Liquidity and Liquid Assets Explained in Six Questions

The complicated stuff in life gets a little less complicated when you break it down into basic questions: What, Where, When, Why, Who and How?

What is Liquidity?

Liquidity is a measure of how easily an asset can be converted into cash or sold in the market. Assets are anything you own of value and can include cash, securities and fixed assets like real estate. 

It should come as no surprise that cash – including money in checking accounts, savings accounts and money market accounts – is the most liquid asset because it’s easily accessible. Securities such as stocks and bonds can also be easily converted to cash, and are generally considered liquid. That being said, how quickly you can sell securities, along with the value you get from selling, may vary.

On the flipside, fixed assets such as real estate, retirement savings and annuities are considered less liquid because they cannot be easily converted into cash. It takes time to convert these assets into cash, or in the case of a retirement plan, you could face a penalty if you don’t follow the rules of the plan. 

Where is a good place to keep liquid assets?

Keeping liquid assets such as cash in high-yield savings accounts, or no-penalty CDs is a good option since your money is easily accessible in these accounts. 

When do you need liquidity? 

An example of when you might need liquidity is if you needed to tap into your emergency fund to cover an unexpected expense, such as a medical emergency or leaky roof. Your emergency fund should contain money that is readily accessible and it’s generally recommended that you have enough to cover at least three to six months of expenses.

Your liquidity needs might also depend on your financial goals. For instance, if you’re saving up to purchase a home, you’ll need a decent amount of liquidity to cover the down payment.  

Why are liquid assets important?

Liquid assets are an important part of your overall financial picture. Liquid assets, such as cash in your emergency fund, may serve as a safety net. 

Who should be thinking about liquidity?

Everyone. Liquidity is an important measure of your overall financial health and at the very least, you should have enough liquid assets (aka cash) saved up in your emergency fund. Having liquidity might also allow you to take advantage of unexpected opportunities – say if an investment opportunity comes up, or it’s the right time to buy a house.

How does liquidity fit into your financial picture?

Diversification is an important part of your overall financial picture. While liquid assets are great for short-term goals and your emergency fund, fixed-assets such as your retirement savings or any investments (such as your home) are an important component for building wealth.