Non-Marketable Security

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Last Updated:October 30, 2023

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What Is a Non-Marketable Security?

Non-marketable securities refer to assets that are extremely hard to buy or sell as they are not actively traded on a trading platform such as a public stock exchange.

Most of these securities generally form a debt or fixed-income instrument usually traded (purchased or sold) through private transactions or over-the-counter markets.

Since these securities do not have a trading platform such as a stock exchange, they are highly illiquid securities traded through private transactions. Examples of such securities include shares of private companies, ownership in limited partnerships, etc.

Moreover, the need for a trading platform makes it extremely tedious for the security holder to locate the buyer. Due to specific government rules and regulations, several of these securities cannot be resold in the market.

Such securities are mostly suitable for investors with a long-term investment horizon, a high guaranteed return, and investors with an excess disposable income that they do not need to use for an extended period of time, given that these securities generally have longer maturities.

Attributes of a Non-Marketable Security

The characteristics are explained as follows:

1. Highly Illiquid Asset

Liquidity is considered an essential feature that defines any financial instrument, such as shares, bonds, real estate investments, etc.

However, since there is no regulated market, such as a stock exchange, to facilitate the purchase and sale of non-marketable securities, such securities are highly illiquid, and it is tough to convert them into cash.

Due to the lack of liquidity, such instruments are often not sold to another buyer and are held by one investor until maturity. Moreover, the maturity period of these assets is ambiguous and is generally considered to have longer maturity durations, typically three to ten years.

2. Low Transferability of Assets

Since these securities are not traded in the open market, it is tough to transfer these assets from one investor to another. As a result, only one investor often holds them until it reaches maturity.

Illiquidity and non-transferability are two characteristics of these securities that have a direct positive relationship. For example, a US Savings Bond, a type of non-marketable security, is not allowed to be resold and is to be held until maturity.

3. High Rate of Return

Due to the lack of transferability and liquidity, these assets are generally favored by investors due to the high rate of return that they tend to offer.

Since longer maturity durations and government backing generally characterize these securities, they are believed to have low risk. Therefore, the investor would always recover the principal amount and earn interest based on the market rate.

Moreover, the return on these securities is also believed to be higher than the return earned on marketable securities.

Advantages of Non-Marketable Securities

Although these securities are illiquid and are extremely difficult to transfer to another party, there are several advantages to owning such securities.

The advantages are listed as follows:

1. Lower Risk

Since these securities have longer maturity durations, the securities issued by government organizations are safer financial instruments and generally possess low default risk and price risk.

As a result, the investors stand at a lower possibility of losing their money on such investments, making these investments an attractive investment option for those who prefer lower-risk instruments in their financial portfolio.

2. Higher Yield on Investment

In most cases, such securities are issued at a discount but are redeemable at their face value.

As a result, the differential in the face value and the purchase price generates a higher return yield for the investor at a lower risk. Moreover, these investments offer higher returns due to longer maturities, lack of transferability, and inferior liquidity.

3. High-Quality Investments

Since these securities are not traded in the open market, the quality of the investments tends to increase. Non-marketable securities such as bonds are regarded as one of the safest investments. However, an individual investor can only buy a specific limit of these financial instruments.

Nevertheless, the risk associated with these instruments is generally shallow, so the return on investment is highly guaranteed to the investor.

As a result, the investors rarely lose money on their investments and will continually earn a return more than what they pay for the financial instrument.

4. Appropriate for Gifting Purposes

Although these securities cannot be easily transferred from one investor to another, these investment options can be purchased as a gift for someone else.

For example, a parent can buy a US Savings Bond for their child when they are born, and the child can access the bond when they turn 18.

Disadvantages of Non-Marketable Securities

Although these securities provide lower risk than other securities and offer high yields of return, there are several drawbacks to owning such securities. The disadvantages are:

1. Lack of Liquidity

One of the most significant limitations of investing in these securities is the lack of liquidity of these securities. Since these instruments are not openly traded, these investment options are highly illiquid.

Due to lower liquidity, these instruments can only be converted into cash easily once they reach their maturity date, making it difficult for the investor to generate additional money when needed.

2. Lower Opportunity Cost

Since the money invested by investors is tied up in instruments that cannot be sold before their maturity date, the opportunity cost of investing in non-marketable securities is extremely low.

