From a personal perspective, it’s important to have liquid assets in your portfolio to pay off debts you incur, handle emergencies and generally give yourself a financial cushion if things go wrong. From a corporate perspective, the same is true on a larger scale.
On the other hand, it’s also vital for businesses and individuals that liquid assets aren’t the only thing in play. When investing for the long term, attempting to maximize your savings and earnings, you’ll quickly see that the closer something is to legal tender, the less potential it has to rise in value over time. The lower the risk, the lower the potential gain.
Why are liquid assets useful?
Liquid assets are more accessible in an emergency. They allow individuals and businesses to meet their financial obligations as they arise.
For example, if all your wealth were tied up in antiquities and collectibles, you might amass quite a fortune for yourself. But in the short term, you could be left unable to handle an unexpected expenditure. You don’t always have six months to find the right buyer in a niche market. Sometimes, you need quick, easy access to your cash.
How does a liquid asset work?
Liquid assets exist in a fluid, moving market. Selling them off in exchange for legal tender doesn’t present a challenge or come with exorbitant fees and complex stipulations, unlike selling off a more illiquid alternative might.
The first and most apparent liquid asset is cash itself. It’s already liquid and available for instant use. The next most liquid asset is any money you have stored in an accessible bank account, which can be instantly used or withdrawn.
Limited-access bank accounts become less liquid, as you’ll often be charged for withdrawals outside a specific time frame or beyond a certain number.
After this point, we come to the “non-cash liquid assets,” generally inclusive of anything that could be liquidated in 90 days or less. Usually, these assets are lower-risk, more popular investments.
Examples of liquid assets
So, what are examples of liquid assets beyond cash and cash equivalents? Let’s outline some of the most liquid asset classes, easy to exchange for cash if necessary:
- Certificates of deposit (CDs) – CDs are accessible if necessary, making them somewhat liquid—but their attractive annual yield comes with strict withdrawal rules. Unless you have a no-penalty CD, you’ll face a fee for accessing this money early.
- Marketable securities
- Precious metals – some US states accept gold and silver coins as currency, putting them even with cash in terms of liquidity. Other precious metals can be sold to dealers. Overall, the liquidity of metals depends on where you’re located.
- Treasury bills and bonds – Treasury bills and treasury bonds are very liquid investments supported by the US government’s credit. You can instantly sell them on the secondary trading market, even if they’ve not matured.
What’s the difference between a liquid asset and an illiquid asset?
So, what are illiquid assets? Having seen some examples of liquid assets, you might wonder what doesn’t fall into this category – particularly what would sit at the other end of the asset spectrum in the “illiquid” category. Illiquid assets, currently rising in popularity thanks to their financial potential, come in all shapes and sizes. Generally preferred by seasoned investors with impressive, diverse portfolios, illiquid assets include:
- Any intangible assets – ideas and thoughts, even those that most people feel have colossal value, are illiquid. They can be tough to turn into cash. After all, how do you assign an accurate dollar amount to something you can’t truly perceive?
- Collectibles (antiques, cars, paintings, etc.) – from Art Deco jewelry to classic cars, these are incredibly valuable but usually have a niche audience. This means they’re fairly illiquid, as the liquidation process will take significant effort and time.
- Estates – all assets in a person’s estate are illiquid, as they must first be subject to the various federal and state rules of inheritance and taxation. It can be several years before you see any benefit from gaining possession of an estate.
- Private equity – venture capital funds and other private equity investments can earn you a lot of money, but they’re illiquid. Stipulations around when these funds can and can’t be sold are usually very restrictive.
- Real estate – if you’ve ever bought or sold a property, you’ll know it can take months, sometimes even years, to seal the deal. Real estate is considered illiquid because although it’s a reasonably stable asset class, it can’t quickly convert to cash.
- Stock options from your employer – some companies give employees stock options. Usually, these are contingent on an employee staying at the company for some time, meaning they’ll remain illiquid and impossible to cash out until then.
How do I diversify my assets?
Hopefully, you now see the idea of liquidity more clearly. If you can easily and speedily turn your asset into cash, it’s liquid. If you won’t be able to turn your asset into cash for a while without facing a penalty, it’s illiquid. If it’s possible to liquidate but not necessarily easy, it’s somewhere between the two.
A diverse portfolio is a must-have for any savvy investor, and that portfolio should always include assets up and down the scale of liquidity. Assets that will be available in an emergency and assets that are higher risk but could provide a significant return on your investment.
For support in building a robust portfolio incorporating liquid and illiquid assets, reach out to an advisor through Unbiased today.