Investments Vs Savings: Liquidity And Financial Planning

Investments are less liquid than savings tools because they may not be easily converted to cash. Liquid assets are those that can be readily converted to cash with minimal impact on their value. Cash in checking, savings, and money market accounts is considered liquid because it can be withdrawn easily. On the other hand, non-liquid assets like real estate, collectibles, and equipment cannot be readily converted to cash without a significant loss in value. They require both effort and time to sell and convert to cash. While investments have the potential for higher returns, they come with the risk of loss and are therefore less liquid than savings tools.

Investments may not be easily converted to cash

Secondly, investments may be subject to lock-in periods or maturity dates, after which an investor can access their funds. For example, certificates of deposit (CDs) typically have fixed maturity dates, and early withdrawal may result in penalties. Similarly, retirement accounts like 401(k)s often have age restrictions, and withdrawing funds before a certain age may incur penalties.

Thirdly, some investments are less liquid due to the nature of the market in which they are traded. For instance, stocks and bonds are typically traded on public exchanges, making them relatively liquid compared to investments in private companies or over-the-counter markets, which have a more limited pool of potential buyers.

Another factor is the impact of selling investments on their value. While liquid assets like cash and savings accounts can be readily converted without significantly affecting their value, selling investments may result in a loss if there are few willing buyers or if the market conditions are unfavourable.

Lastly, investments often serve different financial goals than savings tools. Savings accounts are designed for short-term financial goals and provide easy access to funds, whereas investments are typically made with a long-term perspective and may involve a higher degree of risk. Therefore, it is generally recommended to have a mix of liquid and non-liquid assets to balance accessibility and potential for appreciation.

Non-liquid assets can be difficult to convert into cash

Non-liquid assets are those that cannot be easily converted into cash. They often require a transfer of ownership, which can take months or even years. Examples of non-liquid assets include real estate, vehicles, art, collectibles, and equipment.

The difficulty in converting non-liquid assets into cash lies in the time it takes to find a buyer and the potential loss in value. For instance, selling a house at short notice may result in a serious loss, leading to further financial strain. The process of finding a buyer, negotiating a price, and finalising the sale can take several months. Similarly, selling a vehicle or a piece of art may require finding a specific buyer, which can be a lengthy process.

Non-liquid assets also include investments with long-term maturities, such as retirement accounts, certificates of deposit, and certain insurance policies. These investments often have penalties for early withdrawal, such as steep tax penalties for cashing out retirement accounts before a certain age.

The distinction between liquid and non-liquid assets is essential for financial planning. Liquid assets provide flexibility and quick access to funds, making them ideal for unexpected costs. In contrast, non-liquid assets may increase in value over time, potentially resulting in higher returns. A balanced portfolio should include a mix of liquid and non-liquid assets tailored to an individual's financial goals and situation.

Liquid assets are great for paying unexpected costs

Liquid assets include cash on hand, funds in checking or savings accounts, money market accounts, and certain investment accounts. These assets are readily accessible and can be liquidated without significant delays or loss in value. For example, stocks, bonds, and mutual funds are considered liquid assets as they can be quickly converted to cash.

In contrast, non-liquid assets like real estate, collectibles, and equipment are difficult to convert into cash and may result in a substantial loss in value. Selling such assets often takes a considerable amount of time and effort, and there may be penalties or charges associated with early liquidation.

It is essential to have a mix of liquid and non-liquid assets. While liquid assets provide flexibility and quick access to funds, non-liquid assets may increase in value over time, potentially resulting in higher returns. Consulting a financial advisor can help individuals determine the right balance of liquid and non-liquid assets based on their financial goals and circumstances.

Investments carry a risk of loss

All investments carry some risk. There is always the possibility of losing some or all of your investment capital. Even the least risky investments, such as bonds, carry some risk.

The potential for higher returns comes with the possibility of losing money, at least in the short term, as the value of your assets fluctuates. Depending on when you sell and the health of the overall economy, you may not get back what you initially invested.

For example, stocks can be bought and sold on stock exchanges almost as quickly as cash can change hands. However, an investor who sells equity will likely have to wait a few days to receive the cash from the sale. There is also the risk that they may only be able to sell for less than they paid.

Similarly, exchange-traded funds (ETFs) are relatively easy to sell quickly and convert to cash. But, in an emergency, investors may have to sell at a loss.

The risk of loss also depends on the type of investment. Speculative investments, such as futures, options, and collectibles, are high-risk investments with the potential for significant fluctuations in returns over a short period.

In contrast, saving typically results in a lower return but with virtually no risk. For example, savings accounts, money market accounts, and certificates of deposit (CDs) are considered low-risk savings tools.

Therefore, it is essential to understand the difference between saving and investing. Saving is generally safer than investing, but investing can result in the accumulation of more wealth over the long run.

Savings tools are virtually risk-free

The Federal Deposit Insurance Corporation (FDIC) insures accounts with up to up to $250,000 per depositor, per bank. This means that even if your bank fails, your savings are insured up to that amount. This insurance covers money market accounts, certificates of deposit, cash management accounts, and high-yield savings accounts.

Additionally, Treasury bills, notes, and bonds are backed by the US government, providing another low-risk investment option. These are highly liquid securities that can be bought and sold directly or through mutual funds.

While savings accounts are generally very safe, there are a few scenarios in which your money could be at risk. For example, if your account is hacked or your ATM card is stolen, you may be liable for unauthorized transactions if you do not report the issue promptly.

Furthermore, leaving a large sum of money in a savings account over a long period could carry the risk of earning interest at a rate below inflation, resulting in a loss of purchasing power. Thus, it is important to diversify your wealth by including both liquid and non-liquid assets in your financial portfolio.

Frequently asked questions