One of the first questions that new investors have when researching investment strategies is “why is liquidity important in investing?” This is quite common, and since finance can seem very nebulous or complex from the outside looking in, finding answers can sometimes seem like a daunting task. We’re going to look at just what liquidity means, and why it should be an important factor in your investment strategy.
What Is Liquidity?
In the simplest terms, liquidity simply means how easily a particular asset can be converted into cash, without significant market price movement. Liquidity is a spectrum, as all investments are liquid to some extent, with some being much more liquid than others.
Fiat currency is the most liquid asset, being readily able to exchange for goods and services, especially when speaking of primary global currencies that include the euro, the UK pound, and of course the US dollar. On the other end of the spectrum are investments like real estate. Real estate takes considerable time to exchange for cash, sometimes a month or more to complete the closing process.
Why Is Liquidity Important In Investing?
Liquidity is important in investing to be able to access the wealth that you build. If your assets are all tied up in long-term investments or highly illiquid investments, you may find yourself cash-poor. This can significantly reduce your ability to direct funds into an investment opportunity that comes your way. Your investment strategy should include maintaining a certain level of liquidity.
How Much Liquidity Should I Have?
The level of liquidity you should maintain is going to depend highly on your lifestyle, monthly expenses, and more. You should have a budget or at least a well-informed estimate of your monthly expenses, which will include housing, food, gas & other travel costs, and discretionary spending. Your liquidity will be your safety net in many ways, so you should plan to have anywhere between 3 months and 1 year’s worth of these expenses in relatively accessible liquid assets.
Examples Of The Most & Least Liquid Assets
Cash is the single most liquid asset one can have, with nothing else matching the ability of cash to be readily usable. Just behind cash, and with slightly less liquidity are things like stocks and bonds. While these are considered non-cash assets, they can be converted to or exchanged for cash on a relatively rapid basis, with most of the liquidity depending on the market trade volume. Stocks and bonds can often be converted to cash in just a few business days, provided there is market demand.
Some of the least liquid assets are things like real estate, large or specialized equipment, collectibles of nearly any type, and subsidiary businesses. Real estate often has relatively long periods where the market simply isn’t conducive to selling, and the sale transaction is generally fairly complex. Specialty equipment, such as construction or manufacturing equipment is also highly illiquid since it requires a particular buyer and there is low market demand for such.
Collectibles of just about any type are also highly illiquid since they require a very specific market and buyer, and they are also generally niche interest items. Collectibles would include things like rare stamps, coins, artwork, pop culture collectibles, and more. One of the least liquid assets, but also often one of the most valuable, are subsidiary businesses, or businesses that another business or company owns. They are not only incredibly valuable and require large amounts of capital to buy, but the process for selling or buying them is highly complex and regulated.
Liquidity Is Important In Investing & Prevail Can Help You Strategize
If you’re beginning to plan your investment portfolio, or if you already have one and need a hand refining it and diversifying further, reach out to our team to talk with an advisor about your plans. We can help you create a viable strategy for investing in ways that can help realize greater returns with higher general liquidity.