Introduction
Non-marketable securities play a crucial role in investment portfolios, especially for those seeking long-term asset appreciation and stability. Unlike marketable securities, these investments lack liquidity and cannot be easily traded in public markets. Understanding their nature, valuation, risks, and benefits is essential for financial planning.
Table of Contents
What Are Non-Marketable Securities?
Non-marketable securities are financial instruments that cannot be bought or sold on public exchanges due to restrictions on transferability. These securities are typically issued by the government, private companies, or financial institutions. Examples include:
- U.S. Savings Bonds
- Private Company Stocks
- Limited Partnership Interests
- Municipal Bonds with Restrictions
- Some Retirement Plan Assets
Investors hold these securities for long-term growth, income, or tax benefits.
Differences Between Marketable and Non-Marketable Securities
| Feature | Marketable Securities | Non-Marketable Securities |
|---|---|---|
| Liquidity | High | Low |
| Transferability | Freely Tradable | Restricted |
| Price Transparency | Publicly Available | Privately Negotiated |
| Market Regulation | SEC-Regulated | Limited Regulation |
| Risk Level | Varies (Generally Lower) | Generally Higher |
| Return Potential | Market-Driven | Can Be Higher but Illiquid |
Marketable securities include stocks, bonds, and mutual funds, while non-marketable securities often involve long-term commitments.
Valuation of Non-Marketable Securities
Valuing non-marketable securities is complex due to the lack of market prices. Common valuation methods include:
- Discounted Cash Flow (DCF) Method The DCF approach estimates the present value of future cash flows:
where:
- PV = Present Value
- CF_t = Cash Flow in period t
- r = Discount Rate
- t = Time Period
Comparable Company Analysis (CCA) This method compares similar private companies based on financial ratios like:
- Price-to-Earnings (P/E)
- Price-to-Book (P/B)
- Enterprise Value-to-EBITDA (EV/EBITDA)
Net Asset Value (NAV) Method The NAV method values a company based on its assets minus liabilities:
NAV = \sum (A - L)where:
- A = Total Assets
- L = Total Liabilities
These methods help investors estimate the fair value of their holdings.
Risks and Benefits of Non-Marketable Securities
Risks:
- Liquidity Risk – Selling these securities can be difficult and time-consuming.
- Valuation Uncertainty – Prices are subjective and based on assumptions.
- Regulatory Restrictions – Some securities have legal or contractual constraints on sale.
- Credit Risk – Default risk varies depending on the issuer’s creditworthiness.
Benefits:
- Higher Potential Returns – Some private investments yield higher returns than publicly traded securities.
- Tax Advantages – Certain securities provide tax deferrals or exemptions.
- Portfolio Diversification – Helps reduce overall portfolio risk by adding uncorrelated assets.
- Long-Term Stability – Government-backed securities like U.S. savings bonds offer security and predictable returns.
Examples of Non-Marketable Securities in the U.S.
Example 1: U.S. Savings Bonds
A U.S. Series I Savings Bond offers interest based on inflation. Suppose an investor purchases a $1,000 bond with an annual fixed rate of 0.5% and an inflation rate of 3%. The composite rate is:
r = 0.005 + (2 \times 0.03) + (0.005 \times 0.03) r = 0.06515 = 6.515%The bond earns $65.15 in the first year.
Example 2: Private Equity Investment
An investor buys 10% of a private company for $100,000. After five years, the company’s value grows to $2 million. The investor’s stake is now worth:
V = \frac{10}{100} \times 2,000,000 = 200,000The investment has doubled in value but remains illiquid.
How to Invest in Non-Marketable Securities
- Direct Purchase – Buy U.S. savings bonds or private company shares.
- Retirement Accounts – Invest in private equity through self-directed IRAs.
- Alternative Investment Funds – Some hedge funds invest in non-marketable securities.
- Employer Stock Plans – Employees can receive restricted stock options.
Who Should Invest in Non-Marketable Securities?
- Long-Term Investors – Those willing to hold investments for years.
- High Net Worth Individuals – Investors seeking portfolio diversification.
- Institutional Investors – Endowments and pension funds allocate funds to private markets.
- Tax-Sensitive Investors – Those benefiting from tax-advantaged accounts.
Conclusion
Non-marketable securities provide opportunities for long-term growth, diversification, and stability. However, they require careful consideration due to their illiquid nature and valuation complexities. Investors should assess their risk tolerance and investment horizon before allocating funds to these securities.
