- In personal finance, liquid assets are investments an individual may easily convert to cash without incurring fiscal penalties.
- Most liquid investments — commonly stocks, bonds and mutual funds, among others — can be bought and sold throughout the trading day.
- In business finance, liquidity refers to a company’s ability to pay off its short-term liabilities reported on its balance sheet.
If you're interested in staying on top of your personal finances, you may have a solid money management plan in place, including a budget. However, life often finds a way of complicating our best-laid plans. You may find yourself in a sudden financial bind, such as job loss or in need of an unexpected medical procedure not fully covered by insurance. Or maybe you’re a personal business owner with cash flow issues who’s on the hook to fulfill a large purchase order.
What do the above scenarios have in common? In short, all could benefit from liquid assets to help source the cash needed to handle life’s unforeseen events. The ability to tap into one’s current assets and pay off an unplanned bill is the concept underlying liquid net worth.
Liquid asset definition
Strictly speaking, a liquid asset is any asset that an investor can easily convert to cash or cash equivalents without incurring fiscal penalties. Because they're easily sold at or near their market values, liquid assets can help individuals preserve their net worth while remaining on track with their long-term retirement goals.
|What is Liquidity?
|Liquidity refers to the ease with which an investor can convert an asset into cash without losing its market value.
Liquid assets vs. non-liquid assets
Whereas liquid assets can be easily converted to cash, nonliquid assets (also referred to as fixed or illiquid assets) are vastly harder or costlier to unload: In some cases, willing buyers can be difficult to find. In others, accurately determining the market value of the investment can be a challenge.
For collectibles like vintage cars or one-of-a-kind paintings, appraisers may be needed. Additionally, lengthy negotiations between buying and selling parties may break down at the last minute.
Nonliquid assets can include:
- Classic or collectible cars
- Precious metals
- Hedge fund capital
- Private equity real estate
- Rare art and other collectibles
How liquid assets work
In some circumstances, both personal and business, you may need to easy access to funds. Another name for easy-to-access funds is liquid funds. The unexpected can — and often does — happen at any time. Individuals may need to dip into, for example, an emergency fund during an unforeseen medical emergency in the aftermath of a natural disaster or for any number of reasons. Businesses may also need to liquidate assets in order to pay off unanticipated liabilities, for example, because of market changes or exit strategies.
Personal liquid assets
A personal liquid asset works when an item can be quickly and easily sold or traded on the open market to generate immediate cash. The resultant money can typically be used to pay off liabilities. In the context of investments, the most liquid personal assets are items that trade easily and where there are always willing buyers on the open market, such as individual stocks or mutual funds. Because these items can be unloaded throughout the trading day, they act as a financial safety net for investors.
|What Is Liquid Net Worth?
|Liquid net worth refers to the amount of money an individual possesses in cash or cash equivalents after deducting total liabilities from his or her liquid assets.
Business liquid assets
In business, liquidity refers to a company’s ability to pay off its short-term liabilities reported on its balance sheet. Thus, a company’s liquidity profile is a key metric in evaluating its fiscal health.
Investors and banks alike study a company’s liquidity profile when contemplating making investments or issuing loans. They gauge liquidity by carefully scrutinizing a company’s balance sheet. In determining whether to invest or extend credit, interested parties generally want assurance that a company can satisfy its payment obligations in less than a year by consuming its assets to pay for liabilities.
Liquid asset examples
A liquid asset is an item of ownership that’s deemed to be a current asset, including:
- Cash: This can be used when needed and without any complex transactional hoops to jump through.
- Checking account or savings account: With these accounts, assets are simply the balances held at any given time. Their values will invariably fluctuate with routine bill payments, ATM withdrawals, etc.
- Emergency fund: This refers to any stash of money explicitly earmarked for use in times of financial distress. Emergency funds are often saved to avoid drawing from high-interest debt options like unsecured loans and credit cards.
- Money market account: Offered by banks and credit unions, money market accounts typically pay higher interest rates than other savings accounts. However, these account transactions can be limited and accrue additional fees.
Are investments liquid assets?
Investments may be considered liquid assets if they satisfy certain criteria. Chief among them, a liquid investment should afford individuals the ability to access funds via early withdrawal — and without suffering penalties. In most cases, investments and investment accounts are considered liquid assets. But knowing which items are liquid and which are illiquid is key.
Cash equivalents refer to any balance sheet item, such as bank accounts, that can be readily used to pay off bills in the short term. The readiness with which they can be used makes cash equivalents liquid.
Traditional and Roth IRA distributions can trigger a 10% penalty if you withdraw earnings before age 59. This is because they’re designed to hold your money until retirement age. It is important to note that there are certain exceptions to this rule depending on your circumstances. Similarly, withdrawal penalties may be waived if a permanent disability makes full-time work impossible.
A mutual fund is a professionally managed investment fund that pools money from many investors in order to purchase diversified portfolios of stocks, bonds or other securities. Investors obtain ownership in these vehicles by purchasing individual shares of the fund, which they may sell off at any time throughout the trading day. Because they typically collect the proceeds from the sale by the end of the following business day, mutual funds are considered to be highly liquid in nature.
A stock (aka "equity") is a financial security that lets investors obtain fractional ownership of a publicly traded corporation. As holders of this equity, which comes in units known as "shares," investors participate in the company's profits, either by selling their shares for a gain or by collecting dividends, which are regular payouts throughout their ownership. Stocks are routinely bought and sold over exchanges, making them liquid.
A bond is a fixed-income instrument where investors (known as "creditors" or "debtholders") pay the principal on notes. These payments are made in exchange for guaranteed interest rate payments over fixed payment schedules, and investors typically receive their principal investments back. Bond issuers may be public or private companies, states, municipalities and sovereign governments that use the capital for expansion and improvement efforts. While bonds might be harder to sell than stocks, bonds can be bought and sold and are considered liquid.
Treasury bills are short-dated government securities that yield no interest but are issued at a discount to the redemption price (par). They are considered liquid and their investment cycle ranges from several days to 52 weeks.
Certificates of deposit (CDs)
Liquid certificates of deposit (CDs) are investment certificates banks give depositors for a prespecified length of time. Unlike traditional CDs, liquid CD holders can make withdrawals without incurring a penalty. But there may be downsides to these vehicles — including, lower yields and higher investment minimums.
The bottom line
It's important to know which funds you can tap into quickly, as liquid assets can reduce the financial stress often associated with unexpected expenses. Ensuring you have easy access to funds as an individual, business owner, or both, a financial advisor can help you better understand how liquidity contributes to the long-term health of your net worth or your company’s long-term prospects.
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