What Is Liquidity?

Liquidity describes how quickly you can turn an asset or investment into cash without affecting its value.

Simply put, the faster an asset or investment can be converted into ready cash determines how liquid it is. Something that takes a long time to sell and as a result decreases in value is considered illiquid (or less liquid).

Deeper Explanation

Liquidity explained

The idea of liquidity applies to assets and investments that you trade in a market structure, such as the stock market or housing market. A company that trades on the stock market, such as Google’s parent company, Alphabet, is considered to have liquid stock because you can quickly buy and sell shares of their stock without it losing much value.

Your home is considered an illiquid asset because it can take as long as a year (or more) to sell it for cash. During that time, the value of your home may have decreased, meaning you would have sold it for less than it was initially worth.

Other assets such as fine art, rare books, and memorabilia are considered very illiquid because they can take years to convert to cash.

Above all, cash is considered the most liquid asset of all. Cash does not have to be converted into anything because it’s already cash.

Liquidity example

If you wanted to buy a new phone for $300, you could buy it immediately if you had the cash available. On the other hand, if you had a signed piece of memorabilia worth $300, such as a football, it could take you months, possibly years, to sell the football for cash to buy the new phone.

It’s important to mention that different asset classes have different levels of liquidity. Generally speaking, equities (stocks) are the most liquid asset class because stocks can be bought and sold throughout the day with a brokerage account.

However, some stocks may be very illiquid such as penny stocks that trade on the OTC market. The volume of trading happening on these types of stocks may be zero on any given trading day. This simply means that no one is buying or selling shares of the stock.

On the contrary, a stock like Amazon has a very high trading volume, meaning millions of shares are being bought and sold daily, which translates into high liquidity.