Asset liquidity is one of those financial terms that sounds a lot more complicated than it actually is. It’s a concept worth learning about, especially if you’re in the market for a mortgage.
It doesn’t mean your money is literally liquid (don’t go melting down all your precious metals just yet). But just as a physical liquid flows freely and easily, liquid assets are those that move fluidly from their spot in a savings account or an investment portfolio into cold, hard cash.
Liquid assets are an important part of your financial profile for a variety of reasons. Let’s dig into what exactly they are and why you might need them.
What Is a Liquid Asset?
A liquid asset is something you own that can quickly and simply be converted into cash while retaining its market value.
Some examples of assets that would be considered liquid are:
- Checking or savings accounts
- Certain types of investments
The sum of all your assets combined, liquid or otherwise, minus your liabilities (debts you owe), makes up your net worth. While your net worth is a good number to have on hand, it’s also important to know the total value of your liquid assets, because that tells you how much cash you’d have quick access to if you were in a tough spot.
It’s also good to know what types of assets aren’t considered liquid. Generally, anything that would take some time to convert to cash or anything that could lose value in the process of doing so is considered illiquid. Some examples are:
- Real estate
- Valuable items, such as jewelry
Something to keep in mind: Liquidity isn’t necessarily a fixed, black-and-white designation; it’s actually more of a scale. Cash is considered to be highly liquid because it’s already in its most liquid form and doesn’t need to be converted, while money you have in stocks is slightly less liquid because there are more steps involved in converting it to cash.
What Investments Are Considered Liquid?
There may be some confusion over whether investments are considered liquid assets. The short answer is that yes, most investments would be, but it depends on what kind we’re talking about.
Some types of investments that are considered liquid assets are:
- Mutual funds
- Money market funds
As we already mentioned, real estate isn’t considered liquid, so any investment properties you own aren’t classified as liquid assets. Selling a property can take a long time, and you might not necessarily get its market value back when you sell it – especially if you’re trying to do so quickly.
A certificate of deposit (CD) account may be slightly liquid, depending on its terms. CDs generally come with steep early-withdrawal fees, although some specialty accounts may feature low or even no penalty for early withdrawal.
Certain types of retirement investment accounts may also be considered slightly liquid, based on how easy it is for you to withdraw that money at full value without incurring significant penalties. Some accounts offer the ability to make hardship withdrawals should you find yourself in need of money. However, make sure you understand the terms of your specific accounts and the penalties that come with early withdrawal well before you find yourself needing to make one.
Why Is Asset Liquidity Important?
Liquidity is important in cases of financial emergency. When you encounter hardship, you won’t necessarily have time to go through the process of putting your house on the market or selling your collection of rare artwork. You’ll need quick access to funds so you can pay for your essentials and stay on top of your bills. In a dire financial situation, it doesn’t matter what your net worth is or how wealthy you are on paper. What matters is whether or not you have funds that you can get immediate access to.
When you’re applying for a mortgage, your lender will likely consider this exact situation. They’ll verify the assets you own and how liquid they are, and determine if you have enough easily accessible money in reserve to cover your mortgage payments if you were to encounter a temporary financial hardship.
Ultimately, having a sufficient source of liquid assets is an important part of having a healthy financial profile. We generally can’t anticipate hardships, such as losing a job or developing a debilitating illness. Having cash ready to go in the event of a financial crisis will make getting through it a little more manageable and give you some peace of mind.
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