What is Liquidity?

How Quickly Could You Come Up With Cash?

What is Liquidity?

Liquidity is cash or the ability and speed with which you can turn something into cash.

Why do you Need Liquidity?

Liquidity is an essential part of your investment strategy. While you need to have cash set aside for emergencies, should an emergency arise that exceeds the level of cash you have on hand, you need to be able to come up with cash quickly.  

If all of your investments are tied up in illiquid assets, you may not be able to pay for near-term obligations or emergencies that come up. You may be very wealthy, but if you cannot access your money when you need it most, what’s the point?

What Factors Affect Liquidity?

How easy is it for buyers and sellers to find each other? Is there a typical marketplace (such as the New York Stock Exchange) where buyers and sellers both go looking to transact? How easily can you agree on a price? 

Is there a set or typical price for an asset (i.e., stocks on the stock exchange have a market price¹)? Do you need to spend time negotiating a price, or is there readily agreed-upon value (such as a Kelly Blue Book value – i.e., a price that is easily referenced and generally accepted)? 

What effort is required to market an asset – do you need to spend time advertising and meeting with prospective buyers?

What is the cost of transacting? Are there fees associated with a transaction? Will it cost you additional money to list an item for sale or market it?

How Liquid Different Investment Classes Are

Here is a list of types of investments from most to least liquid.

Credit: A credit card gives you the ability to spend money without even needing cash. It is not technically cash, but it provides some liquidity level as a stand-in for cash. Be careful with credit – don’t spend more in credit than you can manage to pay off in cash every month unless it’s an emergency. Payment history is the most critical factor that impacts your credit score.

Checking account cash: This is the most liquid form of a bank account. You can spend this money without restriction. 

Savings account cash: This is cash, but you may be restricted in withdrawing it. For instance, Regulation D allows you to only make up to six withdrawals from a savings account in any 30-day period. Beyond that, your bank may impose fines. FYI – The Federal Reserve temporarily loosened Reg D during COVID.

Crypto: Crypto investments are more liquid than stock investments. The exchanges that crypto assets trade on are open 24/7, unlike stock markets. This means that you can liquidate your crypto assets 24/7 (assuming you can find a buyer and the asset is not so illiquid that you can’t cash out without crashing the price). Different crypto assets will have varying amounts of liquidity (how much cash moves through any particular asset in a given 24 hours). More commonly traded cryptos (such as bitcoin) are more liquid than lesser-known alt-coins. Beware that crypto is also highly volatile. 

Stocks/ETFs/Mutual funds: You can sell stocks and ETFs for cash any time the market is open for trading. It is usually easy to find a buyer (if nothing else, your brokerage will likely fill the order for you – i.e., “make a market”). The stock market is only open during business days and at certain hours, so if you are desperate for cash on the weekend, this may not be an option. 

Retirement accounts: You may be able to either take out a loan against a retirement account that you own or take an early distribution from a retirement account (taxes and penalties may apply).

Precious metals: To liquidate precious metals, you must find a buyer, and you must find a way to get the metals to them physically. This could mean going to a local pawn shop (good luck getting all of your cash back out of it), selling it to someone online, shipping it to them, finding someone local on Craiglist, etc. 

Cars: If you own your vehicle, you can sell it for cash. However, it may take a while to get the car ready for sale, list or advertise it, let prospective buyers test drive it, negotiate a price, and complete the title transfer. It is not very liquid because it will take some time and effort to find a seller and complete the transaction. 

House: Same process as selling a car, but more involved. Again: get it ready for sale, list it, let prospective buyers look at it, negotiate, and do a lot of paperwork. Then, viola – cash. The whole process may take months or years. 

CDs: Certificate of Deposit savings accounts are not liquid. You receive an interest rate on them based on the fact that they are not liquid. Your bank runs off with the money to do whatever, and you agree not to come around asking for the money back until an agreed-upon time later (usually months or years).

Collectibles: Collectibles are generally not very liquid. You have to find the right buyer at the right time and agree on a price, which can be hard to do for unique items. If they are not traded frequently, then it is more difficult to agree on a fair price. 

 

 

1) Technically, stocks have two prices – a bid and an ask; the “market price” is somewhere between the two.