February 25: People prefer liquid investments for obvious reasons -- they can get their money back whenever they need it. On the other hand, illiquidity implies an inability to get back one's money quickly. It would, therefore, seem that illiquidity is a bane for investors. However, a closer look reveals that it might not be as bad as it appears.In fact, a completely liquid portfolio may suffer from some disadvantages. An investor, for instance, can resort to liquidation of a significant portion of his or her holdings out of panic in a difficult or a sluggish market. A salaried-class investor with a highly liquid portfolio may find that various exigencies force him to repeatedly sell some of his holdings in order to meet pressing needs. As a result he may be unable to build up a sizeable capital. For people with fixed salaries, provident fund and gratuity become sizeable in quantity over a period of time, partly because of their illiquidity.
What is, therefore, required in a portfolio is a mix of liquidand illiquid investments. Some investments fall in between these two extremes. For example, fixed deposits in nationalised banks, which can be encashed before their maturity, albeit at a reduced rate of interest, are such a middle-of-the-road investment.
Undoubtedly, one should aim at sufficient liquidity. But at the same time, certain other investments with different lock-in periods should also be included in the portfolio, such as NSCs and PPF. Different bonds, close-ended mutual funds, contributory provident fund, ULIP and various life insurance policies also represent schemes with different lock-in periods.These investments lead to availability of maturity amounts at different times and may help in meeting different needs at different periods of time--like paying for the higher education of children, their marriages or expansion of an existing house.
For an investor belonging to either the middle-income or upper-middle-income group, the need of liquid money from time to time is a common phenomenon. Itis precisely for this reason that a certain degree of illiquidity forces an individual to seriously try to meet his obligations from within available means.
In many instances he may indeed end up finding ways and means to meet his monetary needs from the available resources only. This, in turn, allows continuous growth of illiquid investments eventually leading to building up of sizeable capital which, in the long run, helps in meeting other important needs.
Nevertheless, some provision of liquid money for meeting contingencies should necessarily be made. Those contingencies, which can be met by various insurance products, should be met through such schemes. Different insurance schemes of LIC and GIC therefore merit serious consideration for a prudent investor.
Investment objectives and plans of investors, however, vary according to their age group and their specific circumstances. In certain instances, one may be forced to accept lock-in periods due to terms and conditions of the investment instrumentunder consideration or due to various provisions of the Income Tax Act such as sections 54EA, 54EB or 88 (in case of infrastructure bonds, for example).
It is, however, pertinent to appreciate that illiquidity per se in the area of investment is not as bad as it appears. In fact, for a savvy investor, illiquidity and liquidity should be mere parameters of investment planning. In many instances, and in some respects, illiquidity may actually help the investor rather than causing any harm to him or her, provided the true nature and implications of illiquidity are well understood.
Copyright(c)1998 Indian Express Newspapers (Bombay) Ltd.
