2851: Why You Don’t Know the Price Until You Sell by Nick Maggiulli of Of Dollars and Data on Liquidity

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[00:01:06] [SPEAKER_00]: This is Optimal Finance Daily, Why You Don't Know The Price Until You Sell

[00:01:11] [SPEAKER_00]: by Nick Medjuli of of dollarsanddata.com.

[00:01:16] [SPEAKER_00]: And I'm your host and personal finance enthusiast, Dianna Merriam.

[00:01:20] [SPEAKER_00]: I'm going to jump right into today's post as we optimize your life.

[00:01:28] [SPEAKER_00]: Why You Don't Know The Price Until You Sell by Nick Medjuli of of dollarsanddata.com.

[00:01:36] [SPEAKER_00]: It was 1935, and the Austrian physicist Erwin Schrödinger had a problem with Albert Einstein.

[00:01:45] [SPEAKER_00]: Einstein had just released a paper with two fellow scientists that discussed the concept

[00:01:50] [SPEAKER_00]: of superposition, an idea that seemed somewhat absurd to Schrödinger.

[00:01:56] [SPEAKER_00]: Superposition implied that an atom, or any quantum system, was simultaneously in multiple

[00:02:03] [SPEAKER_00]: states until the point of observation. Once the system was observed, its true state would be

[00:02:10] [SPEAKER_00]: revealed to the observer. This implied that the act of observation changed how the universe

[00:02:17] [SPEAKER_00]: behaved. In order to convey his skeptical view on the matter, Schrödinger devised a thought

[00:02:24] [SPEAKER_00]: experiment. Quote,

[00:02:26] [SPEAKER_00]: One can even set up quite ridiculous cases. A cat is penned up in a steel chamber with a

[00:02:33] [SPEAKER_00]: Geiger counter and a tiny bit of radioactive substance, so small that perhaps, in the course

[00:02:41] [SPEAKER_00]: of the hour, one of the atoms decays. But also, with equal probability, perhaps none of it decays.

[00:02:49] [SPEAKER_00]: If it decays, the counter tube discharges and releases a hammer that shatters a small

[00:02:56] [SPEAKER_00]: flask of hydrocyanic acid. If one has left this entire system to itself for an hour,

[00:03:03] [SPEAKER_00]: the cat still lives if no atom has decayed. However, the first atomic decay would have

[00:03:09] [SPEAKER_00]: poisoned it. The entire system would express this by having in it both the living and dead cat.

[00:03:17] [SPEAKER_00]: End quote. Schrödinger argued that since the atom's state of decay is unknown,

[00:03:23] [SPEAKER_00]: the cat's state of being alive or dead is also unknown. Only once you've opened

[00:03:29] [SPEAKER_00]: the steel chamber could you determine whether the cat was living or deceased.

[00:03:34] [SPEAKER_00]: You've probably heard of Schrödinger's cat as a thought experiment, but you may not have realized

[00:03:40] [SPEAKER_00]: how useful it is for thinking about asset prices. Most of the time when we want to know

[00:03:45] [SPEAKER_00]: the price of something, we can use the market or comparable assets. When you go to buy and sell

[00:03:51] [SPEAKER_00]: an S&P 500 ETF, the price is known and displayed for you. When you go to sell your home,

[00:03:58] [SPEAKER_00]: a proper appraisal and similar homes can be used to determine the approximate selling price.

[00:04:05] [SPEAKER_00]: This is likely to be true 95% of the time or more. However, when markets become abnormal,

[00:04:12] [SPEAKER_00]: pricing an asset is no longer straightforward. Instability emerges and you quickly realize that

[00:04:19] [SPEAKER_00]: you won't know the price of your asset until you go to sell it. Just like Schrödinger's cat,

[00:04:24] [SPEAKER_00]: we don't know what the state of something is until we observe it. It's in the act of selling

[00:04:31] [SPEAKER_00]: that we have opened the steel chamber to see an asset's true price.

[00:04:36] [SPEAKER_00]: I know you might think of this as a grand leap of faith, but it's not.

[00:04:41] [SPEAKER_00]: History is riddled with examples of individuals thinking they knew the prices of their assets,

[00:04:46] [SPEAKER_00]: only to get a rude awakening when they tried to sell. The Nobel laureates behind long-term

[00:04:52] [SPEAKER_00]: management learned this the hard way when their bets on bond spreads turned against them in 1998.

[00:05:00] [SPEAKER_00]: As Roger Loewenstein writes in When Genius Failed,

[00:05:06] [SPEAKER_00]: Disturbingly, the traders said there was no demand for long-term trades,

[00:05:11] [SPEAKER_00]: despite their seeming soundness. The Tokyo Partners reported a similar story.

[00:05:16] [SPEAKER_00]: There simply weren't any buyers.

[00:05:21] [SPEAKER_00]: LTCM had assumed far more liquidity and ease of exit from their positions than what they

[00:05:27] [SPEAKER_00]: eventually realized during the 1998 crisis. They had no idea the buyers would disappear

[00:05:34] [SPEAKER_00]: and the stable prices would go with them. As you know, if there are no buyers and you need

[00:05:40] [SPEAKER_00]: to sell, you have only one option – lower your price. You might think that this situation

[00:05:45] [SPEAKER_00]: never applies to you. You aren't trading foreign liquid securities, right?

[00:05:51] [SPEAKER_00]: But what about something closer to home, literally? If you're a homeowner and you think you'll

[00:05:56] [SPEAKER_00]: always be able to sell your home at a reasonable price, I would advise caution.

