Understanding Liquidity in Investing

Asset liquidity refers to how easily you can trade an asset. Illiquid assets can be fine if you plan on holding them for long periods of time. But if you have unexpected costs, holding just illiquid assets can pose an issue. Read about the liquidity characteristics of various assets classes so you can potentially mitigate this risk.

Key Takeaways:

  • Liquidity can have a large impact on securities pricing, which can be important for investors.
  • Know which securities are more easily traded and what that can mean for your portfolio's flexibility and return characteristics.
  • Some asset classes are traded less frequently, which can make them less liquid and flexible if you need access to capital.

Liquidity refers to how easy it is to buy and sell an asset. The easier and faster it is to transact, the more liquid an asset is, and vice versa. Liquidity can be an important consideration of portfolio management when evaluating which investments you should hold. The more difficult it is to trade a security, the more risk you have that you may not be able to trade the asset when and for the price you want.

In this article, we'll discuss the liquidity of some types of investments.

Easily Traded Asset Classes: Cash, Equities and Fixed Interest

Cash is by its very nature incredibly liquid. Cash can be traded for other financial investments, goods or services extremely quickly. Readily available cash may not earn much or any interest, but provides easy access to capital for investors who may need to pay debts or expenses or transfer funds quickly. Cash has much less risk and volatility than investments as it's meant to provide liquidity, stability and a means of exchange.

Some equities are liquid financial assets. Equities trade in open markets where millions upon millions of people and companies buy and sell their investments daily, which provides liquidity. Pricing is fast and efficient. Unless you’re trading a tremendous amount of stocks in one transaction, the price you see quoted during trading hours is typically very near the price you’d get if you sold at that instant. Financial transactions can be completed in the blink of an eye.

Fixed-interest securities are sometimes less liquid financial assets than equities. They often trade over-the-counter rather than on open exchanges. This may make trading more difficult, time-consuming, expensive and opaque. That said, asset liquidity varies by fixed interest type.

  • US Treasurys are some of the most liquid fixed interest securities in the world. They have a great amount of supply and are traded often. They also settle quickly—normally, the day after the trade.
  • Other developed nations’ debt—such as gilts and Japanese government bonds—may be just as freely traded as US Treasurys but may have less fixed-interest supply.
  • Corporate fixed-interest securities are also less liquid than US Treasurys. They may not be traded as frequently, and the market liquidity may be less robust.

While these financial securities are relatively common and well-known, some investors may be considering other liquid assets or non-liquid assets to grow their capital.

Illiquid Investments: Property, Annuities and More

Property often has less liquidity than equities and fixed interest. For example, you generally can’t sell your home overnight and receive its market value. And locality can greatly affect even structures’ values. It could take months (and potentially lots of haggling) to find a buyer. There are also property valuations, commissions and stamp duty costs to consider. Further, if you own physical real estate and plan to rent it out, you will be in charge of the property management, which can be time-consuming and costly. Pooled real estate investments may provide more liquidity than physical property, buy they may not be as liquid as equities.

Annuity contracts are illiquid as well. In these insurance contracts, you generally provide an initial amount, called capital, and receive ongoing payments of capital and some amount of interest. Once the annuity is in force there is not usually an option to access a lump sum of capital under any circumstances, although some specialist annuities may offer the facility to alter the payment terms.

Other less liquid assets include private placements and partnerships. These have periods where you may not be able to trade, limiting access to your money. The universe of buyers is smaller than with larger organisations, and share values may be determined by investment companies or individual directors, not the open market.

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Investing in financial markets involves the risk of loss and there is no guarantee that all or any capital invested will be repaid. Past performance neither guarantees nor reliably indicates future performance. The value of investments and the income from them will fluctuate with world financial markets and international currency exchange rates.