What Are Liquid Assets And Why Are They Important?

9 Min Read
Updated Dec. 9, 2024
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Written By
Victoria Araj
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Whether you’re facing an expensive auto repair or want to remodel your kitchen, nothing moves these situations forward like liquid assets. Tapping a retirement account bears financial penalties and taxes, and much of the rest of your net worth is likely tied up in your home and other possessions you’re unwilling to sell. 

Here, the spotlight shines on the critical role of liquid assets – the financial superheroes that bridge the gap between immediate needs and long-term goals. Liquid assets are a type of asset you can convert to cash quickly and easily. They can help you navigate unforeseen financial twists and turns, provide a lifeline for unexpected expenses and serve as a strategic pillar for financial resilience.

What Are Liquid Assets?

Liquid assets are usually considered cash – either cash on hand or what’s in your checking and savings accounts. Stocks, bonds, money market funds, shares and certificates of deposit are some of the more common types of liquid assets. You can easily liquidate each into cash.

Liquid assets play a pivotal role in meeting short-term financial obligations due to their accessibility and the ability to become cash without losing value. As a result, they provide stability and security, especially if you need money quickly. 

In contrast, illiquid assets, such as real estate, lack swift convertibility to cash. For this reason, liquid assets are crucial for financial planning, whether for immediate purchases or emergency funds.

Additionally, liquid assets count toward your net worth, a comparison of your financial resources versus your debts. So, the more liquid assets you have, the healthier your net worth. 

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Why Are Liquid Assets Important?

Liquid assets are a key indicator of a borrower’s financial health and ability to make big-ticket purchases, like buying a house. In other words, the more cash you can easily access, the less likely you may be to miss a payment or default.

As a result, your lender will verify the assets you own when you apply for a mortgage. During the underwriting process, your lender will review your financial accounts to measure your liquid assets.

A strong financial profile assures lenders that a borrower can handle the down payment, closing costs and monthly payments that a mortgage entails. A stockpile of liquid assets signifies that borrowers are well-positioned to meet these financial obligations without jeopardizing their overall financial well-being.

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Liquid Assets Examples: At A Glance

Here are the different types of liquid assets:

  • Cash: The bills and coins in your physical possession. Its immediate usability makes it a highly liquid resource for individuals and businesses alike. Keep in mind, for mortgage transactions, actual, physical cash is generally not acceptable, as funds need to be traceable.
  • Savings or checking accounts: Savings and checking accounts held at banks, credit unions and other financial institutions. They allow you to make transactions, pay bills and withdraw cash.
  • Certificate of deposit (CD): A time-bound deposit with a fixed term and interest rate. While CDs restrict immediate access to funds, they are still liquid assets because they can be redeemed at any time (although doing so early bears a financial penalty).
  • Treasury bills: Interest-bearing securities from the U.S. government with maturities ranging from a few days to 1 year. Like CDs, they can be liquidated before the maturity date.
  • Money market account: A type of savings account with a higher interest rate and restricted capabilities for writing checks and making payments with debit cards. However, account holders can freely withdraw money in person, on the phone or by mail.
  • Money market funds: Investment accounts that hold short-term, low-risk securities such as Treasury bills and municipal bonds. They provide liquidity and avoid volatile investments.
  • Certain types of investments: Mutual funds, stocks and bonds are liquid investments because you can sell them anytime. Stocks are investments in a company’s future, while bonds are shares of a company’s or government’s debt. Mutual funds allow investors to combine resources with others to buy larger amounts of stocks or bonds.
  • Accounts receivable: Accounts receivable are payments owed to you or your business for goods or services provided in the past. While not as immediately accessible as other forms of liquid assets, accounts receivable hold value and can be converted into cash as customers fulfill their payment obligations.
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Cash And Cash Equivalents

Cash and cash equivalents are typically the most common liquid assets because they require minimal effort for purchases. In other words, if you need to make a purchase today, cash and cash equivalents empower you to do so.

Cash equivalents are bank accounts with money available for immediate withdrawal: your checking, savings and money market accounts. These assets are more helpful for short-term needs rather than long-term investments.

These assets offer the most flexibility because they can be quickly and easily accessed and used for various purposes. Whether for daily expenses, emergencies or investment opportunities, cash allows individuals and businesses to respond immediately to financial needs.

Investors use cash and cash equivalents to acquire new assets. For example, investors often encounter opportunities requiring swift action, such as a momentary drop in stock prices or a desirable rental property. Cash proves invaluable in such situations due to its immediate accessibility.

In contrast, if the investor had a significant portion of their portfolio tied up in illiquid assets like real estate or long-term bonds, reacting quickly to capitalize on the market opportunities would be challenging. Liquid assets, particularly cash, enable investors to navigate volatile market conditions strategically and make timely decisions. As a result, savvy investors keep a certain amount of their assets liquid so they can pounce on new ventures.

Taxable Investment Accounts

Taxable investment accounts, also known as brokerage accounts, can hold stocks, bonds, investment funds and other securities. You can liquidate a taxable investment account by selling the assets it holds.

