Learn about high and low liquidity levels and what each could mean for your current and future portfolio decisions
Think of assets as ice and money like water, and you’re getting the gist of liquidity. The less time the ice takes to melt, the faster the money appears. In real terms, the liquidity of an asset depends upon how quickly it can be converted into cash of equal value. Liquidity levels drop in direct correlation with time—the longer the conversion period, the less the liquidity.
This factor is also lessened if the asset’s face value is greater than its cash conversion. Levels vary from investment to investment, but one thing remains constant: the higher the liquidity, the more attractive the vehicle, in many cases. Managing your wealth can be significantly aided by understanding which assets are most liquid and how these may factor into your short- and long-term financial goals.
Some common assets in order of liquidity
Nothing is more liquid than cash, of course; it’s already in the desired state. No conversion period means cash is readily available to draw on when required. This immediacy of access is why it’s good practice to keep some of your wealth in this supremely liquid form. Cash will be there should the need for quick capital arise, and its value will be the same (outside of international exchange rates, of course).
Securities can have high liquidity if they meet specific criteria, such as how marketable a stock is currently and if it’s sold on a prominent platform/exchange. The reason securities rank beneath cash, however, is fairly ironic; their value in liquid terms is far more fluid. This month’s hot stock may be next month’s loss, forcing the owner to sell for less than they paid. Bonds sold before maturity also run the risk of generating less than they were purchased for depending on interest rates.
Investments placed in a traditional or Roth IRA can be liquidated relatively quickly, but both come with a penalty fee if taken out before a certain period has elapsed. Traditional IRAs impose a tax upon withdrawal, which only compounds the loss of value and thus, lowers the level of liquidity.
The IRS states that early withdrawal from an IRA prior to age 59 and a half is subject to being included in gross income plus a 10 percent additional tax penalty with the same percentage applied to early Roth withdrawals. However, there are some exceptions in both cases. Early withdrawal fees and inflation concerns also apply to Certificates of Deposit.
The least-liquid assets
Homes (and other real estate, including land), vehicles, and other tangible assets are naturally lower on the liquidity scale; so low, that they’re often defined as non-liquid assets. Since liquidity has a built-in quality of urgency about it, converting these assets has time against them.
A home, for instance, may sell quickly if well-staged in a highly favorable market—but “quickly” is around 24 days, at best. And, of course, it may languish if the opposite applies. Preparing a home for a successful sale alone can take weeks, if not months, before buyers even enter the picture.
The same uncertain timescale can apply to other personal property, and there’s a further liquidity-lowering factor that affects all three. Their conversion value is prone to depreciation and/or buyer subjectivity. Both of these issues may see an asset liquidized for less, sometimes significantly so, than it was purchased for—or less than the anticipated gain in value.
Deciding on the liquidity profile that’s right for you
Wealth management is essentially risk management by another name, and greater or lesser liquidity across assets and portfolios factors directly into each individual’s tolerance for risk. Few wealth advisors would tell a client to have no assets that are at least in the upper echelons of the liquidity scale. Having these liquidity reserves puts an individual in a better position to obtain cash in a crisis or to pounce on a promising investment opportunity.
And the more liquid assets one has, the more chances can be taken on less-liquid or non-liquid assets. Playing the long game is usually the best strategy, and, should the need arise, and less-liquid assets need to be sold, those liquidity reserves can make up the shortfall in the meantime.
The “right” liquidity level differs between individuals and even for the same individual over time, so we recommend speaking to an experienced wealth management team about making a liquidity budget part of your strategy.
Let Lindberg & Ripple keep your liquidity in focus
Wealth can bring many diverse investments, interests, and possessions into our lives. Keeping an eye on the liquidity level of each one before adding it to your portfolio is a solid way to stay flexible in the future. Our team can assess your current liquidity and advise you on how to achieve the level that’s right for your short and long-term financial strategy.
Lindberg & Ripple offers customized wealth management, investment, and insurance solutions to wealthy families and successful businesses. We help our clients craft a comprehensive wealth planning model to achieve their financial goals with minimum fuss and maximum savings. Connect with us to learn more.