Editor’s note: This article was first published in March 2014, and its land-and-property anecdote refers to Spain’s property crash, before the crisis. The sale of a plot for €3,000 versus €70,000 is the author’s personal account.
One of our readers asked us “what counts as an illiquid asset, and could we give some examples?”
Let’s start with a simple definition of a liquid asset: “A liquid asset is one that can be converted into cash easily, quickly and at market value.”
With that in mind, the most liquid assets there are cash (liquidity personified), shares and bonds. Basically, we could include “marketable securities”.
In reality, almost every asset is liquid nowadays, but we have to measure the degree of liquidity. Saying that someone has a net worth of 3 million euros is not the same as saying they have 500,000 euros in liquid assets. If I were lending them money, I’d trust the second one more.
Examples of low-liquidity assets (illiquid or non-liquid assets)
Illiquid assets could include practically anything, from your TV, car or iPhone to a house or a plot of land (real estate), as well as any investment we’ve made in works of art.
You might own a home worth 300,000 euros, but if you needed the money tomorrow, you probably couldn’t turn it into cash in that time, and depending on the state of the market you might struggle to sell it even over several months. That’s why real estate is considered one of the least liquid assets there are.
Take a car as an example. Today there’s a large market for buying and selling used cars, where we could sell our vehicle tomorrow and get cash for it on the spot, but it would be at its appraised value, which is usually well below what we consider a fair price for our car. In fact, a car is a depreciating asset.
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Additional comments
Although 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 aren’t listed on a stock exchange, your money is in an illiquid asset, since you depend on finding a buyer willing to pay you for your stake.
Likewise, among listed companies some trade very thinly, and we could have trouble selling our shares at a reasonable price. This happens above all with companies quoted on OTC Markets.
As a general rule, though, if you hold “normal” shares in your portfolio, you can sell at the market price whenever you want. Whether they happen to be trading at a good price for selling at the moment you need to turn them into cash is another matter (they could be trading below what we paid for them). That’s why the usual advice is to put into the stock market only money we won’t need for the next 5 or 10 years.
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The difference between liquid assets and net worth
Net worth is the sum of all our assets, both liquid and illiquid. Before the crisis I knew people with more than 10 million euros of net worth in land and property who literally didn’t have 3 euros to buy breakfast. Their wealth was “illiquid” and, on top of that, losing value fast.
I’ve seen them sell rural plots for €3,000 to meet other payments, plots they could have sold for €70,000 just two years earlier. In a property crisis, with supply and demand out of balance, a plot of land may be worth nothing at all, and so the only way to turn it into cash is to sell at a loss.
That’s 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 dreaded inflation. So cash should be invested, and, as we’ve seen, invested as far as possible in liquid assets with the potential to grow in value.
Further reading
- The 4 most notable differences between how the rich think and everyone else
- The magic of compound interest
- 12 things millionaires know
- Charlie Munger’s 5 steps to getting rich
- The 10 dumbest things to spend money on
Featured image: Markus Spiske from Forchheim, Bavaria Upper Franconia, CC BY 2.0, via Wikimedia Commons.
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