What Are Liquid Assets?
What Are Liquid Assets?
- Mutual Funds
- Money Market Funds
A non-liquid asset is known as illiquid—meaning it cannot be turned into cash quickly. Precious metals are one such asset, though some states allow certain gold and silver coins to be used as currency, which means they are cash. Nothing is more liquid than actual cash, though.
The value of certain assets may be greater than their cash value, such as collectible coins issued by the United States Mint. Sometimes individuals also collect precious metals in the form of bars or bullion and store it in an inaccessible location, like a safety deposit box at the bank, which renders it illiquid. Other individuals who collect precious metals in the form of crafted items or jewelry will find that turning these items into their cash equivalent is difficult. They will have to either need to find someone to purchase them for cash or bring them to a dealer who will probably give far less.
Real estate is another type of asset that is illiquid. Tangible landed property cannot be easily turned into cash, legally. The transfer of property requires documents of conveyance like a deed, often accompanied by a title search, and these documents have to go through a government mandated process that varies by state.
Business ownership or intellectual property (a patent, royalty rights, etc.) are other types of assets that are not liquid assets. This is because in order to convert these assets to cash, the owner has to find a willing buyer.
Collectibles such as fine art, vehicles, and memorabilia are also considered illiquid.
In order for an asset to be liquid, it must have an easily accessible marketplace where it can be unloaded for cash with minimal effort on the part of the owner.
What Are Liquid Assets?
Liquidity is the ability of an asset to be traded in for cash. The easier this is, the more liquid the asset is. Nothing can beat straight cash. Cash can be accessed with an ATM card, check, or withdrawal from the bank.
Liquid assets, like cash, are important for maintaining a life and covering expenses like bills. You can’t pay your rent with stocks, but you can pay it with a check, credit card, or direct deposit.
However, liquid assets do not increase in value like illiquid assets. In fact, they tend to lose value over time due to inflation and the rising cost of living. Stocks, bonds, and mutual funds grow in value over time, as does a collectible piece of art or a plot of land. This is why it’s important to also possess illiquid assets that build net worth.
For instance, most Americans cannot build a nest egg for retirement by putting coins in a piggybank or burying cash in the backyard. But they can build it by saving five percent of their paycheck in a retirement fund with eight percent growth over a 40-year period.
What Are Liquid Assets?
A few of the most common liquid assets include:
Cash is the currency of wherever you live. In America, that means the dollar and its fractional components like quarters, dimes, nickels, and pennies.
Cash is used as legal tender to offer payment in return for goods or services. Even if you pay for something with a debit card or check, cash is at the core of that transaction, and its value is immediately recognized for an immediate sale.
Most Americans keep their cash in a commercial bank, and their financial institution sends them periodic financial statements letting them know how much liquid cash they have in their checking account and/or savings account. Most banks offer a tailored software suite of financial support that breaks down spending, helping consumers make positive decisions to keep their bank account in good standing.
A bond is a certificate that shows a bondholder has made a loan to an entity. This could be a private company, which issues corporate bonds, or a government entity—federal, state, and even local or municipal—that takes cash from lenders with the promise to return the money (plus interest after a set number of years).
Generally speaking, the longer the maturity rate of the bond, the higher its annual yield. For instance, a treasury note with a two year maturity will pay the investor far less than a treasury bond with a thirty year maturity.
A treasury bill is another common form of a bond with a maturity date of generally less than one year, offering a quicker cash conversion. However, the interest rates are fairly low, which means that only an investor who purchases a large number of such T-bills (as they are called) can benefit from the cash conversion at the end of their maturity. Most retail investors see greater benefit from purchasing bonds with a longer term, such as series EE bonds, which can be purchased at half their maturity value. It’s not a bad deal for those looking for a long-term investment strategy.
Stocks are one the most popular and instantly recognized form of liquid investments, second only to cash.
Stocks are certificates of fractional ownership in a business that has decided to auction off shares of the business on a public market, such as the New York Stock Exchange. Consumers can buy these stocks through a broker or bank and obtain a small share of the company.
