Summary:
A liquid investment is any asset that can easily be converted to cash without losing value. Liquidity varies by asset type, and liquid assets, like cash and checking accounts, provide flexibility and less risk in your portfolio.
Main Points:
- Liquid investments are easily convertible to cash.
- Common liquid assets include cash, checking accounts, and money market accounts.
- Illiquid assets, like real estate, take more time and effort to sell.
- Balancing liquid and illiquid assets helps manage risk.
The basic definition of a liquid investment is straightforward. What does liquid investment mean? This term refers to any investment that is either cash or can quickly be converted to cash.
Physical dollars and cents are the most liquid investment. They’re already currency, so they don’t require any additional work to turn them into cash.
However, every investment has varying degrees of liquidity. The general principle is that the faster the investment can be converted into cash, the more liquid it is.
How Are Liquid Assets or Investments Different Compared to Other Assets?
Virtually every asset has some degree of liquidity. However, some assets specifically earn the name liquid assets. These assets essentially operate as cash.
Liquid assets do not lose any value when they are sold, and there is a readily available market to sell them. They often have a very short-term maturity (generally less than 90 days), so you can convert them into cash at almost any time.
Illiquid assets, like hard property (vehicles, jewelry, etc.), are hard to sell. They often lose some, most, or, in certain cases, all of their value from the date you acquired them compared to the date you are ready to sell them. That’s true even when the wear and tear on the property is minimal.
Keep in mind that real estate, which tends to increase in value over time as compared to the other hard property examples above, is still an illiquid asset. The foundational definition of a liquid asset rests on its ability to be easily converted into cash. While real estate can be a good investment, it’s not a liquid investment, as Quicken Loans explains in more detail.
Types of Liquid Assets
Because every asset has some degree of liquidity, defining liquidity can be a bit tricky. For that reason, liquid assets are sometimes also referred to as “cash equivalents.”
It’s better to think of liquidity as a spectrum that various types of assets sit on than as two categories — liquid and illiquid — where all assets fall into either one or the other.
Examples of liquid investments are set out below, generally in order of liquidity.
Cash
Cash is the ultimate liquid investment. When you transfer money, it will never lose its value simply because of the transaction. Having a large amount of cash on hand poses some important questions, but you never have to wonder if cash is a liquid investment.
Think of it this way: Cash is the measure by which all other investments are compared.
Checking Account
Although it is easy to assume that a checking account is just an account with your cash sitting there, that is not the case. Instead, a bank or other financial institution uses your money to make investments, pay out other clients, and make loans.
However, whenever you want money from your checking account, you can generally get it, and the value of those dollars will not change. Additionally, some checking accounts generate interest for the account holder based on the funds deposited. The checking account itself is considered the asset, even though cash is inside of it.
High-Interest Savings Accounts
A high-interest savings account operates a lot like a checking account. However, these accounts might have some restrictions on how often you can remove funds or how much you can remove to continue to receive the high-interest benefits. For this reason, high-interest savings accounts are generally considered less liquid compared to a checking account.
Money Market Accounts
A money market account functions very similarly to a high-interest savings account. However, there are some important differences between these two assets.
First, a money market account is likely to have a higher interest rate compared to even a high-interest savings account. Money market accounts also often have ATM access or check-writing abilities, unlike a savings account. These accounts also often have minimum account balance requirements.
As a result, they are often considered just as liquid or perhaps slightly more liquid compared to a high-interest savings account.
Certificates of Deposit (CD)
A CD is an investment product offered by banks and other financial institutions. It provides a specific (usually higher) interest rate for a certain amount of money. In exchange for this benefit, you have to agree to leave the money with the bank for a certain amount of time.
The longer the wait is to get your money back, the higher the interest rate is likely to be. When the CD fully matures, you get your investment back along with the promised interest rate payment. If you want your money before the CD matures, the bank will penalize you by taking back some of the interest earned.
Bonds
A bond is another investment tool that a corporation or the government usually uses. You provide money to the corporation or government. Then, that entity pays back your investment plus a certain amount of interest (called the bond rate) once the bond has matured.
The most common example of a bond is a U.S. savings bond. The federal government issues bonds as a way to generate income. State and local governments often use the same type of system as well.
