What is Liquidity?
4 minutes for reading
In very simple words, liquidity indicates an asset’s ability to be sold in a short period of time at the price that is close or equal to the requested price. If we dig into the matter, we’ll find out that liquidity means an opportunity to convert an asset into its monetary equivalent. An asset may be represented by different things, such as goods, raw materials, bank deposits, stocks, bonds, securities, real estate, etc.
Types of liquidity
Degrees of liquidity are classified in accordance with an asset conversion speed into money. In other words, how fast an asset can be sold.
High-liquidity assets
So, assets are considered highly-liquid when they are sold quite fast and at the price, which is close to their average market prices. At the conditions indicated above, highly-liquid assets are stocks, bonds, and even bank deposits.
However, liquidity may vary a lot in a single industry: “blue chips” (securities of companies with the largest capitalization and market share) are more liquid, while “mid-caps” (securities of smaller companies) – less liquid. According to this classification, “penny stocks” (securities of companies experiencing hard times) are considered as low liquid.
When it comes to stocks, some of them may be of absolute liquidity, which means that this asset is a “ready-to-use” payment instrument and it will surely be bought. Quick liquidity implies investments in government bonds and bills. As a rule, these assets can be quickly sold within 7 days. Low liquidity is a long-term investment (for instance, in some large-scale projects) or a debit debt.
Low-liquidity assets
However, let’s get back to global definitions. If there are assets with high liquidity, then which ones are called low liquid? Strange as it may sound, but it’s real estate. Sale of real estate depends on a great deal of factors, such as location, housing system, public works, social overhead capital, network utility, neighbors, etc. Real estate can be sold quickly only if the requested price is much lower than the market price. In most cases, those who want to sell their real estate should be very patient and have plenty of time, because this process may take weeks or even months.
The more expensive your real estate, the more difficult to sell it. Hence, this asset’s liquidity is reducing. On the other hand, liquidity of economy-class apartments may be much higher due to reasonable prices and higher demand.
Business is another low liquid asset. It’s not so easy to find a group of people or an individual who are looking for exactly what is being sold and ready to pay the requested amount of money for it.
Conclusion
For investors, it’s very important to understand what liquidity is and how it may be assessed. Mostly, it is related to the fact that the key goal of investments is to earn as much and quickly as possible. When market conditions change to negative, investors must have an opportunity to get rid of their assets. This is why they have to understand how liquid an asset that they are going to invest in is.
