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Investors prefer to choose the most liquid assets to make their portfolio generate low-risk returns. The liquidity of an asset is determined by how easily it can be converted into cash at market price.
Quick Insights
Assets having the ability to be quickly convertible into cash without affecting the current market price are considered liquid assets.
Liquidity of an asset determines the overall risk and also the potential returns of the portfolio the investor holds.
Investors choose between liquid or illiquid assets based on their financial objectives and risk tolerance.
Liquidity is the degree of availability of an asset or security to purchase or sell at its current market price of any quantity. Put simply, the easiest and quickly an asset can be bought and sold, the more liquidity it is said to have.
When an asset is liquid, it refers to having been most actively traded by a large number of buyers and sellers. Examples of liquid investments include,
There are a few drawbacks to investing in illiquid assets. They are,
The liquidity of a security is affected by numerous factors in the market. They are,
The more buyers and sellers participate in the trade of security, the more it is quick and easy to buy or sell.
Financial crises or economic instability may cause panic among investors, thereby making them more cautious about buying assets.
Some policies and regulatory activities by the government restrict certain trading activities of the assets to buy or sell.
Different types of assets have different levels of liquidity. For example, government bonds always have more liquidity than the corporate bonds.
Assets that are low in liquidity are high-risk for both short-term as well as long-term investments. However, assets being non-liquid or illiquid can offer greater returns over time. Let us discuss the liquidity of each investment below:
Stocks usually have high liquidity but small-cap stocks have less liquidity due to the availability of fewer outstanding shares in the market. They also have a smaller investor base compared with large-cap stocks, resulting in lower daily trading volumes.
Liquidity in real estate depends on the location and the type of the property. For example, residential properties in metro cities and prime locations can be easily bought or sold at any time. Commercial real estate assets involving huge investments and regulatory approvals affect liquidity most of the time.
Risks involved in arts and collectibles investments such as availability of limited potential buyers, trends, research, artist’s reputation, demand, storage and insurance, volatility, etc., make arts and collectibles highly illiquid. They are also less reliable compared with stocks and bonds.
Precious metals such as gold and silver are usually world-wide safe-haven assets for everyone. Though physical gold and silver have low liquidity, ETFs and securities of gold and silver are highly preferred liquid assets for all types of investors.
Since the tenure of the deposits is longer and early withdrawals attract more penalties, CDs and savings bonds are considered illiquid investment assets.
Cryptocurrency investments have been attracting modern investors only in the recent past. Popular cryptocurrencies such as Bitcoin, Ethereum, etc are highly liquid yet certain exotic and the others are relatively very illiquid.
Most of the time, investors buy commodity futures or physical commodities for diversification. Though futures contracts can be liquid, physical commodities are too difficult to sell. It is also a complicated process to cash-in cryptocurrencies.
Direct ownership gives sure potential returns yet it is too difficult to find a buyer for the owned shares. Moreover, they are not traded in public, and hence private equity ownership is an illiquid investment.
Liquidity is the primary concern in hedge fund investments. Many funds have lock-in periods that restrict investors to withdraw money during the tenure.
Investors have both liquid and illiquid assets to balance their portfolios. Despite its risk, illiquid investments are preferred for a few reasons.
The requirement of long tenure in illiquid investments allows value appreciation. Most of the time, returns derived from illiquid investments are much better than those of liquid investments.
Illiquid assets are not volatile like liquid assets. They are reliable and make steady growth even amid adverse market conditions. Hence, illiquid assets provide a hedge against market volatility and are best suited as a diversification option.
Investors have more tax benefits in illiquid assets due to the nature of holding long tenure. Private equity and real estate offer tax advantages and preferential tax benefits on capital gains.
Investments that have the least liquidity are direct ownership of private companies, real estate, art and collectibles, etc. Illiquidity doesn’t mean the investments are not good, yet they provide less market risk and higher returns.
Pro Tip
Learn the basics of liquid and illiquid assets and the benefits of holding them with our trusted forex broker’s insightful guides not only on cryptocurrencies but also on stocks, CFDs, banking, and other investing vehicles.
Assets that cannot be quickly sold without a loss in market value are called illiquid assets.
The liquidity ratio is a measurement to calculate the debtor’s ability to pay off the debt obligations without raising capital.
Liquidity in stocks involves how quickly and easily a huge quantity of stocks can be bought or sold without affecting the market price.
Low liquidity in stock means, the investor is not able to cash in the equity stock in the desired quantity at its current market price.
Exit liquidity refers to the ease of the traders’ exiting positions and cashing out their cryptocurrency assets.
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