Choose Two: Principal Protection, Liquidity, and Above-Market Returns

Two pieces worth reading today from Eleanor Laise at the Wall Street Journal, which go along with what I have been writing in my Unstable Value Funds series:

I just want to make the short, simple point that an investor can only get two of the following three items (at best):

  • Principal Protection
  • Liquidity
  • Above-Market Returns

Perhaps I am a bit of a pessimist, but as a wide number of products came into existence attempting to offer all three back in the 90s, I would ask questions like, “But what happens if you have losses on assets and redemption requests at book at the same time?”  An answer would come back on the order of, “You worry too much.  We’re making money.”

True, as parties are willing to take more and more risk, you can get all three for a time.  But over a full market cycle, it can’t be done.  And, by a full market cycle, I mean a period of time long enough to include a major debt deflation, like the 30s and now.

So, be aware of withdrawal provisions on your investments, both the formal ones listed in the prospectus or its equivalent, and the informal ones where ability to withdraw is suspended as a matter of fairness to all clients, and/or protecting a business at a financial firm (though risking lawsuits in the process).

Also, try to understand what underlies the shares in any pooled investment vehicle that you own.  If the underlying does not have a liquid secondary market, the shares of the pool won’t be liquid under all conditions.  If the value of the assets vary considerably over time, stability of principal won’t be possible under all conditions.

So, be aware.  Though there are laws and courts, you are your own first and best defender when it comes to any investments.