Liquidity is one of the three most important metrics of any asset, the other two being profitability and risk. Liquidity refers to an asset's ability to easily and quickly be converted into cash. The more likely it is for you to find a buyer for an asset you're holding, the more "liquid" it is. For example, if you're holding common stock in a company, you can usually sell your shares quickly since demand is typically high on the stock market. On the flip side, real estate often takes a long time to sell since you need to find a reliable buyer, show them the property, and so on.
Since money is the ultimate goal of all investment activity, cash is considered the most liquid asset of all. But there are other investment choices that may benefit your portfolio. In order of liquidity, the most liquid investments include:
- Money – actual cash currencies
- Money market assets – short-term debt securities such as CDs or T-bills
- Marketable securities – stocks or bonds
- US Government bonds – only if the maturation date is one year or less
- Mutual funds or exchange-traded funds (ETFs)
The Difference Between Liquid and Illiquid Assets
It's generally accepted that assets are considered liquid if they can be turned into cash within one year or less. If it takes more than a year, the asset is deemed to be illiquid.
The liquidity of an investment is usually dependent on whether the asset can be actively traded on financial markets and if there's a demand for it. That's one reason why long-term assets such as bonds are usually considered less liquid than short-term ones. A prospective buyer needs to be willing to wait for the maturity period of a bond before receiving the bond's principal.
How Does Liquidity Affect Profitability?
In investment terms, the liquidity of an asset doesn't necessarily affect its profitability. But you should keep in mind that assets that are highly liquid, highly profitable, and almost risk-free do not exist. Highly liquid assets are typically either less profitable than illiquid equivalents or more risky. This is why investors don't use liquidity as the only measurement to judge an investment opportunity.
As always, diversification is key! Combining highly liquid investments and illiquid but more lucrative ones in your portfolio may provide you with great returns, while a part of your money is still easily accessible when you need it.
Liquidity isn't the be-all-and-end-all of investment metrics. But it can be crucial to investors since it measures how easily they can convert their assets into hard cash if they need to. If you're suddenly and unexpectedly faced with financial obligations and all of your wealth is tied up in non-liquid investments, you may effectively be poorer than if you had just put all of your money into a savings account and watched it slowly lose value due to inflation.
Even if you don't invest in risky financial products – unexpected medical bills, a broken-down car in desperate need of repairs, or a burst pipe in your home are all financial obligations that may strike without warning. Keeping some of your money easily accessible for such cases is just common sense.
For example, imagine you're putting all of your money into real estate as a long-term retirement investment. Real estate is generally considered to provide reliable returns at minimal risk, but it's also highly illiquid. Now imagine you or one of your loved ones suddenly fell ill, and the medical bills start piling up. You usually won't be able to find a buyer for your property on short notice, but the rent you gain every month isn't enough to cover the bills either. Suddenly you find yourself in urgent need of cash and might be forced to take out a loan, even though you could easily pay your bills if your money were in liquid assets.
This is also why personal net worth is a somewhat deceptive measure of a person's wealth since much of that net worth may be tied up in highly illiquid assets.
So far, we've only talked about how liquidity affects private investors who invest their money directly. You may be wondering how the hedge fund model – or the mutual fund or ETF models, respectively – change the game. And the answer is: typically not to a great extent. Hedge funds, mutual funds, and ETFs are all based on the idea of pooling money from multiple investors, investing that money, and paying out proportionate returns for every individual investor as income.
This means that the money of these individual investors may be tied up into non-liquid investments, however – depending on which types of investments the fund focuses on. This is why many funds have lock-up periods, limiting individual investors when they can withdraw their money. For hedge funds, these lock-up periods are typically six months or more. This means that after you have notified the fund that you want to withdraw money, the manager has at least six months to withdraw your money from the assets under management. After all, they may have put your money into illiquid investments and can't withdraw it quickly either.
This still makes hedge funds liquid investments as per our previous definition (unless the lock-up period is more than a year). Still, it also means that typical hedge funds aren't exactly the most liquid investments around, certainly not compared to investing in marketable securities.
The CARL app doesn't just break down barriers, giving you unprecedented access to quantitative hedge funds. It also gives you the freedom to invest your money and withdraw it on a monthly basis. You can react quickly to unforeseen events, whether changes on the market or sudden unexpected financial obligations such as medical bills.
CARL wants to open the world of hedge fund investing to private investors while making the actual investing process as easy as possible. That's why CARL's quant investment strategies have no lock-up periods, which means they are noticeably more liquid than comparable hedge funds while outperforming many of them with 15%+ targeted returns.
If you qualify as an accredited investor, you can set up your CARL account and start investing in high-yield, highly liquid quantitative hedge funds today. Build your financial future and react to anything life throws your way!