This article discusses liquid assets, their types, and the difference between liquid and non-liquid assets. It will also look at the advantages of liquid assets and how purchasing them can add value to your investment portfolio.
Cash is king. You’ve probably heard this many times as an investor or an entrepreneur. To a large extent, the saying is factual. A business may make billions in profits but struggle if all the revenue is tied up and can’t be converted into cash. Alternatively, an individual may have a vast investment portfolio with all sorts of assets, but if none can be liquidated in a sticky situation or financial crisis, the assets essentially become worthless.
Because here’s the truth – mainly, in a monetary crisis or war, only cash can help you stay afloat.
So, no matter how diverse your portfolio is and how much you love your hard assets, you must keep some liquid assets aside as insurance to keep you going in an emergency.
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What are Liquid Assets?
Liquid assets are assets that can be easily converted to cash or cash equivalents in a short amount of time.
Liquid assets can be sold at or near their market value. Both individual and corporate investors and companies use liquid assets to preserve their net worth, stay afloat, protect their other assets, or as an emergency fund.
Liquid assets are integral to investment portfolios since they can be easily sold without incurring any significant financial loss. Moreover, their importance often increases in turbulent social or political conditions.
What is Liquidity?
Liquidity refers to the ease with which an individual/corporate investor or company can convert an asset into cash without causing a drastic change in the asset’s market value or price.
Essentially, it is a trade-off between an asset’s selling price and how quickly it can be sold.
Understanding Liquid Assets
Not all liquid assets share the same degree of liquidity. Naturally, the most liquid asset is cash on hand because you can readily use it without going through any transaction or conversion.
Some factors that determine the liquidity of assets are mentioned below:
- How long it takes for the assets to be liquidated (converted into cash): Most liquid assets are the ones that take little to no time to convert into cash.
- How established is the liquid market: A liquid market has readily available buyers and sellers and low transaction costs.
- How easy is it to transfer ownership: The easier it is to transfer ownership of an asset, the quicker you’ll receive your cash.
Examples of Liquid Assets
The following are the most common liquid assets that you may hold or invest in.
Cash on Hand
Cash on hand is the most common example of a liquid asset, as you can use it readily. Moreover, you don’t have to go through any exchange or transaction to retrieve or utilize it.
Checking Account or Savings Account
Checking or savings accounts are also very common examples of liquid assets. However, their values may go up or down with each transaction (debit or credit).
Cash equivalents are the next best thing to cash on hand in terms of liquidity. They refer to items such as bank accounts, treasury notes, etc., that can be readily used to pay off bills or debts in the short term. They also involve much less risk.
Here are some examples of cash equivalents:
- Treasury Bills: Treasury bills, notes, and bonds are considered liquid, and their investment cycle (maturity dates) ranges from several days to 52 weeks. Treasury bills are interest-free short-term government securities issued at a discount to the redemption price.
- Certificates of Deposit (CDs): Banks issue Liquid certificates of deposit (CDs) to depositors for a particular length of time. Unlike traditional CDs, liquid CD holders can withdraw without a financial penalty. However, CDs aren’t considered good investment options owing to lower yields, less liquidity, and higher investment minimums.
Your emergency fund could be any asset you can easily access during an emergency. Usually, it’s a stash of cash that people keep close by to use in times of financial distress or a country-wide crisis. Emergency funds save you from having to draw from high-interest debt options like credit cards – some of which may not even be accessible in certain turbulent times.
Money Market Accounts
Banks and credit unions offer money market accounts. They typically pay higher interest rates than other savings accounts. However, these account transactions can be limited and may incur additional fees.
Money market funds are fairly easy to buy and sell in the open market due to higher activity volumes and demand.
Many investment accounts are considered liquid owing to ease of withdrawal and the absence of hefty penalties. Some retirement accounts can also be considered liquid assets.
A mutual fund is a professionally managed investment company that pools money from many investors and invests it into securities such as stocks, bonds, and short-term debt. Investors can buy shares in mutual funds, which they may sell off at any time during the trading day.
Mutual funds are considered liquid because investors can expect to collect the proceeds from the sale of shares by the end of the following business day.
A stock, also known as equity, is a financial security representing fractional ownership of the issuing corporation. The units of stock are called shares. Equity holders or shareholders participate in the corporation’s profits by selling their shares for a gain or by collecting dividends. The stock market routinely sees the selling ad buying of shares, making stocks highly liquid.
