If you’ve been around finance for any length of time you’ve likely read or heard the term liquidity. Liquidity in finance or investing is simply how much cash they have, or assets they can quickly turn into cash. Examples of liquid assets include:
- Anything you can sell in a day for cash
It’s important to have liquidity. This affords you investing opportunities when they arise. Another term people use is liquid net worth.
You can argue that stocks and bonds are liquid. They are, but when you sell security there is typically a waiting period for the trade to settle before you have access to those funds. I would consider that liquid but it’s certainly up for debate.
Take someone wealthy for example. No one questions they are wealthy, but it’s how their wealth is distributed. Let us use $100 for example purposes. Say you have $100 net worth, but your $100 is tied up as follows:
- $50 in real estate
- $50 in cash
While they have a total net worth of $100, their liquid net worth is only $50. The reason being real estate takes time to liquidate and turn into cash. At a quick glance you can get an idea of the risk profile or concentrations.
Let us switch it to a personal finance example. Any money in your checking or savings account is considered liquid. Your home is not liquid. Your stock portfolio is liquid, but it may not be advantageous to liquidate depending on tax implications. You get the idea.
Why is liquid net worth important?
It’s a measure of risk and opportunity. As mentioned, the more money you have a liquid the greater opportunity you have to invest in new ventures. Reverting to our first example, say you have $95 in real estate and $5 in cash. There is a home on the market that is offering a great rental opportunity. But the cost is $10. While you have the wealth, you do not have the cash to invest, thus missing the opportunity.
Extremely wealthy individuals are mostly tied up in real estate and other long-term ventures. Bill Gates, Elon Musk, Jeff Bezos, etc. While they’re worth billions, their liquid net worth may be relatively low.
Whether it is business or personal finance, it’s always important to have some cash sitting on the side. This can cover a small emergency that arises or give you the chance to grow your money through investing. Liquid money should be kept in a savings or checking account, given you quick access should the need arise. You can keep it elsewhere but know it may take some time before you can spend those funds.