• Skip to primary navigation
  • Skip to main content
  • Skip to primary sidebar

Wealth Pilgrim

No Money Worries. No Matter What.

Neal Frankle featured in
  • Home
  • Life Insurance
  • Investing
    • Build Strong Investment Building Blocks To Avoid Going Broke In Retirement
    • Systematic Mutual Fund and ETF Investing
    • Stock Market Investing Guide
    • Choosing the Right Investment Brokerage Guide
    • How Bonds Work Guide
    • How Banks Really Work Guide
    • Annuities – What You Need To Know Before You Invest
    • A Beginners Guide To Buying Individual Stocks
    • Create A Pool Of Great Mutual Funds and ETFs To Pick From To Secure Your Retirement
    • ETF and Index Fund Investment Guide
  • Earn More
  • Banking
  • Retirement Planning
    • Retirement Guide
  • Ask Neal a Question
  • Reviews
    • Upgrade Personal Loans Review
    • Lending Club Review
    • Prosper Review
    • Ally Invest TradeKing Review
    • CIT Bank Review
    • LegalZoom Review
    • Lexington Law Review
    • Airbnb Host Review
    • Should You Drive For Uber?
  • Tax
  • Courses
    • Raise Your Credit Score So You Can Buy a House – Free Video Course

Investment Liquidity Explained

by Neal Frankle, CFP ®, The article represents the author's opinion. This post may contain affiliate links. Please read our disclosure for more info.

Investment liquidity refers to how quickly you can sell a particular investment and receive cash for it in exchange. If it doesn’t take long to accomplish the trade, your investment is said to be very liquid. If it typically takes a very long time to convert an investment into cash, it is considered illiquid.

Which investments are liquid?

In reality, every investment is liquid and you’ll see why in a minute. For now, let’s get back to our discussion.

Cash is extremely liquid. In fact, cash defines liquidity. Also, stocks are considered pretty liquid.

With stocks, all you generally have to do is place a market order to sell your shares and within 3 days, your trade will “settle”. After settlement, you’ll receive your cash.

Shares are especially liquid if they are heavily traded. In other words, if millions of shares are traded every day it won’t be hard for you to sell your shares at the prevailing market price whenever you like.

This is not the case with “thinly traded” stocks. A thinly traded stock is one that isn’t traded very much. If very few orders come in to buy or sell this stock every day, you may find it very difficult to sell your shares when you want to at the price you want to receive.

As a result, thinly traded shares may not be as liquid as you think. And it gets worse. When very few shares are traded, there is usually a huge difference between the buy and sell price – known as the “spread”. The larger the “spread”, the greater the slippage (difference between the market price of the stock and what you will ultimately get when you sell) and that means thinly traded stocks cost more to trade than heavily traded shares. Illiquidity is directly responsible for these additional costs.

If you use a good online broker like Scottrade, you can check on the liquidity before you decide to make an investment. That is a very smart move.

Bonds are considered liquid although somewhat less liquid than stocks. While you can usually sell your stock shares instantly, it may take several hours (or days) to unload your bonds. Why?

The vast majority of bonds are traded by professionals between themselves and they prefer to deal in very large trades. We are talking about multi-million dollar transactions. If you want to sell your $25,000 or even $100,000 bond, it may take a while to find a buyer. So bonds are liquid but not quite as liquid as other securities.

Real estate is not considered very liquid. It can take months, years or decades to sell a piece of real estate at a price you think is fair. The same is true with regards to selling a small business. When it comes to real estate and/or small businesses, there are a smaller number of qualified people who have the resources and desire to buy compared to stocks. Let’s look at an example.

Millions of people have the capacity and desire to own (at least a few) Apple shares. But how many people have the capacity and know-how to buy and manage an apple orchard? Far fewer. As the number of buyers and/or sellers gets smaller, the investment becomes less and less liquid.

Why Everything I Just Said Is Wrong

In reality, every investment is liquid. It just depends on the price you are willing to sell for. Let’s say you are fortunate enough to own 10 city blocks in Manhattan. That property might have a market value of several billion dollars.

If you are in a pinch and need to sell that property fast, you can do so. All you have to do is drop your price by 80% and I guarantee you’ll have your money within a few hours. That’s an example of taking an illiquid investment and making it very liquid. It also illustrates one of the most important lessons every investor must understand:

No matter how great an investment is, if it’s not liquid, it increases your risk. So the more money you allocate to illiquid investments, the more time you must be willing (and able) to wait to convert those investments into cash.

You never know what the future holds and as a result you have to be ready for anything. If all your investments are illiquid – you are asking for trouble. Very big trouble.

This is not to say that buying real estate or owning your own business (the two least liquid investment there are) are bad ideas. I think they are wonderful ideas. But to invest in real estate or a business without making contingencies for their lack of liquidity is super dangerous. Please don’t ignore this risk.

How liquid is your portfolio? Have you ever paid for the price for having illiquid investments?

Tweet
Pin
Share2

Reader Interactions

User Generated Content (UGC) Disclosure: Please note that the opinions of the commenters are not necessarily the opinions of this site.

Comments

  1. Neal Frankle says

    December 27, 2012 at 9:39 AM

    Agreed Krant Cents. Liquidity can make a great investment a nightmare.

    Reply
  2. krantcents says

    December 27, 2012 at 9:01 AM

    With interest rates and real estate values so low, many people are interested in investing. The biggest shortcoming of real estate is liquidity. If it is a good investment, you must consider liquidity.

    Reply

Leave a Reply Cancel reply

Your email address will not be published. Required fields are marked *

Are You Human? * Time limit is exhausted. Please reload CAPTCHA.

Primary Sidebar

Who is Neal Frankle

Neal Frankle

I'm a CERTIFIED FINANCIAL PLANNER™ Professional with more than 25 years of experience. I feel very blessed and hope to share my personal financial experience and professional wisdom with readers of WealthPilgrim.
Read More »

Stay Connected

Facebook Twitter YouTube RSS

More Categories

Career Development
College Funding
Credit Cards
Credit Score Fixes
Money and Marriage
Debt Relief
Estate Protection
Property Investment Loans
Small Business Strategies
Spend Less Money

Disclaimer

Wealth Pilgrim is not responsible for and does not endorse any advertising, products or resource available from advertisements on this website. Wealth Pilgrim receives compensation from Google for advertising space on this website, but does not control the advertising selection or content. Please do the appropriate research before participating in any third party offers. The information contained in WealthPilgrim.com is for general information or entertainment purposes only and does not constitute professional financial advice. Please contact an independent financial professional for advice regarding your specific situation. Wealth Pilgrim does not provide investment advisory services and is not a registered investment adviser. Neal may provide advisory services through Wealth Resources Group, a registered investment adviser. Wealth Pilgrim and Wealth Resources Group are affiliated companies. In accordance with FTC guidelines, we state that we have a financial relationship with some of the companies mentioned in this website. This may include receiving payments,access to free products and services for product and service reviews and giveaways. Any references to third party products, rates, or websites are subject to change without notice. We do our best to maintain current information, but due to the rapidly changing environment, some information may have changed since it was published. Please do the appropriate research before participating in any third party offers.


About · Contact · Disclaimer & Privacy policy

Copyright © Wealth Pilgrim 2022 All Rights Reserved