In the world of investment, the concept of liquidity plays a key role. Liquidity refers to the amount of cash in the form of ready cash or assets available to be used to fulfil financial responsibilities.
It plays a vital role because liquidity ensures you have enough cash in emergencies. But the terms that can easily baffle a non-businessman are Liquid and Illiquid assets. Knowing the difference between them may aid in investing.
Key Takeaways
- Liquid assets can be quickly converted into cash with minimal impact on their value, while illiquid assets have limited marketability and longer conversion times.
- Stocks, bonds, and cash are liquid assets, while real estate, artwork, and collectibles are illiquid assets.
- Liquid assets offer greater financial flexibility, whereas illiquid assets may have higher potential returns but also come with increased risk.
Liquid vs Illiquid Assets
Liquid assets can be easily converted to cash without a significant loss in value. It includes money, checking accounts and savings accounts etc. Illiquid assets cannot be easily converted to currency without incurring a significant loss in value or taking a substantial amount of time.
Liquidity or Liquid Assets are those assets that, can be converted into quick cash by quickly selling on rainy days. They are majorly in the form of ready cash or marketable securities.
A high amount of Liquid Assets means the company has enough financial capital or net worth and won’t face any economic issues. These assets ensure that the company will not face any severe financial loss.
On the other hand, Illiquid Assets are those assets that can’t be easily converted into cash without a loss.
These assets may seem of no value but, are more valuable than Liquid Assets as they manifest to be challenging to be sold and thus carry more weight.
But more Illiquid Assets mean that the company may face severe losses if they do not have any backup plan. Illiquid Assets are challenging to sell as there may be fewer buyers or massive procedures involved in selling them.
Comparison Table
| Parameters of Comparison | Liquid | Illiquid |
|---|---|---|
| Conversion to Cash | Easy | Difficult |
| Financial Security | High | Low |
| Accessibility to Investors | Easily Accessible | Comparatively Low Accessibility |
| Stability | Not stable during Inflation (Fluctuations) | Relatively Stable for more extended period |
| Examples | Cash, Stocks, Bonds, etc. | Penny Stocks, Hedge Funds, etc. |
What is a Liquid Asset?
As aforementioned, a Liquid Asset is a type of Asset that can be readily converted into real/ quick cash without any significant loss.
A Liquid Asset is quite helpful in emergencies, and Liquid Assets also prove that a company has a good cash inflow and will not suffer soon. More Liquid Assets also ensure that the company has an excellent net worth.
In an emergency, when a company needs to pay back instant cash Liquid Assets like a small property, a gold watch, or some antique jewellery proves to be quite helpful as by quickly selling them, the cash could be paid back without the company suffering a considerable loss.
A company always ensures that the amount of Liquid Assets is more than any other asset because they prove to be helpful and maintain the company’s financial stability.
For instance, if we take the example of a Bank, a bank is expected to maintain Liquidity throughout the year as they always need to fund new loans, account withdrawals, etc.
A bank with the highest liquidity fulfils all these expenses only with its Liquid Assets.
At a consumer level, a person can achieve Liquidity by earning a monthly income that can fulfil all his expenses without borrowing a loan or selling anything precious.
A few more examples of Liquid Assets are Mutual Funds, Exchange Trade Funds (ETFs), Cash, Certificates of Deposits, etc.
What is an Illiquid Asset?
As mentioned above, Illiquid Assets are those assets that cannot be easily converted into quick cash without significant loss.
These assets hold more value in the long run as they carry colossal deal and do not suffer fluctuations even during inflations.
The challenging part of selling an Illiquid Asset may be that more buyers won’t be interested in buying the asset, or they may back out due to the expense involved in purchasing the Illiquid Asset.
An Illiquid Asset is not bad on its own; it is just advised that a company should not possess too many Illiquid Assets or Investments as they may prove detrimental during bad times.
An Illiquid Asset has few benefits, too. They are one-time investments that guarantee that a company wouldn’t suffer in the long run; for instance, a real estate property will not suffer the impact of inflation and will always be of great value with no practical fluctuations.
So, giving up your company’s liquidity may have some pros too.
The overall value of these Assets improves with time,; hence, possessing some Illiquid Assets is quite significant. This benefit is compensation for the loss of Liquidity of a company.
Illiquid Assets ensure the diversification of your investments, as it is not a safe option to have all your investments as Liquid Assets.
Illiquid Assets are quite helpful in down markets as they minimize your portfolio losses.
The only con of an Illiquid Asset is the Longer Lock-Up Time as you won’t be able to sell them quickly, and also, they take up more time to grant returns, with some Illiquid Assets taking up to 10 years.
Examples of Illiquid Assets are Real Estate, Houses, Antique instruments/ articles, Investments in a Private Company, etc.
Main Differences Between Liquid and Illiquid Assets
- Liquid Assets are those assets that can be quickly sold without any loss, whereas Illiquid Assets are those assets that cannot be sold without any significant loss.
- Liquid Assets are easily accessible to all the investors, on the other hand, Illiquid Assets are almost inaccessible to all the investors due to the expense involved in the sale of these assets.
- Liquid Assets may face fluctuations in the long run. In contrast, Illiquid Assets guarantee stability even during inflation.
- Liquid Assets may grant instant returns, while Illiquid Assets grant returns after a few years ranging from 5 to 10 years.
- Possessing a higher amount of Liquid Assets ensures good financial security and net worth, whereas possessing a higher amount of Illiquid Assets may be a disaster during a huge crisis.
- A Liquid Asset is easy to be sold off and get rid of, but Illiquid Assets are not easy to get rid of as they carry a long lock-up period.
References
Last Updated : 13 July, 2023
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Chara Yadav holds MBA in Finance. Her goal is to simplify finance-related topics. She has worked in finance for about 25 years. She has held multiple finance and banking classes for business schools and communities. Read more at her bio page.
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