When you liquidate a taxable investment account, you’ll receive the proceeds as cash. However, this process can take 2 or more business days, so it’s not advisable to rely on taxable investment accounts for cash.

That being said, taxable investment accounts are a valid source of liquidity if you can’t get cash from anything else. Here are some types of assets you might liquidate in a taxable investment account:

Money Market Funds

Money market funds are vehicles for stable securities like Treasury bills and municipal bonds. They minimize risk while providing higher returns than interest-bearing accounts. You can sell T-bills and bonds before their maturity date, making them highly liquid. However, doing so means giving up the interest you would have earned by continuing to hold the assets.

Stocks And Bonds

Stocks represent ownership in a company, while bonds represent ownership of corporate or governmental debt. When held within taxable investment accounts, stocks can be bought and sold quickly on the open market.

Investors can liquidate stocks and bonds to access cash or rebalance their portfolios. Selling these assets results in capital gains or losses, and the tax implications depend on the holding period and the investor’s tax bracket.

Mutual Funds

Mutual funds pool money with other investors to increase your purchasing power of stocks, bonds or other securities. The liquidation of mutual fund shares in taxable accounts has tax implications depending on capital gains or losses generated by the fund’s transactions. Additionally, liquidating mutual funds can take longer than other asset types.

How To Build Your Liquid Assets

Building up liquid assets is an excellent way to achieve financial goals, improve your net worth and overcome challenges. Doing so provides a solid financial foundation for future investing.

Specifically, establishing an emergency fund before investing is crucial for financial stability. This fund acts as a financial safety net, providing a cushion to cover unexpected expenses like medical bills, car repairs or job loss.

Without an emergency fund, you may have to tap illiquid investments at inopportune times, incurring losses. By securing a reliable emergency fund first, investors can navigate unforeseen financial challenges without jeopardizing their long-term investment goals.

When building liquidity, it’s crucial to acquire multiple types of liquid assets. Doing so helps spread risk and exposes you to different types of returns, such as interest and capital gains. You can start by:

  • Creating a budget and tracking spending
  • Setting financial goals
  • Automating savings to build an emergency fund
  • Investing in liquid assets
  • Directing extra money to savings, such as raises and tax refunds
  • Choosing a high-yield savings account for a higher interest rate

Benefits Of Having Liquid Assets

The benefits of liquid assets extend to both personal finance and investment strategies. Such advantages include:

  1. Financial Security During Emergencies: Liquid assets provide financial security during emergencies. Whether it’s unexpected medical expenses, urgent home repairs or a sudden job loss, having readily accessible cash or liquid investments allows you to address these challenges without resorting to selling illiquid assets or taking on high-interest debt.
  2. Flexibility And Quick Access To Funds: Liquid assets, by their nature, offer flexibility and quick access to funds. In personal finance, this flexibility is vital for covering day-to-day expenses, managing short-term financial goals or seizing investment opportunities that may arise suddenly.
  3. Opportunity To Capitalize On New Investments: Liquid assets allow investors to capitalize on new investments and take advantage of market opportunities. For example, liquidity allows investors to purchase undervalued assets without delay during a market downturn. This timely investment leads to higher returns when the market recovers.
  4. Easier Implementation Of Financial Plans: Whether it’s saving for a down payment on a house, funding education or planning for retirement, liquid assets make financial planning straightforward. They provide the necessary liquidity to meet short-term goals and allow long-term assets to continue growing.
  5. Liquidity In Personal Transactions: Liquid assets are valuable in personal transactions, such as buying a home. They provide the necessary funds for down payments, closing costs and other immediate expenses associated with such transactions.

FAQ

The answers to these frequently asked questions give a clearer picture of liquid assets.

A house isn’t a liquid asset because you can’t immediately turn it into cash. Selling real estate can take weeks, months or even years, and selling at the wrong time can result in heavy financial losses. For these reasons, relying on a house for liquidity isn’t practical.
Assets are called “liquid” when they can easily and quickly be converted into cash (liquidated). Liquid assets can be readily bought, sold or exchanged in the economy with minimal price differences, providing immediate access to funds without sacrificing purchasing power.
Liquid assets are easily convertible into cash and typically include cash itself, bank deposits, money market instruments and particular securities like stocks and bonds. Illiquid assets are not easily convertible into cash and include real estate, vehicles, antiques and jewelry. These assets may take time to sell, and the selling process can result in a loss of value.
The term “nonliquid assets” is often used interchangeably with illiquid assets. As a result, nonliquid assets include long-term investments, real estate or assets that you can’t easily turn into cash.

The Bottom Line

Liquidity means immediate accessibility and convertibility of financial resources into cash. Whether for personal financial security, navigating emergencies or seizing investment opportunities, liquid assets, including cash, savings accounts and money market funds, prove invaluable.

Building and maintaining these assets involves strategic financial practices, and their benefits are far-reaching. They provide flexibility, quick access to funds and the ability to capitalize on new ventures. Additionally, the role of liquid assets extends to shaping a borrower’s financial health, influencing mortgage applications and significant purchases like homes.

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