Not all types of assets are the same. This is particularly true if you need to extract the value of the asset in order to pay for something else which might be a more urgent need. For example, if you needed to sell your house to pay for an emergency surgery, it would take more time than if you already had the money in your savings account. The cash in the bank is known as a liquid asset while real estate is not.
When investing you should be aware of what types of assets you are investing in are liquid since these types of assets will provide you with more flexibility with your resources. Also, financial firms will provide special benefits to those with a large amount of liquid rather than illiquid assets.
What exactly are liquid assets?
Assets are considered to be liquid if they can be easily converted to cash. Any asset which has this quality will retain its value upon being sold. If you think about it, cash is used in this way. When you purchase something with cash, you are essentially selling the cash in exchange for the item or service you are purchasing. This is why liquid assets that are not cash are referred to as cash equivalents.
Examples of cash equivalents
Usually, an asset can be considered a cash equivalent if it can easily be converted to cash. Securities can be categorized as cash equivalents if their maturity terms are less than 90 days. This can include stocks and other similar market assets. Also, U.S. Treasuries and bonds are considered cash equivalents.
Shares in mutual funds are cash equivalents, since investors are able to sell their shares relatively easily at any time, receiving their money within a few days. Mutual funds are an investment vehicle where multiple investors pool their money in order to invest capital into the markets for profit. One specific type of mutual fund is a money market fund which invests in low-risk, interest-yielding assets such as municipal bonds.
Assets considered illiquid or non-liquid are more difficult to convert quickly into cash through selling. Real estate and land are categorized as non-liquid since it can take several months for an individual or a firm to market the property, find a seller and then receive the cash from selling the asset. Also, these assets may experience significant fluctuations in value which could affect the amount the seller ultimately receives.
For example, if the owner of real estate needs to liquidate the asset quickly, it could take quite a while to find a buyer. Within that time, the real estate market can change the price of the asset significantly for one reason or another.
How much liquidity should your portfolio have?
The balance of your portfolio should be designed to ensure you achieve your financial goals and investment objectives. Also, your tolerance for risk will need to be considered as well. These factors should be used to guide how much liquidity you keep in your investment portfolio. Additionally, how often you will need cash to make investments and purchases will determine how much your portfolio should be liquid assets.