When you begin investing, one term that you are sure to come across is “investor liquidity.” This is an important factor when you begin contemplating what to invest in, as well as how you view and handle your entire financial situation. In this article, we will discuss liquidity, what it is, and how it is vital for an individual who would like to invest successfully.
So What is Liquidity?
To put it simply, liquidity is the ability to turn any asset you own into cash in a short amount of time. It also refers to being able to buy or sell what is known as a security without affecting the price of the asset. In regards to investments, liquidity is how easy it is to buy or to sell.
Cash is regarded as one of the assets that are most “liquid.” That is due to the fact that it can be used to purchase pretty much anything. Many stocks that are traded using the major exchanges are also considered to be fairly liquid because of their ability to be converted to cash fast and easily since there is nearly always another investor willing to pick up your shares.
Of course, not every asset is able to be liquidated, or turned into cash, in an easy manner. For example, you may have the majority of your net worth in your home. This can be hard to tap into regardless of your equity amount, although not building equity will make it that much more difficult. Other assets that are not considered liquid include certain debt instruments as well as private company shares. Selling these assets during an economic crisis will result in you losing quite a bit of money in the process, and you may not have any buyers at all.
Why is Liquidity Important?
There isn’t anything wrong with having some of your net worth tied up in illiquid assets. But you will want to own assets that can be turned into cash quickly if needed. Some assets considered illiquid at present could present you with the opportunity of gains in the long run, but you will need to be financially secure enough to not need to sell them. When they have matured to be able to become liquid, you can sell then, providing you are able to find a buyer.
Cash can sometimes be illiquid. Say you have set up a CD for yourself. For a specific amount of time, you will not be able to touch this money. Or, if you decide that you do need the funds and withdraw cash, you could be charged a significant fee. Therefore, when you are planning your investments as well as overlooking your finances, make sure that there are liquid assets that you can tap into in case of an emergency or any time that you need funds in a timely manner.
These are the basics of investor liquidity, and understanding its importance will enable you to plan efficiently as well as successfully enjoy investing.