Bonds are still considered liquid assets, even though they require waiting for maturity for a direct payout of principal and interest. As FINRA explains, the bond market doesn’t always offer instant and perfect liquidity. However, in many cases, it is relatively simple to sell bonds issued by a reliable government or organization.
Mutual Funds or ETFs
A mutual fund is a pool of money used to invest in various securities, including stocks, bonds, money market accounts, and other assets. A money manager generally operates it.
Mutual funds are priced once a day after the market closes. While it’s generally easy to sell shares of a mutual fund, your trade will take one day to settle.
An ETF is similar, but it has some key differences. ETF stands for “exchange-traded fund.” These funds often require lower initial investments, and they have real-time pricing every time you sell.
Both assets are considered liquid because most ETF’s and mutual funds have a readily available market for them. However, their value will fluctuate based on the value of the market, so you might not always get as much out as you put in.
Stocks
A stock represents partial ownership in a company. They are traded on various public exchanges.
Publicly held stocks are much more liquid than ownership or stock in a privately held company. They are generally very easy to sell through established markets. While they don’t have a fixed value, they don’t lose value through the acts of purchasing or maintaining ownership.
In contrast, a stock in a private company is one of the least liquid types of securities you can hold in many cases. These assets can be very valuable, but they are not nearly as easy to convert into cash as publicly held stocks.
Prepaid Expenses
You may not think of prepaid expenses as an asset — but they certainly are. However, converting them to cash is difficult. Nonetheless, they are considered current assets on a balance sheet because expenses have already been paid.
Retirement Investment Accounts
Retirement investment accounts can be considered liquid assets, but the ability to convert these assets into cash can be subject to taxes or penalties in some situations.
As a result, while this investment can be considered liquid, it is farther down the spectrum than some of the previous options we discussed.
The Best Liquid Assets for Investments
Cash is obviously the most liquid asset available. However, having cash stashed under your mattress is certainly not a great idea if you want any kind of return on your money. If you are interested in a liquid asset that gives you some interest or other return, you have a few options.
If access is more important than the return, consider a simple savings account or money market account.
If the return is more important than access, Consider a CD, bond, or investment in a mutual fund or ETF.
What Are the Most Liquid Investments?
In general, the most liquid investments include:
- Cash
- Checking accounts
- High-yield savings accounts
- Money market Accounts
Remember, any asset that can be converted into cash with very little effort is liquid.
What is a Liquid Investment Portfolio?
In the simplest terms, a liquid investment portfolio is a group of liquid investments owned by a person, couple, or organization. Most investors and people in general own some assets that qualify as liquid. For example, if you have a checking account and some stocks, you have a liquid investment portfolio.
The value of holding liquid assets in an investment portfolio comes from their ability to be easily exchanged for or converted into cash. If you need money for a large and unavoidable expense or want to end ownership of an asset because you believe it will soon lose value (as can be the case with stocks), liquid assets make it easy to access cash.
Examples of Non-Liquid Assets
A non-liquid asset is any asset that has value but cannot easily be converted into cash. It will often, although certainly not always, lose some of its value when you attempt to resell it or transfer it.
Examples of non-liquid assets include:
- Real estate
- Jewelry
- Cars
- Collectibles
- Furniture and furnishings
Non-liquid assets sometimes have to be valued by a third party because of disagreements between parties about the true value of the asset. Some can hold strong value and even increase in value, although can be more of an exception than a rule. The key fact to remember is that non-liquid assets require much more time and effort to convert into cash than liquid assets.
Why Liquidity Matters – Should I Have Liquid Assets?
The next question to ask after “What is a liquid investment?” is “Should I have liquid investments?”
The more liquid an asset is, the less risk is associated with holding that asset. Having cash in your pocket, for example, is obviously less risky than putting money in the stock market. There is virtually no chance that you will lose the cash in your pocket, but the market can go down, causing you to lose the value of your investment.
Having the right balance of liquid assets compared to less liquid assets hedges your overall risk in your investment portfolio. Whether you should have liquid assets will depend entirely on your risk tolerance and overall investing goals.
Talk to Dechtman Wealth Management to get more information about liquid asset options and whether liquid assets are a good idea for your investment and savings goals.
