Understanding Liquid Versus Illiquid Assets

One key to creating a diverse portfolio that works for you is having a mix of both liquid and illiquid assets. Both are equally important to creating an investment strategy, so it’s a good idea  for investors to understand just what these concepts mean and how they work. Here’s a closer look at liquid assets, illiquid assets, and how they play a role in your investment portfolio.

Liquid Assets Defined

Liquid assets are those you can convert into cash quickly with a minimal loss in value. They might include money market funds or short-term bonds, but you can also include money you have in any traditional bank as a liquid asset. Any funds or investments you can convert into cash in your hand are considered liquid. Businesses consider inventory among their liquid assets, as their sale yields cash or a cash equivalent. 

All investors should have some level of liquid assets at their disposal, as they are used to cover living expenses as well as emergency expenses. Having all of your money tied up in long-term investments means you won’t have access to cash when you need it most. Liquid assets in the form of money market accounts and short-term bonds can be used to ensure steady cash flow in the event of unforeseen circumstances, such as job loss.

Illiquid Assets Defined

Illiquid assets are those that can’t be sold quickly and may be subject to a significant loss in value if sold early. Long-term investments, such as REITs, small-cap stocks, artwork, and antiques are all illiquid. IRAs and 401Ks can also be considered illiquid, as early withdrawals yield certain tax implications and potential penalties. Some can be sold off when an investor is in need of cash, though there may be significant penalties or losses in value at the time of sale. Others may not have an option for early sell-offs or cash-outs. While having money tied up in illiquid assets may seem inconvenient, many of these investments are ideal for building wealth. 

Some illiquid assets may be more likely to generate a better return on your investment, and they can even help you hedge against inflation and market volatility. Real estate investments (including single-asset investing and REITs) are great examples of illiquid assets you can use to diversify your portfolio and protect against volatility. 

Finding the Right Mix

When you’re looking to build your portfolio, you’ll want to find the right mix of liquid and illiquid assets. Liquid assets, including your traditional checking and savings account, are important to keep current, but other assets might depend on your unique needs. Tradable stocks and bonds can be ideal if you aren’t yet comfortable holding onto a lot of long-term investments, as they can be sold quickly for cash. You’ll want to talk to your financial advisor about your risk level and your monthly cash flow needs to help ensure you have access to the money you need each day while still creating a plan to build growth long-term. 

Adding illiquid assets to your portfolio may help you build wealth more quickly, depending on the investments you choose. While investing in art or antiques might call for higher risk and speculation, investing in savings bonds and FDIC-insured certificates of deposit can be good choices for those with lower risk tolerance. You can also look at investing in real estate as an option for long-term investing and adding an illiquid asset to your portfolio. Over time, as your investments grow, you may decide to move more money into illiquid assets as your plan for building wealth evolves.   
As always, you’ll want to consult with your financial professional to provide guidance when crafting your investment strategy. To learn more about DiversyFund and the role it can play in your wealth-building journey, click here.

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