“What do we call liquid or illiquid assets?” is a very common question, because in finance these are two terms that come up all the time. So today we are going to give the definition and some examples so that the difference between a liquid asset and a non-liquid asset is perfectly clear.
We will also look at the types of liquid assets that exist, and here you can see what kinds of assets you can build to generate passive income.
What are liquid assets?
By definition, liquid assets are assets that we can convert into cash easily, quickly and at market value, that is, without losing value or paying a penalty.
Examples of liquid assets
With that said, the most liquid assets there are are cash (liquidity personified), shares and bonds. Basically, we could include “marketable securities”.
In reality, nowadays practically all assets are liquid, but we need to measure their degree of liquidity. Saying that someone has a net worth of 3 million euros is not the same as saying that someone has 500,000 euros in liquid assets. If I were lending money, I would trust the second person more.
Examples of low-liquidity assets
Definition of non-liquid assets
Practically anything could be called a non-liquid asset, from your TV, car or iPhone to a house or a plot of land (real estate assets), as well as our investment in works of art.
We may have a house valued at 300,000 euros, but if you need the money tomorrow, you probably could not turn it into cash in that time, and depending on the state of the market you might struggle to sell it even over a period of months. That is why a property would not count as a liquid asset.
Real estate is considered one of the least liquid assets there is
If we take a vehicle as an example, today there is a large market for buying and selling cars, where we could sell our vehicle tomorrow and get cash for it on the spot. But it would be at the appraised value, which is usually well below what we consider a fair price for our vehicle. In fact, a car is a depreciating asset.
In this case, although in theory a car could be considered a liquid asset because it can be sold easily, it would not really be a liquid asset if we bear in mind that we could not sell it without losing value. At least we have no guarantee of being able to sell it without a loss compared with the value we consider acceptable.
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While we say that shares are liquid assets, the truth is that not all shares enjoy the same liquidity.
To begin with, if you buy shares in companies that are not listed on a stock exchange, your money would be in a non-liquid asset, since you depend on finding a buyer willing to pay you for your block of shares.
Likewise, among listed companies there are some with low trading volumes, where we might have trouble selling our shares at a reasonable price. This mostly happens with companies quoted on OTC Markets, the famous penny stocks.
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As a general rule, though, if you hold “normal” shares in your portfolio, you can sell at the market price whenever you want. Whether those shares are trading at a good price for selling at the moment we need to turn them into cash is another matter (they could be trading below the price we paid for them). That is why the usual advice is to invest in the stock market only money we will not need for the next 5 or 10 years.
The difference between liquid assets and net worth
Net worth is the sum of all our assets, both liquid and non-liquid. Before the crisis I knew people with more than 10 million euros of net worth in land and property who literally did not have 3 euros to pay for breakfast. Their wealth was “non-liquid” and, on top of that, losing value fast.
I have seen them sell rural plots for 3,000 euros to meet other payments, plots they could have sold for 70,000 euros just two years earlier. In a property crisis, with supply and demand out of balance, a plot of land can be worth nothing, and so the only way to turn it into cash is to sell it off for a pittance.
That is why the health of our finances and our financial peace of mind depend to some extent on liquid assets making up a high percentage of our net worth.
As the saying goes, cash is king, but you should avoid hoarding cash because of the dreaded inflation. So cash should be invested and, as we have seen, invested as far as possible in liquid assets with the potential to grow in value.
Further reading
