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What Are the Most Liquid Accounts? Liquidity vs. Yield


Written by David Rodeck | Published on 7/1/2020

 

A liquid bank account is one that lets you take out cash quickly without penalties or fees. When it comes to picking an account, it’s typically a trade-off between liquidity and yield, the interest rate you earn on your money.

Checking accounts, for example, are very liquid because they do not limit withdrawals, whereas CDs are less liquid accounts because they can charge an early withdrawal penalty. That being said, the average CD earns a higher yield than a checking account. In this article, we explore why liquidity matters as well as which accounts are most — and least  — liquid.

In this article we will cover:

What is a liquid account?

If you are wondering “what is the definition of liquidity?” the Federal Reserve describes liquid assets as “cash and assets that can be converted to cash quickly if needed to meet financial obligations.” Most bank accounts fit the liquid assets definition because you can take out money quickly. Real estate, on the other hand, is not liquid because it takes time to sell your property.

Another part of the liquid definition is that you can convert the asset to cash without it losing value. So while the different types of bank accounts all meet the first part of the definition of liquid assets, in that they can be turned to cash quickly, some are more accessible than others because of fees and early withdrawal penalties.

Why is liquidity important?

Liquidity is important to cover your day-to-day expenses. If you had to wait several days to take out money, it would be a headache for shopping and paying your bills. Liquid accounts can also help you deal with financial emergencies. If you need money for a surprise bill, you can withdraw from your liquid accounts without penalty, versus turning to payday loans, credit cards or other expensive options.

With that being said, there is a trade-off for liquidity. Generally, the more liquid the account, the lower the yield. If you keep all of your savings in cash or other liquid accounts, your savings will not grow much for the future.

Ideally, you would find a balance between keeping some money in liquid accounts — enough for day-to-day spending and your emergency fund — while putting the rest in higher earning accounts, even if they are less liquid.

Liquid assets examples: Accounts in order of liquidity

To help you understand what is an example of a liquid asset, we’ve ranked assets in order of liquidity along with their yields. Let’s see which one of the following is the most liquid:

Account Type Level of Liquidity Average Rate of Return
Checking account Highest 0.140% APY
Savings account Decent 0.201% APY
Money market account Decent 0.237% APY
Certificate of deposit Low 0.254% APY on a 3-month CD 0.649% APY on a 1-year CD 1.130% APY on a 5-year CD
Brokerage and retirement accounts Moderate for brokerage accounts, low for retirement accounts 5% to 6% per year for bonds 10% per year for stocks

Checking account

Which bank account is most liquid? A checking account claims the title of the most liquid bank account. Just how liquid is a checking account exactly? It’s very nearly as liquid as straight up cash. Checking accounts let you freely take out money whenever you want, and there isn’t a limit on monthly transactions or a fee for taking money out. Checking accounts are a good place to keep money that you might need in the immediate future.

The only thing you need to watch out for is whether your checking account has a minimum balance requirement  — if your withdrawal pushes you below this limit, you’d owe a fee. But there are many accounts that have very low or no balance requirements to minimize this issue.

Savings account

Is savings a liquid asset? For the most part, yes.

Savings accounts are another liquid bank account, and you can withdraw money or transfer funds out of a savings account without delay or an early withdrawal penalty. However, a federal government rule, Regulation D, gets in the way of a completely liquid savings account.

Regulation D limits certain transactions in a savings account. Each statement cycle, you can only make up to six of certain transactions like checks, automated transfers and debit card purchases. If you make more than six of these transactions during a statement cycle, your bank could charge a fee. This makes savings accounts a little less liquid than checking accounts.

Money market account

A money market account is similar to a savings account — these accounts follow the same rules and restrictions for withdrawals under federal Regulation D. What’s different is that money market accounts pay on average a higher interest rate, but may also require a higher minimum balance.

For accessibility, a money market account is about as liquid as a savings account because they follow the same withdrawal rules. However, since a money market account may require a larger minimum balance, you need to keep more of your savings in there to avoid fees — this makes them a little less convenient for liquidity.

Certificate of deposit

Is a certificate of deposit a liquid asset? Compared to other bank accounts, a CD is less liquid. When you sign up for a CD, you agree to leave your money with the bank for a set period of time, the CD term. Terms can range from a few days to many years.

If you try to take out money before the end of the term, the lender could charge an early withdrawal penalty. This penalty could wipe out your earned interest and even some of your initial deposit. To see how the penalty compares at different companies, check out this calculator.

In exchange for the lower liquidity, CDs pay a higher yield than more liquid bank accounts. The longer the term, the higher the interest rate, as you’re locking up your money for a longer period of time  — just make sure that you can commit to the full term before signing up.

Brokerage and retirement accounts

Besides the bank, you could also put your savings in brokerage and retirement accounts. These let you invest in assets like stocks, bonds and mutual funds. We’ll look at which investments are liquid and which investment has the least liquidity in the next section, but let’s start with the actual accounts themselves.

Brokerage accounts are more liquid than retirement accounts. If you want to sell an investment for cash, you can do so with a brokerage account and then transfer your earnings to your bank account penalty-free. However, you could owe taxes if you sell for a gain. Capital gains taxes are higher on short-term investments — those held for less than a year — than they are on long-term investments held for over a year.

On the other hand, if you’re wondering “is a 401(k) a liquid asset?” the answer is generally no. Typically, 401(k) plans and other retirement accounts are largely non-liquid assets. A 401(k) could limit your ability to take out money except for emergency hardships, like medical bills or necessary home repairs. 

In addition, if you try to take money out before retirement, not only could you owe taxes, you could also be charged an early withdrawal penalty by the IRS. These accounts are meant for long-term savings, not liquidity.

Can investments be liquid assets?

There are some liquid investments that can be quickly turned into cash. Liquid stocks and bonds are a good example, because you can sell them for cash immediately in a trade whenever markets are open. Mutual funds are also liquid, but they take a little more time to convert to cash: You’d need to wait until the end of the trading day to sell your mutual fund. During this time, it could have lost value. Still, these funds are quite liquid.

Other investments like real estate and land are much less liquid. It can take days, weeks or even months to find a qualified buyer, negotiate a sales price and turn your investment into cash.

Here is a list of liquid assets to nonliquid assets when it comes to investments:

  • Stocks (very liquid)
  • Bonds (very liquid)
  • ETFs (very liquid)
  • Mutual funds (liquid)
  • Physical gold, silver and jewelry (somewhat liquid)
  • Collectibles (not liquid)
  • Real estate (not liquid)
  • Land (not liquid)
  • Small businesses (not liquid)

While some investments are liquid, they are not a good fit for handling day-to-day cash needs. In the long run, investments can earn a higher yield than bank accounts, but they are riskier short-term. For example, you could lose money during a stock market crash. If you put all your money in investments, this could mean selling at a deep loss. It’s better to keep liquid cash in the bank to cover your day-to-day needs, while using investments to build long-term wealth.

By understanding the liquid account definition and how it applies to the different accounts, you can find the right balance of liquidity and yield for your savings.

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