Liquidity is one of the most important metrics of any asset, alongside profitability and risk. A liquid asset can be readily converted to cash, with little impact on its value. This means that the asset is in high demand and can be easily sold on an established market.
When it comes to investment portfolios, liquidity is crucial as it allows investors to quickly free up cash to cover living expenses or emergencies. However, it's important to note that the more liquid an asset is, the less its value will increase over time.
So, which investment portfolio is the most liquid?
Cash is widely considered the most liquid asset. Following cash, the most liquid investments include money market assets, marketable securities, US government bonds, mutual funds, and exchange-traded funds (ETFs). These investments can be easily converted to cash, providing quick access to funds when needed.
It's worth noting that while real estate is often touted as a great investment, it is considered illiquid due to the time and effort required to sell properties.
Characteristics | Values |
---|---|
Most liquid asset | Cash |
Other liquid investments | Money market assets, marketable securities, US government bonds, mutual funds, exchange-traded funds, stocks, bonds, online savings accounts, money market accounts, online checking accounts, cash management accounts, taxable investment accounts, corporate bond funds, treasury inflation-protected securities |
What You'll Learn
Cash and cash equivalents
Cash equivalents are other asset holdings that are treated similarly to cash due to their low risk and short-term duration. Examples of cash equivalents include treasury bills, treasury notes, commercial paper, certificates of deposit, and money market funds.
Treasury bills and treasury bonds are highly stable investments backed by the US government. They can be sold instantly on the secondary market if you need their value before they mature, making them highly liquid.
Money market funds are mutual funds that invest in highly liquid, near-term investments. They are a great option for saving for short-term goals as they offer high liquidity with very low risk.
Cash is the most liquid asset as it is the most easily accessible and can be used to make payments on liability obligations. However, the more liquid an asset is, the less its value will increase over time. Completely liquid assets, like cash, may fall victim to inflation, resulting in a decrease in purchasing power over time. Therefore, it is important to balance liquid and illiquid assets in your investment portfolio.
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Money market instruments
Money market funds are a type of mutual fund that falls under the category of money market instruments. They invest in highly liquid, near-term instruments, such as cash equivalent securities and high-credit-rating, debt-based securities with short-term maturity. Money market funds aim to provide investors with high liquidity and very low risk.
Money market accounts, on the other hand, are a type of savings account that offers higher interest rates than regular savings accounts but often come with restrictions on withdrawals. While money market funds and money market accounts sound similar, they are distinct, as money market funds are investment vehicles, whereas money market accounts are a type of bank account.
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Marketable securities
There are three different classifications of marketable securities:
- Available for Sale (AFS): Purchased with the intention to sell prior to maturity
- Held-to-Trading: Bought to receive a short-term gain post-sale and before full maturity
- Held to Maturity (HTM): Purchased with plans to hold until the date of maturity
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Short-term bonds
The main advantage of short-term bonds is their ability to generate current income with a lower risk. While they are subject to interest-rate risk and credit risk, their short maturities result in more muted losses compared to longer-term instruments. Short-term bonds are also inherently safer than stocks and rank higher in the capital structure, offering protection to investors in the event of bankruptcy.
There are two main ways to invest in short-term bonds: purchasing individual bonds or investing in a fund. Individual bonds offer the simplicity of collecting semiannual interest until the bond's maturity date. On the other hand, investing in a fund provides benefits such as lower trading costs, professional management, broader diversification, and the flexibility to reinvest proceeds at higher interest rates.
When considering short-term bonds, it's important to evaluate your investment goals and risk tolerance. These bonds are well-suited for investors seeking a stable and relatively safe option for short-term financial goals, such as building an emergency fund or saving for a down payment on a house.
In summary, short-term bonds are a liquid investment option that provides income with lower risk. They are a key asset class that most investors should consider, along with cash and large-cap stocks, to diversify their portfolios and effectively manage their financial strategies.
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Mutual funds or exchange-traded funds (ETFs)
Liquidity is a key consideration when building an investment portfolio. A liquid asset is one that can be easily converted into cash within a short amount of time, with little impact on its value.
Mutual funds and exchange-traded funds (ETFs) are both funds that hold portfolios of investments like stocks, bonds, or commodities. They can be good options for investors but have some key differences. Here's a detailed comparison of the two:
Mutual Funds:
Mutual funds are commonly managed by financial institutions and are typically purchased through a brokerage firm. They are actively managed, meaning the fund manager buys and sells securities as deemed necessary to attempt to outperform the market. This active management results in higher costs compared to ETFs. Mutual funds can also have load fees, which are charged as a percentage of the dollar amount purchased, and these can be front-end or back-end loads. Mutual funds tend to generate more capital gains, which have tax implications for investors. They also usually have higher management fees than ETFs.
Exchange-Traded Funds (ETFs):
ETFs trade on exchanges like common stocks, and most track an underlying index like the S&P 500. They are considered passively managed since they only trade securities when the composition of the underlying index changes, resulting in lower expenses than mutual funds. ETFs are priced based on market demand and can be bought and sold throughout the trading day, making them more liquid than mutual funds. They also don't have load fees, making them more accessible to investors. ETFs generate little in the way of capital gains, resulting in lower tax liability for investors.
Both mutual funds and ETFs offer benefits and have their place in an investment portfolio. Mutual funds are suitable for investors seeking to beat the market and are willing to pay higher fees for active management. On the other hand, ETFs are ideal for those wanting a more passive investment strategy, lower fees, and easier liquidity.
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Frequently asked questions
A liquid asset is an asset that can be readily converted to cash. This means the asset can easily be sold with little impact on its value. Liquid assets include cash, money market instruments, and marketable securities.
Examples of liquid assets include cash, money market accounts, marketable securities, short-term bonds, stocks, and accounts receivable.
Liquid assets are easily converted to cash with little to no decrease in value. Illiquid assets, on the other hand, are more difficult to sell and may result in a loss if liquidated quickly. Examples of illiquid assets include real estate, antiques, and art.