As the investor cannot access the money for an extended period of time, other opportunities arising in the market will be lost. Although these instruments guarantee a return, the investor will not be able to make extra returns from other options.

3. Lack of Transferability

As these investments are not traded on public stock exchanges, transferring these assets from one investor to another is extremely difficult. Therefore, these assets are favored by investors with a high disposable income that will not be used until the asset reaches its maturity date.

Moreover, due to the lack of a trading platform and fewer players for these instruments, it is hard to locate buyers for these assets, making it very hard to transfer these securities from one person to another.

Types of Non-Marketable Securities

There are several types of these securities being traded on the market. The different kinds are as follows:

1. Savings Bonds

Government authorities issued savings bonds to fund the government's borrowing needs. These investment options are considered one of the safest forms of investment due to the credit backing of the government.

These bonds can only be cashed by the person whose name is written on the security documents.

2. State and Local Government Securities

These securities comprise different types of securities such as certificates of indebtedness, treasury notes, and other forms of investments that are generally issued with maturity duration of 15-40 years. The interest earned by the investors on such financial instruments is accrued daily.

3. Shares in Limited Partnership Firms

Such firms are a hybrid form between a partnership and a limited liability company. The ownership of these organizations is divided into small units, i.e., shares that private individuals own. Shares of such firms are categorized as non-marketable securities where it is tough to find a buyer for these securities for reselling.

4. Shares in Private Companies

Ownership of such privately owned companies is also divided into small units (shares) owned by private individuals other than the company owners.

These instruments are also classified in this category as these shares are not traded on public stock exchanges as it is for public limited companies.

5. Post Office and Bank Accounts

Being non-transferable and non-marketable, post offices and bank accounts are considered one of the most common forms of non-marketable securities owned by individuals.

Use of Non-Marketable Securities

These forms of securities are generally used by investors who have a long-term investment horizon, and such instruments are only used to diversify away the risk in the investment portfolio and instill stability in the portfolio.

Let us consider an investor who is aiming to save a certain amount of money to pay for his daughter's university education in the future, who is currently six years old. The investor has two options – a US Treasury Bond or a US Savings Bond.

Since the aim is to invest for the long-term and based on his needs, the correct recommendation for the investor would be to invest the funds in a US Savings Bond, which is a non-marketable security.

A US Savings Bond will be a long-term financial instrument and can be transferred to the daughter when she turns 18. Since it is backed by the credit rating of the US Federal Government, US Savings Bond will be one of the safest forms of investment.

This form of investment would be preferable over a US Treasury Bond as the investor would face the risk of price volatility (frequent price fluctuations) as these bonds are openly traded on the stock exchange.

Marketable Vs. Non-Marketable Securities

A significant difference between the two types of securities is the availability of a trading platform. The key differences between the two types of securities are listed as follows:

1. Marketable securities are openly traded in the secondary market

The secondary market refers to the public stock exchanges. On the other hand, non-marketable securities cannot be traded in the secondary market.

2. Marketable securities comprise the market value

Market value is affected by fluctuations in market factors of demand and supply and other economic factors like inflation rates, market cycles, etc., and also the intrinsic or book value of the stock.

On the other hand, non-marketable securities do not possess a market value and only reflect the intrinsic or book value of the security.

3. Marketable securities carry higher risks along with them as the prices of the securities are significantly influenced by market factors.

This means the returns of such instruments for marketable securities are highly volatile. On the other hand, non-marketable securities are low-risk instruments, as the government's creditworthiness backs instruments such as savings bonds. As a result, such securities often generate higher returns than marketable securities.

4. Marketable securities can be easily liquidated

Marketable securities can easily be converted into cash and easily transferred from one person to another due to the presence of the secondary market.

On the other hand, non-marketable securities are highly illiquid and cannot be easily transferred from one party to another due to the lack of buyers in the market.

Conclusion

Non-marketable securities, therefore, are not the most popular source of investment options among retail investors due to the lack of availability of a public market to exchange these securities.

However, these securities are popular among professional investors as they offer high liquidity and lower risk. In addition, investors use these securities to diversify their portfolio risk as these investment options tend to provide a fair return yield with low-risk attributes.

Moreover, these securities do not tend to possess market value, so they only tend to reflect the intrinsic or book value. On the other hand, marketable securities carry a fair market value as it is impacted by the different factors affecting the functioning of the market.

Although these securities do not have a regulated market for their dealings, they play an essential role in investors' investment decisions.