A bond is a fixed-income instrument representing a loan made by an investor to a borrower. Bonds are usually used by public or private companies and state and federal governments to aid the development of projects and operations. Bonds are considered liquid. However, they’re harder to sell than stocks.
Exchange Traded Funds (ETFs)
ETFs are investment funds that trade like stocks on public exchanges, making them fairly liquid. ETFs are less riskier than stocks, but you may incur a loss if you want to liquidate them quickly.
Liquid Assets vs. Non-Liquid Assets
We’ve already talked about liquid assets and their examples. Let’s discuss what non-liquid assets are.
Non-liquid assets, also known as fixed or illiquid assets, are quite hard to sell. The following are some reasons why non-liquid assets are hard to sell (or liquidate):
- Difficulty finding willing buyers
- Hefty fiscal penalties
- Difficulty in determining the asset’s accurate market value
- Lengthy negotiations between the buying and selling parties
- For some assets or investments, appraisers may be required
Some common examples of non-liquid assets are mentioned below:
- Real estate
- Collectible art
- Vehicles like vintage cars
- Rare collectibles
Types of Liquid Assets
So far, we’ve discussed liquid and non-liquid assets and their examples. Now, let’s discuss the types of liquid assets.
There are two types of liquid assets – personal liquid assets and business liquid assets. Let’s briefly discuss them below.
Personal Liquid Assets
In personal finance, liquid assets are assets or investments that an individual can readily convert to cash at or near their market value.
An individual can use the resultant cash to pay off bills or debts. They can also use it in times of political instability or monetary crisis. Cash on hand is one of the best items to hold during a banking crisis.
Regarding investments, stocks or mutual funds are excellent liquid assets as they can be bought or sold throughout the trading day.
Business Liquid Assets
In business finance, liquid assets are corporate assets that can be converted into cash quickly. Business liquid assets are documented on the company’s balance sheet. A business’s liquidity refers to its ability to pay off its short-term liabilities.
Investors and financial institutions like banks evaluate a company’s liquidity profile to assess its fiscal health.
They invest or extend credit to the company if they feel like it can satisfy its payment obligations in less than a year by selling its liquid assets to pay for liabilities.
Importance of Liquid Assets
Now that you know all the basic terms, let’s discuss the importance of liquid assets. The 2008 financial crisis and the pandemic highlighted the importance of liquid assets.
- Portfolio Diversification: Owning liquid assets can come in handy irrespective of the nature of your portfolio. Adding some liquid assets into the mix can significantly diversify your portfolio, even if you’re in a business that deals primarily with hard assets. Investing in liquid assets also improves your portfolio’s liquidity profile.
- The Perfect Insurance: The most significant purpose of a liquid asset is to provide you with cash when needed. People and companies often need immediate cash in emergencies. An emergency could be a threat of bankruptcy, a natural disaster, or a financial crisis. Whatever it is, cash on hand can always solve many problems for individuals and companies.
- Instrumental In Gaining Credit or Investments: Are you in a business that requires funding or external investments? If so, having a healthy mix of liquid assets in your profile may improve your company’s liquidity profile and help you gain better investments or loans with better terms and interest rates. The same principle applies to any person looking to secure a home or property loan. Moreover, some properties require ample cash down payments.
Go Where You’re Treated Best
No matter how much you prefer an asset class, having a diversified investment portfolio is always a good idea to decrease your risk profile. Learn about different asset classes and figure out how each can help you and in what way.
At Nomad Capitalist, we take diversification very seriously. Getting a second passport is the best way to immune yourself and your finances to the ever-changing regulations and economic situation. If the idea of second citizenship overwhelms you, you can always start with establishing a second residency and see how it goes.
We’ve helped many seven and eight-figure investors and entrepreneurs diversify their investment and passport portfolio. Their only regret was not doing it earlier. So don’t make the same mistake and get in touch with us today. We guarantee it’ll be the best investment of your life.
What are Liquid Assets and How Can They Improve Your Portfolio FAQ
Your liquid net worth refers to the amount of money you have in cash or cash equivalents after deducting your total liabilities from your liquid assets.
Gold and silver coins were used as currency and, in theory, are highly liquid. However, precious metals are less liquid than cash or cash equivalents as they must be removed from storage and exchanged for money through a dealer. In this case choosing the right dealer, who can also help broker your precious metal sales quickly, can make all the difference.