On your road to building financial wealth and developing your financial wellness, one of the most important things to remember is to diversify, diversify, diversify. This includes broadening your investment portfolio to include highly liquid investments.
Not sure where highly liquid investments have a place in your portfolio? Here’s your primer on the subject, along with some of your best options to consider to get started!
What is the definition of liquidity?
To fully understand what liquid investments are, it helps to understand liquidity.
Liquidity means you have a sufficient amount of accessible liquid assets that you can easily convert into cash. E.g. your liquid net worth.
For your day-to-day life, this basically means you have enough cash (or cash equivalents) on hand so you can pay all your bills on time.
When you compare your liquidity to your overall assets (including non-liquid assets), you'll find your liquidity ratio.
Highly liquid investments 101
Liquid investments are assets that can easily be converted into cash in a short amount of time with little to no decrease in their value. Highly liquid investments, on the other hand, are simply assets that can be most easily and quickly converted into cash.
You may also hear liquid investments referred to as cash equivalents. This is because people can usually have confidence that they can easily exchange their liquid investments for cash at any time, whenever they need.
But there's more to liquid investments than just being cash equivalent.
Factors that make an investment liquid
In order for an investment to be a highly liquid investment, it must meet a number of factors:
- The asset must be in an established liquid market.
- The asset must maintain a large number of readily-available, interested buyers.
- The asset must be able to be transferred easily and securely.
Why are highly liquid investments important?
If you've done any reading about personal finance and how to strengthen your personal finances for today, tomorrow, and the future, then you've undoubtedly read about the importance of investing in retirement accounts.
But while fattening up your retirement accounts and investing smartly to plan for retirement should certainly be a top priority, you also need to think about the here and now.
This is why highly liquid investments are so important.
Low-risk investing for the near future
Owning liquid investments means that you can pay for your living expenses today. It also gives you a comfortable cushion to prepare you to pay for any emergencies that may come your way.
Liquid investments are a great tool when you're saving for a short-term financial goal. For one, it gives you an opportunity to invest, but with low risk. This means you can incrementally grow your funds and then still easily access the cash you need in the near future.
How near is the near future? Liquid investments are a good option when you want to be able to use that cash in less than three years.
This makes highly liquid investments a great option for saving for things like an emergency fund, a down payment for a new house, or a wedding.
The downside to highly liquid investments
Remember the first rule to investing: diversify, diversify, diversify.
Although liquid investments can be very advantageous and should definitely make up a portion of your overall investment portfolio, you definitely do not want to rely solely on liquid investments to build your wealth.
What's the catch with highly liquid investments?
Well, the more liquid an asset is, the less its value will increase over time. For example, suppose you're saving up for a big purchase in the near future.
You may choose to maintain some funds in cash, one of the most highly liquid investments. But over time, the cash won’t be able to compete with inflation. Inevitably, its purchasing power will decrease as the years go by.
This is why preparing for retirement is about more than just saving cash—it’s about investing wisely. To grow your wealth over time and build long-term financial health, the key is to have a mix of different assets. This includes highly liquid investments, among others, like real estate investing or even cryptocurrency.
12 Highly liquid vs short term highly liquid investments
Of course, not all liquid investments are the same. Some assets are more liquid than others. For instance, short term highly liquid assets.
The biggest variable among liquid investments is the time to conversion. This just means how easy it is and how long it takes to convert an asset to cash. And the easier it is to convert an asset to cash, the more liquid it is.
Then there are illiquid assets (or nonliquid assets). While illiquid assets can make up a very valuable part of your overall portfolio, you can't easily convert them to cash or sell them without taking a loss on the sale.
Examples of illiquid assets might be real estate, collectibles, estates, or other intangible assets.
Short-term highly liquid assets and accounts
Short term highly liquid investments can be accessed quickly and easily.
Cash is the most liquid asset among short term highly liquid investments. You can either hold the physical currency yourself or easily access it via ATM withdrawals.
2. Treasury bills and treasury bonds
Also called T-bills and T-bonds, these highly liquid assets are some of the most stable, as the United States government itself backs them up. Holding on to the bond will earn you interest up until the maturity date. But if you need cash fast, you can also sell them sooner.
3. No-penalty certificates of deposit
With certificates of deposit (CDs), you can usually earn higher interest rates than you would with a standard savings or checking account. The catch? It’s usually more difficult to withdraw from a CD before its maturity date.
But if you invest with a no-penalty CD, you can tap into your funds more easily as a short term highly liquid investment.
With exchange-traded funds, you can invest in an index fund instead of the stocks of just one company. But don’t forget—ETFs are just as volatile as the market.
There’s no telling whether your ETFs will be worth more or less when you’re ready to sell them. But you are able to sell them freely whenever you need the cash.
5. Money market funds
These are mutual funds that invest specifically in highly liquid, near-term investments. Investors will turn to money market funds because they offer high liquidity with very low risk, so they’re a great option to tap if you need to save for a short-term goal.
6. Interest-bearing checking account
Checking accounts come in second after cash as being the most liquid asset. While checking accounts aren't usually a place for investing, there are some options that offer interest.
7. High-yield savings accounts
A high-yield savings account will offer a much more attractive interest rate than an interest-bearing checking account, but it will be slightly less liquid. For example, banks may restrict your number of monthly withdrawals.
Highly liquid assets and accounts
Highly liquid assets and accounts can still be accessed relatively quickly and easily but often not as fast as those listed above.
8. Certificates of deposit
We already know that CDs are a great option for a highly liquid investment. If you don’t need a short-term, highly liquid asset, you can forgo the no-penalty CD for a traditional option.
Stocks are some of the easiest investments to liquidate—but they are also the most volatile. This means you may face a loss if you need to liquidate your assets while the stock market isn’t in your favor.
For this reason, stocks are not the safest choice for building an emergency fund, but they are still an important part of building a diversified portfolio.
10. Mutual funds
A lot of investors like mutual funds because they offer an easy way to diversify your investments.
The catch is, though, that mutual funds only trade once per day at the close of the market, making them slightly less liquid than ETFs or stocks. They are also known to have higher management fees than index funds.
11. Taxable investment accounts
Taxable investment accounts can hold stocks, bonds, ETFs, and mutual funds. You can open this kind of account via a brokerage. Once you sell your assets, they’ll be available as cash, usually within days.
Remember, though, that your assets will be vulnerable to market conditions, so you may have to sell them at a loss in some cases.
12. Precious metals
While not a popular choice for investing, precious metals can actually be both liquid and illiquid investments. This depends on several things, including where you store your metals and how readily you can find dealers to make an exchange for cash.
Meet your financial goals with highly liquid investments!
Liquid investments make up a key part of any healthy financial portfolio. You can leverage them to achieve your short terms goals while adding additional diversity to your investments.
Start by doing your research on the different types of highly liquid investments and then chose one to invest in. You can then add on additional investments as you feel more comfortable. As mentioned, having highly liquid investments are an essential part of any portfolio.
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