Investment Liquidity: What it is and Why it is Important


Liquidity is a concept that many investors fail to take into account or understand and as a result their financial plans fail to come through in such critical times as retirement or college funding for a dependent. However, the fact is liquidity or a lack thereof causes more financial problems than almost any other aspect of finance. People either lose money, which they needed in the short term because of improper investments or they find they have insufficient funds upon retirement because of years of investing in short term investments for a long-term goal.

From a financial perspective, liquidity refers to the accessibility of an investment. The best way to find the liquidity of something is to determine how long it would take to arrive into your pocketbook if you happened to need it today. By illustration, the funds in a retirement account are not liquid because they require paperwork to redeem and time for the money to arrive in your bank account or your mailbox. Money Market funds, on the other hand are very liquid with the access to them often provided through a linked checkbook or at the very least, easy transfer to a bank account. However, there are other aspects to liquidity that make it a slightly more complicated subject.

One important thing to realize is that over the years liquidity has come to mean something a bit different than its intended meaning. This added meaning often refers to the volatility aspect of an investment. An example of this is when someone refers to a stock as lacking liquidity. The fact is that with modern technology it is often fairly simple to sell a stock one day and then have it in your account the next. Obviously when people say a stock lacks liquidity they are not referring to this aspect of modern investment technology. Instead, what they are referring to is the fact that money invested in a stock is meant to be invested for the long term and removing it fairly quickly may result in a loss of money. So, in a sense some people often consider volatility to be an aspect of liquidity, which it is not. However, knowing that this may be the intended meaning will help in understanding the following lists of various investments along with the relative liquidity of each.

Money Markets – As discussed above money markets are the closest thing to cash you will find in the investment world. Very liquid and very little fluctuation makes for a safe and dependable investment appropriate for funds you may need on the spur of the moment or in emergencies.

Savings Accounts – Most traditional bank savings account are just as liquid as having cash in the checking account. Most people open a savings account at the same institution and as a result a simple phone call is all that is required to get the money over to the checking account.

Annuities – Annuity investments are notorious for their lack of liquidity. They are designed for the purpose of creating an income stream in most cases and as a result it becomes virtually, if not actually, impossible to remove the lump sum or a portion of it once it has been invested. The volatility aspect depends on the specific annuity since many of them contain both stock and/or money markets in their portfolio.

Stocks/Bonds – Stocks and bonds (including their mutual fund equivalents) are best viewed as having very little liquidity. Though it is possible to access the money fairly easily, in most cases it is best left alone due to the fact that leaving the money invested for a period of time ranging from one year and greater is often required to recoup the original investment.

 

Information is for educational and informational purposes only and is not be interpreted as financial advice. This does not represent a recommendation to buy, sell, or hold any security. Please consult your financial advisor.

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