One of the core terms you may come across when you start investing is liquidity. When you evaluate investments and consider the financial situation, liquidity can become one of the most significant factors. This article will provide information on liquidity and its importance to a financial investor.
What Is Financial Liquidity?
In its most simplistic form, liquidity is the ability a person has to convert assets into cash. It also refers to the ability to purchase or sell security without influencing the asset’s price. When speaking about investments, liquidity typically involves how simple it is to buy and sell.
Cash is considered one of the most liquid of all assets as you can use it to buy almost anything. The majority of stocks traded on exchanges are considered liquid because they can be converted to cash easily. Moreover, there always seems to be another investor willing to purchase the shares.
Other types of assets may not be as easy to convert to cash as stocks. For instance, if you have your net worth placed in your house, it may not be simple to access that value – particularly if you do not have a large amount of equity. Additional investment assets that are considered illiquid can include debt instruments and private company shares. It is near impossible to sell these assets without losing large amounts of money.
What Is The Significance Of Liquidity?
While it can be useful to hold some illiquid assets, it is important to have assets that can be sold quickly if there is an emergency. Illiquid assets can be beneficial when dealing with long-term investments, but this is only in the situation where you feel you do not need to sell them. You might be able to hold onto the assets as they appreciate in value and wait for someone to purchase them, but they will not be available to sell quickly.
Conversely, liquid assets can be accessed quickly and easily. If you take the case of a certificate of deposit, with this certificate your money will be inaccessible for long periods. In fact, you will not be able to access the cash without incurring some large penalties. When looking at asset allocation, it is important that you consider how you will access the wealth if necessary. If you have liquid assets, it is vital that you are able to access them quickly and easily.
For instance, while I have a large portion of my emergency fund held up in a high-yield savings account, the cash can be accessed quickly. The money placed in ETFs takes only a few days to reach a bank account when selling something for emergency reasons. However, the liquid assets available can typically cover any gaps in time.
When putting together an investment portfolio, it is also important to consider one’s degree of liquidity. Do not forget about the element of liquidity in other areas of your financial life. You may be tempted to purchase shares in a private company. However, if the time comes to sell these shares, the company will present different rules and you could find yourself selling something no person wants.
Final Words On The Matter
Investing is an interesting area of the financial sphere, so it is important to take care when navigating these waters. The first thing to do is consider your long and short-term financial goals, the look at your financial situation. We don’t like to think about emergency situations, but it is vital that you take into account what would happen from a financial perspective if there is an emergency. Would you have access to your assets during this period and can you access other liquid assets if needs be? Plan the investments carefully and you won’t have any financial issues to worry about.