[00:06:00] [SPEAKER_00]: The Vanderbilts discovered this bitter truth after spending $11 million dollars in 1892

[00:06:07] [SPEAKER_00]: to build the famed Marble House, only to sell during the depths of the Great Depression

[00:06:13] [SPEAKER_00]: for $100,000. That's a 99% haircut on one of the most beautiful homes ever built.

[00:06:21] [SPEAKER_00]: I understand that the Great Depression was unlike any other time in American financial

[00:06:25] [SPEAKER_00]: history, but that doesn't mean that your home is exempt from price discounts during

[00:06:30] [SPEAKER_00]: financial calamity. And it's during such financial calamity when the harshest truth

[00:06:36] [SPEAKER_00]: about asset pricing becomes apparent. Those times when you are most desperate to sell

[00:06:41] [SPEAKER_00]: are the same times when prices are most likely to be in flux. When you're the neediest for cash

[00:06:48] [SPEAKER_00]: is also when it's the most difficult to sell an asset at a fair price.

[00:06:54] [SPEAKER_00]: Consider the unfortunate experience of Jews trying to emigrate out of Europe during the

[00:06:59] [SPEAKER_00]: start of World War II, from Wealth, War and Wisdom. These middle-class Jews had less to

[00:07:08] [SPEAKER_00]: than the wealth, and often they were more amenable to emigrating. Many of them faced

[00:07:13] [SPEAKER_00]: with this cruel dilemma of the persecuted minority opted to sell and get out. Of course,

[00:07:20] [SPEAKER_00]: when they went to sell their businesses and homes, they found it was a buyer's market,

[00:07:24] [SPEAKER_00]: and the proceeds they received were half of what the true value was.

[00:07:28] [SPEAKER_00]: Nevertheless, they took what they could get and fled Germany as virtually penniless refugees,

[00:07:34] [SPEAKER_00]: but still having one priceless possession, their brains.

[00:07:40] [SPEAKER_00]: While I hope you never have to experience anything so drastic, the cruel world of price

[00:07:46] [SPEAKER_00]: discovery can befall anyone. I experienced this when I tried to sell a thousand-dollar guitar

[00:07:52] [SPEAKER_00]: amp before moving to New York City. I thought conservatively I'd be able to get $500,

[00:07:59] [SPEAKER_00]: half the price of a brand new amp. But when I went to sell it, I found few buyers.

[00:08:03] [SPEAKER_00]: In the end, I got $240 and went on my way. It can happen to anyone.

[00:08:10] [SPEAKER_00]: Fighting Against Schrodinger's Price

[00:08:13] [SPEAKER_00]: The best way to prevent yourself from selling at a loss is simple. Have ample liquidity.

[00:08:20] [SPEAKER_00]: If you have large enough cash reserves, that is emergency savings, to support your

[00:08:25] [SPEAKER_00]: liabilities during economic crises, you will never be forced to sell. In fact,

[00:08:31] [SPEAKER_00]: if you have enough cash on hand, you'll be able to dictate the prices you can buy assets for.

[00:08:37] [SPEAKER_00]: But how much emergency savings is enough? I've heard amounts that range from six months to two

[00:08:43] [SPEAKER_00]: years' worth of expenses. I maintain a little over six months' worth, but I'm young and I have

[00:08:49] [SPEAKER_00]: few liabilities. That's mostly rent and food. I don't know what's right for you, but I always

[00:08:56] [SPEAKER_00]: like to remind myself that cash during a panic is like having water in the desert.

[00:09:01] [SPEAKER_00]: More won't necessarily hurt you, but it can go a long way towards your peace of mind.

[00:09:10] [SPEAKER_00]: You just listened to the post titled Why You Don't Know The Price Until You Sell

[00:09:15] [SPEAKER_00]: by Nick Medjuli of ofdollarsanddata.com, and I'll be right back with my commentary.

[00:09:21] [SPEAKER_00]: Buy low, sell high. Buy low, sell high. It's a simple concept, but not necessarily an easy

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[00:10:21] [SPEAKER_00]: advertisement this article has me thinking about liquidity which from my perspective is an

[00:10:28] [SPEAKER_00]: important aspect of overall financial security when i look at my net worth i see it as

[00:10:35] [SPEAKER_00]: different piles of money having different jobs my investments have the job of growth i want

[00:10:42] [SPEAKER_00]: money working to make more money but my cash has the job of liquidity i want that money to be very

[00:10:49] [SPEAKER_00]: easily accessible some of that cash is just sitting there for unexpected emergencies some

[00:10:56] [SPEAKER_00]: of it is waiting for my 40 year old furnace to croak and some of it is waiting for a good

[00:11:02] [SPEAKER_00]: opportunity for an investment or a life experience to present itself i know many people who want

[00:11:09] [SPEAKER_00]: all their money invested as they feel it's a waste to let cash sit around when it could be

[00:11:14] [SPEAKER_00]: working but i see my cash as an important part of my overall strategy having cash on hand makes

[00:11:22] [SPEAKER_00]: it very unlikely that i will ever have to sell investments at a loss it means that i can be

[00:11:27] [SPEAKER_00]: more aggressive about investments and have 100 stock asset allocation which also means that i

[00:11:39] [SPEAKER_00]: allows me to set it and forget it with my investments which is well worth the peace of

[00:11:44] [SPEAKER_00]: mind for me and that's another edition of optimal finance daily thank you for listening

[00:11:50] [SPEAKER_00]: have a great rest of your day and i'll be back tomorrow as usual where your optimal life

[00:11:55] [SPEAKER_00]: awaits