Some stocks award the privilege of collecting dividends, which are a percentage of the company’s profits. General stock sold to consumers on the stock markets also provides shareholder voting rights, enabling the stockholder to have a say in corporate decision making. In fact, if a business or individual purchases enough stock in a company, they can have a controlling interest in how that company is run. Stocks are liquid investments because they can almost always be instantly sold on the stock market.
There are a variety of strategies around investing in stocks. Some individuals engage primarily in the trading of stocks, buying and selling them to capitalize on the fluctuation of stock prices. Others have a long-term strategy of buying and holding stocks to collect revenue from the dividends issued by the company.
Generally speaking, unless an individual is a knowledgeable trader with a system for analyzing the ups and downs of the market, along with the time for performing in-depth fundamental analysis of companies on the stock market, they should stick with the more stable (although perhaps less exciting) strategy of long-term investing.
A mutual fund is an investment vehicle where money is pooled and allocated among different securities, like stocks.
Mutual funds are often devoted to a specific industry or genre of stocks, such as consumer staples, technology, energy, or financials. The advantage of participating in a mutual fund is that every dollar is diversified among a wide range of assets, which generally leads to greater stability.
Mutual funds are cared for by a money manager. This is a great solution for the average retail investor with little knowledge of the stock market or too little time to devote to researching and developing their own stock portfolio. Most retirement funds, like a company 401(k), are made up of one or more mutual funds. Investors can also pick and choose mutual funds to invest in on their own through the brokerage site offered by a bank.
Money Market Funds
Money market funds are a specific type of mutual fund that is geared toward low-risk debt instruments, like government and municipal bonds. Sometimes the money manager will add some bank securities into the mix to provide a greater yield in terms of dividends.
One of the prime attractions of money market funds is their dividends. Generally speaking, government issued bonds do not grow in value very quickly, nor do stocks in the financial industry (due to stability). But the return of government bonds and dividends offered by bank stocks are solid and steady, which is where the attraction of a money market fund lies.
How Much Should I Have in Liquid Assets?
It’s generally recommended that an individual have a rainy day fund of cash that can cover three to six months of living expenses in case they experience some sort of financial setback, such as losing a job or illness. What they do with the remainder of their cash is up to their discretion, but investments like stocks, bonds, and mutual funds are easily accessible to the average consumer.
Tax free investments, like a Roth IRA, provide a safe place for money to grow over the course of decades, where the power of compound interest can turn it into a sizable nest egg for retirement.
Remember that liquid assets do tend to move up and down in accordance to their particular marketplace. This is true of stocks, bonds, commodities (a sort of raw materials market), and even precious metals like gold and silver.
That said, there is great value to placing money into illiquid assets, like real estate. Though the real estate market does fluctuate over time; as mentioned, landed assets cannot be bought and sold so quickly. As long as you pay your taxes and current liabilities on time, land is something that nobody can take away from you.
Alternative illiquid assets include collectibles. Though you might be tempted to raise an eyebrow, many individuals with a high net worth actually have collections of significant value, such as the Queen of England, who owns a stamp collection worth one hundred million pounds sterling (that’s roughly $133 million), and designer Ralph Lauren, who has a collection of roughly 70 vehicles valued at $300 million.
For most individuals, their best bet is to have cash reserves covering three to six months of expenses and allocate around five to 10 percent of their paycheck to a managed liquid asset, like a retirement account.
Liquid Assets Can Be Converted to Cash Quickly
Liquid assets vary in scope, from stock investing to actual cash. Their ability to quickly turn into cash is a measure of security, because at the end of the day, cash is the main vehicle for purchasing goods and services.
Unfortunately, cash presents little opportunity for growth. In fact, it loses value over time, while liquid assets like stocks, bonds, and mutual funds grow in value. That why it’s important that every individual who wants to build wealth must consider how to build a portfolio of liquid assets where their money can go to work for them.
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