Investment Liquidity

Asset liquidity refers to how easy it is to buy and sell an asset without needing to offer a large price discount. The easier and faster an asset is to buy or sell, the more liquid it is, and vice versa. Liquidity is a spectrum ranging from easy-to-sell assets like large-capitalization stocks to harder-to-sell assets like private equity.

Liquidity can be an important component of investing because it can affect your ability to adjust your investment strategy if your outlook or goals change. Liquidity is particularly important if you have short-term cash flow needs such as regular withdrawals. By understanding some of the more common types of liquid and illiquid assets, you’ll have a better grasp of the roles they can play in your investing strategy.


Liquid Assets: Stocks and Bonds

Listed stocks generally are highly liquid assets. The stock market sees billions of shares traded daily by millions of participants. Pricing is fast and efficient, and most transactions happen nearly instantaneously, making it easy to adjust your positioning quickly if necessary. Their liquidity is one reason stock markets can experience severe gyrations in the short-term, particularly in times of panic.

Bonds are also very liquid assets, but to a lesser degree than stocks. Most bonds trade “over the counter”—directly between counterparties—rather than trading on open exchanges, which can make trading more difficult. That said, asset liquidity varies by bond type with some being more openly traded and easy to convert to cash than others.

US government bonds—called Treasury bonds—are the most liquid bonds in the world. They have the most supply, their trading volume is highest and transactions settle quickly. Other nations’ government bonds can be less liquid because of lower trading volume, foreign demand and supply.

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Corporate bonds also have lower liquidity than both stocks and US Treasury bonds. The liquidity can vary dramatically depending the issuing company. Certain bonds can trade frequently, while many individual bonds rarely change hands. This is also true for municipal bonds—debt securities issued by states, cities, counties and other local government entities.

While bond market liquidity can vary dramatically, sellers are usually able to get out of their positions without offering a severe price discount. One way to avoid the potential illiquidity of individual bonds is to purchase fixed income products—such as mutual funds and ETFs. These instruments also allow investors to achieve broader diversification while helping to ensure they can liquidate their investments easily on short notice.

Illiquid Assets: Real Estate, Non-Traded REITs, Annuities, and More

Real estate is an example of an illiquid asset. It would be almost impossible to sell your home overnight and receive its market value. Your exact home’s price can’t be found scrolling across a market ticker. It could take months and potentially lots of negotiating to find a buyer. Once the deal is closed, the transaction can sit in escrow for weeks. The selling process usually involves inspections, appraisals commissions and closing costs, which can add time and money.

Non-traded real estate investment trusts (REITs), as their name implies, are also illiquid assets. Unlike normal REITs, they don’t trade on exchanges. Their values are often opaque, making price discovery difficult on the secondary market, where buyers may be few and far between. Even if the prices were more transparent or discoverable, the lack of available buyers limits an investor’s ability to sell at the moment of their choosing.

Annuities also lack liquidity since they  are contracts with restrictive redemption terms and many may not be redeemable. Given the contractual nature of annuities, they cannot be sold freely regardless of how liquid the assets in which they are invested appear to be. Stocks and bonds generally have ready markets available to facilitate their sale, drastically increasing their liquidity compared with an annuity.

Other less-liquid assets include private placements and partnerships, which can have long lock-up periods and very limited redemption windows. Both of these features generally limit access to your money for periods of time. Trading on the secondary market can include more complications. The universe of buyers is small and share values are typically determined by investment companies (e.g. venture capital funds, investments banks, or certain private investors), not the open market.

Generally speaking, the more steps an investor must take in order to convert their asset to cash, the less liquid that asset is. The liquidity spectrum is well illustrated  in the liquidity differences between a stock in your investment portfolio and your house. While a piece of real estate may appreciate in value—making it a positive investment—you more than likely cannot realize the gains of that asset’s growth as easily as with a stock or bond.


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