Investors face a diminishing list of places to park money in the low-rate environment of today.
Holding cash is a losing strategy over the long-term as inflation reduces purchasing power. Bonds have little to offer as rates have remained low for a long time. Equities have soared in valuations leading to a cyclically adjusted price-to-earnings ratio (CAPE) that is at its second highest level since 1880. This elevated figure suggests that the stock market is overextended. As a result, stock prices may have exceeded the value of their underlying fundamentals.
What do these conditions mean for investors? It means that investors have fewer places to go when seeking ways to grow their wealth over time. Waiting just means suffering the effects of rising inflation. Jumping into stocks risks buying at a time of unreasonably high prices.
This predicament likely explains why investors appear more willing to embrace lower liquidity in their portfolio. Recent research from the World Gold Council examined data from five hundred global institutional investors and learned that “investors are targeting a third of their portfolio in alternatives and other assets over the coming years.” These alternatives offer less liquidity than most traditional investments.
Liquidity risk is a gauge of how easily an asset can be bought or sold in the market. An asset is highly liquid if it can be converted to cash fast. Today, investors seem to have pulled their attention away from this risk as they seek viable investments in a setting where good options are limited.
A low liquidity portfolio means that the investor will need more time to exit their positions. This characteristic could become a problem if sudden market movements threaten holdings. It is not surprising that 42% of investors surveyed by the Greenwich Coalition cited liquidity as one of the top three influencers of asset allocation choices for the long-term.
However, today’s investors seem less aware of the risks present when liquidity is low. As a result, many are turning to alternative assets like NFTs and cryptocurrencies. Now is the time for investors to rethink liquidity.
They need to reevaluate their true risk tolerance in an increasingly volatile market. Gold can provide a counterbalance to these fluctuations. Why? Because gold offers a relatively higher degree of liquidity when compare to many alternative investments. This fact is clear from data showing one-year trading volumes of major assets. Only US T-Bills and the S&P 500 index have higher volumes than gold. The Euro, Yen, DJIA, US corporate bonds, and German bonds all trade at lower volumes according to data from Bloomberg, the UK Debt Management Office, and others.
The combination of a low-rate environment, rising inflation, and elevated equity valuations have pushed investors into more alternative investments. As a result, their portfolio liquidity is prohibitively low. This low liquidity presents risks when markets fall rapidly in a short period as they have in recent weeks. Investing in gold provides a measure of stability.
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