You’ve heard it countless times: Build your assets and invest for the future. It’s sound advice, but if you needed money right now, how easily could you turn your assets and investments into cash?
All of your assets have value, but liquid assets are the ones you can quickly turn into cash without incurring any significant fees or penalties. Non-liquid assets either take time to sell or may lose value if you need to quickly turn them into cash.
The money you have in your checking and savings accounts, accessible on demand with a debit card? That’s a highly liquid asset. The RV parked in your driveway? It takes time and expense to sell, making it a non-liquid asset.
All of your assets and investments can be liquidated, if necessary. But before you sell anything, financial planners say you need to take stock of your asset portfolio and understand the liquidity of your holdings.
What to know about liquid assets
Simply put, liquidity is your ability to convert assets into cash. A liquid asset is often defined as cash or an investment with a maturity of 12 months or less, according to Marty Reid, president of Reid Financial Consulting and a certified financial planner. Holding liquid assets is important in case you need cash for emergencies, unexpected expenses or to make big purchases on short notice.
When explaining liquidity to clients, some financial advisors illustrate a pyramid of assets, with cash on hand or money in a savings or checking account at the top as the most liquid, and items or properties that take more time, effort and expense to sell, such as a house or a boat, towards the bottom.
Some assets that can fall into a gray area between liquid and non-liquid are stocks, mutual funds and longer term government securities. You can liquidate these investments for cash, but it could take up to a few days to get your money. You could also face penalties or costs, including brokerage fees, changes in market value, forfeiting interest gains or possible tax implications.
With stocks in particular, when you go to sell, you’re at the whim of the markets and it can take up to three or four days to get your funds. “What if the market is down the day you need money? If the market is down or volatile and you need money, you could be forced to sell and lose money,” said Kaya Ladejobi, a CFP and founder of New York-based Earn Into Wealth Strategies.
Examples of liquid assets:
- Cash: Hard cash you physically have on hand to pay for expenses.
- Checking or savings account: Money on deposit with a bank or credit union that you can access immediately.
- Money market account: A money market, or MMA, is a high-interest savings account that can have check-writing privileges. MMAs may have more restrictions than a typical savings account, including higher minimum balances and limited number of withdrawals.
- Certificate of deposit: Also known as a CD, this can have a duration that ranges from a few months to several years and offers higher interest rates than savings accounts. If you cash in your CD before the term expires, you could face a penalty on your accrued interest.
- Treasury bills, notes and bonds: Government-issued securities with maturities ranging from a few weeks to 30 years. Shorter term securities are more liquid than long-term holdings. Interest rates are higher on longer securities. If you sell before maturity, you could lose value and possibly pay broker fees.
What to know about non-liquid assets
Non-liquid assets can be very valuable and marketable. These fixed assets should not be considered as a source of funds for your daily lifestyle or basic needs, but rather as tools to build long-term financial success, said Reid. If you try to sell a long-term asset on short notice, you might not receive the full benefit of their value and you could incur excessive fees associated with a hurried sale. Most of all, the sales process can be slow, which is the very reason they are not liquid assets.
That’s not to say there isn’t a market for these non-liquid assets. On the contrary, when you sell real estate or personal effects like jewelry or collectibles, you can realize considerable financial gains. Likewise, the long-term investment accounts, including IRAs and 401ks, can appreciate over time, but you’d lose value if you sold early, including potentially steep tax penalties.
“Any time you have to pay transaction costs, like using a broker, to sell something, it might be more costly. In addition to that, when you have to find a buyer and the pool of buyers is limited to turn an asset into cash, that makes it challenging,” Ladejobi said.
Examples of non-liquid assets
- Real estate: Homes and land hold considerable value, but would take time and expense to sell, making real estate one of the most non-liquid assets.
- Cars, RVs and boats: Recreational vehicles can also have strong monetary value, but take time and resources to sell.
- Jewelry: Individual pieces and collections can fetch large sums, but you’ll need to find a buyer or possibly a broker to handle the transaction.
- Furniture and collectibles: Like jewelry, these personal effects can appreciate strongly and may have enthusiastic buyers, but you’ll need to handle marketing and transactions, or work with a broker.
- Retirement accounts (401ks, IRAs and investment accounts): These long-term investments will grow over time, eventually funding your retirement. If you cash out early (usually before you’re 59 1/2 years old), you could face steep penalties and tax implications. If you take money out of an IRA early, it could be included in your taxable income and incur a 10% additional tax penalty (there are some exceptions).
Why is asset liquidity important?
You never know what hardships or adventures life might throw your way. That’s why it’s important to have liquid assets at your disposal. Many investment advisors often urge clients to keep between three to six months of cash on-hand to pay living expenses, including housing, food and utilities.
Amit Chopra, a CFP and managing partner of Ramsey, N.J.-based Forefront Wealth Planning and Asset Management, often adjusts his advice based on a client’s age and expectations. Younger clients, he said, may want to keep six to 12 months of living expenses on hand in cash in case they decide to pursue a less stable job, such as at a startup, or a personal adventure. “Having a little more cash gives them the flexibility to do that,” he said. With older clients, who may be more established in their careers and personal lives, Chopra recommends setting aside enough cash for six to nine months of expenses.
As you prioritize how much liquidity you need in your financial portfolio, there are some additional considerations, including your tolerance for risk with investments and your long-term financial goals. To determine what’s right for you and how much liquidity you might need, the U.S. Securities and Exchange Commission (SEC) recommends investors take stock of their personal financial needs and determine the right mix of liquid and non-liquid assets. While cash and cash-equivalents are the safest investments — and the most liquid — they also yield the smallest returns.
Liquidity is a balancing act. Having cash on-hand is important for emergency car repairs or medical bills, and to fund lifestyle expenses, such as home improvements or a wedding, Reid noted. He encourages clients to mix liquidity with long-term investments.
“In real estate, they say, location, location, location. With investing, it’s diversification, diversification, diversification. How you diversify depends on your financial position, your risk tolerance level, and your long term and short term objectives,” said Reid.
The final word on liquid assets
When it comes to financial flexibility, cash is king. From there, your personal liquidity plan is a very personal choice, based on how much cash you think you need to be secure and comfortable. There’s no single right answer.
However, when it comes to realizing the value of your assets, not all investments are created equal. If you need funds quickly, with minimal headache and minor expense, cash and cash-equivalents are the easiest and fastest way. If you have more time to put into selling an asset or a longer timeline for needing money, non-liquid assets can be transformed into liquid ones, but it takes both planning and an active market to realize their fullest value. One thing is certain: The cash in your wallet and your checking and savings accounts are the ultimate liquid asset.