What Are Liquid Assets And Why Are They Important?
Asset liquidity is one of those financial terms that sounds a lot more complicated than it is. It’s a concept worth learning about, especially if you’re in the market for a mortgage.
Since they are able to transfer freely from a savings account, an investment portfolio or other spot into cash, liquid assets are an important part of your financial profile for a variety of reasons Let’s take a closer look at the definition of liquid assets, examples of liquid assets and why you might need them.
What Is A Liquid Asset?
An asset describes anything you own that holds monetary value. A liquid asset is defined as a type of asset that can quickly and easily be converted into cash while retaining its market value. Liquid assets are a particularly important safeguard to have if you experience financial hardship and need cash fast.
Your liquid assets also help contribute to your overall net worth. Calculate the sum of all your assets combined, liquid or otherwise, and subtract your liabilities (debts you owe) to figure out 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.
Whether you're working on your personal finances or painting your financial picture as a business owner, recording assets and liabilities on a balance sheet can help you quickly understand your financial future.
Liquid Assets Examples
What exactly are liquid assets in the real world? Some examples of assets that would be considered liquid include the following:
- Cash: These are any physical bills you have in your wallet.
- Savings or checking accounts: This is any and all cash available in your bank accounts.
- Mobile payment accounts: This includes any money in mobile payment service accounts like Venmo or PayPal.
- Money market account: This is a type of savings account at a bank or credit union that bears a higher interest rate.
- Certain types of investments: This often includes bonds, certificates of deposit, money market accounts and stocks.
- Accounts receivable: Although often debated, many business owners consider the money owed from clients a type of liquid asset.
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 and marketable securities that are considered liquid assets are:
- Stocks: Any stocks you own or are held in your name are typically liquid. The stock market is considered liquid because of the constant number of buyers and sellers.
- Cash equivalents: In the business world, these refer to a company’s short-term investments, 90 days or less. Long-term investments aren’t considered liquid.
- Mutual funds: This is a fund that pools money from many investors to purchase stocks and other securities.
- Bonds: A bond is a type of low-risk investment loan that can provide a steady cash flow for borrowers.
- Treasury bills: These are short-term securities that are issued and backed by the U.S. Treasury Department.
- Money market funds: Different from a money market account, this is a type of mutual fund that invests in highly liquid, short-term securities like cash and cash-equivalents.
- Certificates of deposit (CDs): A CD is a savings account that generally comes with steep early-withdrawal fees, although some specialty accounts may feature low or even no penalty for early withdrawal.
- Retirement accounts: A retirement account can include a 401(k), an IRA and/or other accounts. They are only considered liquid when the owner has reached retirement age.
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Non-Liquid Assets Explained
It’s also beneficial to understand what types of assets aren’t considered liquid. Non-liquid assets, otherwise known as illiquid assets, are assets that would take significant conversion time or will depreciate when converting them to cash. Illiquid assets include:
- Land and real estate: Selling real estate doesn’t happen overnight. If a property owner wants to sell, it takes time to find a new owner, negotiate and close before they see the money in their bank account.
- Collectibles: Valuable items such as jewelry, artwork or hobby-related collections aren’t considered liquid because these items can be hard to resell or determine value.
- Private equity: Even if you own a business or organization, tapping into its equity isn’t always easy. There are many restrictions on when you can sell shares, especially with venture capital funds.
- Employee or company stocks: Although company stock options for employees can be a wonderful incentive, it’s typically only beneficial for those who stay with the company long enough to see ownership. These types of stocks aren’t always easy to trade either.
Keep in mind that liquidity isn’t necessarily a fixed, black-and-white designation but more of a scale. Cash is highly liquid because it’s already in its most liquid form and doesn’t need to be converted. Money you have in stocks, on the other hand, is slightly less liquid because there are more steps involved in converting it to cash.
Is A House A Liquid Asset?
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 your house’s market value back when you sell it – especially if you’re trying to do so quickly.
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 you have immediate, accessible funds.
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.
The Bottom Line
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.
Building your liquid assets not only contributes to your overall financial wellness, but it can pave the way toward potential homeownership. Lenders may evaluate your assets on your mortgage application and like to know that borrowers have cash reserves available.
Now that your liquid assets are in order, are you ready to take a step toward homeownership? Start your mortgage application process today.
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