Let’s say you buy stock in Twilio ($TWLO) through your broker. You deposit money into your brokerage account, select the number of shares you want to buy, and purchase those shares. If you’re using an online broker, this usually happens in a matter of minutes.
Now let’s say Twilio tanks one week later. You lose all faith in the stock, and you want to sell it. All you have to do is go to your broker, sell your shares at a loss, and watch the proceeds from the sale end up in your account. This also only takes a few minutes.
This is due to the fact that stock has high liquidity, or really easy to convert into money. If a financial asset like a stock is highly liquid, it means that you can exchange your money for that asset and turn that asset back into money with relative ease and in a short duration of time.
Not all assets are highly liquid, and liquidity isn’t always crucial in a financial transaction. Yet since you can eventually exchange all assets for money, and you might need that money for a rainy day, learning the facts about financial liquidity is absolutely crucial.
Liquid assets can be easily converted to cash, or from cash back to those assets.
Stocks are highly liquid because you can buy and sell them whenever you want. Bonds are liquid, but since they take time to mature and have restrictions on sales, they’re not as liquid as stocks.
Illiquid assets are the opposite. They are harder to convert back into money.
Real estate is illiquid because you have to do a heck of a lot to sell your house before you can actually get any money for it.
Liquid assets barely change in value when you sell them.
When you sell a stock, you know what price you’re going to get for your shares. Also, cash, which never changes in face value, is the most liquid asset in existence.
Illiquid assets change in value all the time, and often decrease in value.
Your home could go down in value from when you first bought it.
Liquidity is important if you need to convert things like stocks and bonds to cash — and fast. When you’re retired, converting your stocks or bonds to cash (and fast) is important if you want to derive any sort of income. You don’t want to worry at an old age about jumping for hoops just to get cash when you purposely spent years investing your money for your retirement.
When you’re younger and making money, however, liquidity is less important. After all, if you liquidate your assets before you retire, you’ll have nothing to live off in the future!
Share this story with your friends below, and maybe rethink about selling your stock to pay for that iPhone.