot easily sell or transfer without a significant drop in price. Other than for shares in huge corporations, illiquid securities do not have frequent purchasers. They consist of private equity, real estate, venture capital, and some bonds. Moreover, investors will find it difficult when they need to withdraw their funds urgently. They contrast with liquid securities, which you can simply sell at any time at market price.

Types of illiquid securities

Illiquid securities come in a number of different varieties. Some of the most common are

• Private equity: Equity holdings in non-listed private companies.
• Venture capital: Investments in high growth potential but risky start-ups.
• Investments in property: Holding property, especially in less liquid markets.
• Restricted stocks: Stocks one is not allowed to sell prior to a condition being met.
• Specific bonds: Bonds with insignificant trading volume or extended maturity periods.

Furthermore, each type has specific features, but all of them share the feature of restricted marketability.

Pros of investing in illiquid securities

Illiquid securities could be attractive to many investors for several reasons. The following are several benefits:

1. Potential for High Returns

Illiquid assets generally have a higher return than liquid assets. The premium is paid to investors for higher risk. Private equity funds, for example, will generate better returns than publicly traded stocks in the long run.

2. Lesser Market Volatility

Such securities are less subject to fluctuation in the daily markets. Therefore, they are stable when markets become volatile. This could be an insurance against an unexpected loss for your investment portfolio.

3. Access to Exclusive Opportunities

Illiquid investments allow you to access companies or assets that are out of reach for the masses. This can lead to discovering undervalued assets or early growth-stage startups.

4. Long-term Growth Potential

Illiquid investments typically appreciate significantly over a period of years. Long-term investing can lead to greater gains than short-term trading.

5. Diversification Advantage

The inclusion of illiquid securities will diversify and reduce overall portfolio risk. They move differently from stocks or bonds and serve to balance your holdings.

Moreover, diversifying with illiquid stocks is often recommended when you are looking for investment advice in the stock market in India.

Cons of investing in illiquid securities

Despite the benefits, there are very strong drawbacks to consider:

1. Lack of Liquidity

The primary drawback is that it is hard to sell urgently. It will take months or years before you can find a buyer. This hinders the ease of the cash when you need it.

2. Higher Risk of Loss

Illiquid stocks are riskier because they are not highly transparent.  Therefore, there is little information and it becomes more complex to properly assess them.

3. Difficulty in Valuation

Unlike public shares, illiquid assets are not valued on a daily basis. Their value can be subjective and prone to errors.

4. Long Investment Horizon

It is patience-demanding because the money gets tied up for quite a long time. In case your circumstances are otherwise, an early sale could be costly.

5. Limited Regulation

Private equity illiquid securities are less regulated than public shares. This implies that there are greater risks of fraud and mismanagement.

Therefore, investors who want the best stocks to invest in India at present should consider these risks before they add illiquid stocks to their investment portfolio.

Factors to consider before investing

Before you decide to invest in illiquid securities, bear the following key considerations in mind:

• Investment Goals: Are you seeking short-term profit or long-term growth? Illiquid investments suit long-term goals.
• Risk Appetite: Are you able to stomach high risk and uncertainty? Illiquid investment needs a steel stomach.
• Financial Needs: Do you need access to cash in a rush? If so, do not place it in illiquid assets.
• Portfolio Allocation: How much of your portfolio will illiquid securities take up? Professionals recommend 10-20% frequently.
• Research and Due Care: Understand the asset class, the market, and the historical record of the investment manager.

Moreover, having information regarding stock market investment tips India can be helpful in making the right choices.

How illiquid securities fit into your portfolio?

Smart investors combine liquid and illiquid securities. This strategy balances risk and return. For example:

Furthermore, illiquid stocks can enhance returns with little additional volatility. As such, numerous financial planners suggest including them for building wealth.

If you are interested in knowing the best shares to buy now in India, keep illiquid stocks as part of your overall plan. 

Final Thoughts

Investment in illiquid securities has its pros and cons. The potential for higher returns is the primary attraction for investors. But it must not be forgotten that there is limited liquidity and added risk. Always check your financial objectives and risk tolerance prior to investing. Moreover, combining illiquid securities with liquid assets creates a balanced portfolio. Tips for investment in the stock market in India lead you to take such decisions prudently. Finally, research and seek professional assistance prior to making commitments.

FAQs