Note: This article is part of our Basic Banking series, designed to provide new savers with the key skills to save smarter.
“Cash is king,” the old saying goes. But here’s something that’s just about as good as cash: liquid assets. A liquid asset is a financial instrument that can quickly and easily be converted to cash without losing a significant amount of its value.
“From a personal finance perspective, you can access cash at a moment’s notice [with your liquid assets],” said Leslie H. Tayne, Esq., founder of Tayne Law Group, a law firm that specializes in debt solutions.
Assets that are not liquid, on the other hand, take longer to convert into cash, making them less handy in an emergency.
As you build your financial portfolio, liquid and non-liquid assets each offer distinctive advantages. Here’s what you need to know about these two types of financial tools.
What are liquid assets?
Cash is the ultimate liquid asset, since you can instantly use it to settle debts and make purchases. However, there are a variety of other non-cash tools that are also considered assets that are liquid, like your checking account balance. Whether or not something is a liquid asset depends on its ability to convert all or most of its value into cash with short notice.
“The criteria that make an asset liquid are access to the funds — the ability to convert it to cash through sale or liquidation,” said Tayne. “Liquid would include an asset that is easy to buy and sell, and that doesn’t necessarily lose value when you buy or sell it or dispose of it. Additionally, having quick and easy access to the cash tied to the asset also is a criterion of liquidity.”
As DepositAccounts' parent company LendingTree puts it, “The faster an asset can be turned into cash, the more liquid it is considered.”
Here are some common examples:
- Cash: Whether it’s under your mattress or in your wallet, cash is the most liquid asset to fulfill financial obligations.
- Bank accounts: You can withdraw money from your bank accounts at the bank or an ATM, or spend it using your debit card.
- Money market funds: These low-volatility investing products hold various securities, like corporate commercial paper and U.S. Treasury securities, and are considered highly liquid.
- Stocks: You can sell your stocks quickly at today’s current value if you need cash fast.
- Mutual funds: The fund will buy your shares back at any time, making it easy for investors to get cash.
- Treasury bonds: There is a very active market buying and selling Treasuries throughout the day, making it easy to trade bonds for cash.
Why are liquid assets important?
As you build wealth, it’s a smart idea to find a balance between assets that are liquid and assets that are not.
“If you’re ever in a situation where you need to sell your assets, you can do so and receive your money right away for use in another matter. Assets that are liquid are helpful in case of financial emergency, as well as investing,” said Tayne.
Your assets that are not liquid may be used for long-term investing or provide other benefits (such as a property to take summer vacations).
If you’ve already built a sizable emergency fund, you might be tempted to focus exclusively on acquiring non-liquid assets, like real estate. However, keeping a portion of wealth liquid allows investors to take advantage of investment opportunities as they pop up.
Unlike liquid assets, assets that are not liquid may lose a significant amount of their value on a quick sale — if you can even find a buyer in a short period of time. The value of these can fluctuate significantly over time, and if you need to convert them into cash quickly, you may be forced to sell them at a steep discount.
“Real estate is a commonly used example of a non-liquid asset because you may not be able to sell the property right away and it may lose value,” said Tayne.
Here are some common examples:
- Your home
- Other properties
- Retirement savings
- Vehicles (e.g. cars, boats)
Liquid assets and non-liquid assets in business
While both consumers and businesses need liquid and non-liquid assets, they tend to use them in different ways. For example, a business may be able to secure financing by using its accounts receivable as collateral, since that liquid asset will convert to cash soon. An “I-owe-you” from a friend could not be used in the same way.
A business might also hold onto certain assets that are not liquid, like equipment, for other reasons, such as tax breaks. Companies also acquire intangible assets — things that add value to the business, but might not be able to be sold, such as patents, corporate intellectual property or goodwill.
“Financial institutions and lenders look at a company’s ratio of liquid to non-liquid assets to gain a better understanding of how the company manages its money,” said Tayne. “On the personal finance level, being liquid for lending doesn’t necessarily impact your financial health but allows the individual to maneuver an asset easily.”