In the world of investment, the concept of liquidity plays a key role. Liquidity refers to the amount of cash in the form of ready cash or assets available to be used to fulfill financial responsibilities. It plays an important role because liquidity ensures that you have enough cash in emergencies. But the terms that can easily baffle a non-business man are Liquid and Illiquid assets. Knowing the difference between them may aid in investing.
Liquid vs Illiquid Assets
The main difference between Liquid and Illiquid Assets is that Liquid Assets are those assets that can be easily and readily converted into ready cash that can aid during emergencies while Illiquid Assets are those assets that cannot be readily converted into real cash easily without any significant loss. Quick cash cannot be obtained from Illiquid Assets.
Liquidity or Liquid Assets are those assets that on rainy days can be converted into quick cash by easily selling them. They are majorly in the form of ready cash or marketable securities. A high amount of Liquid Assets means that the company has enough financial capital or net worth and won’t face any financial issues. These assets ensure that the company will not face any severe financial loss.
On the other hand, Illiquid Assets are those assets that can’t be easily converted into cash without a loss. These assets may seem of no value but in reality, are more valuable than Liquid Assets as they manifest to be challenging to be sold and thus carry more value. But more Illiquid Assets mean that the company may face severe losses if they do not have any backup plan. Illiquid Assets are difficult to sell as there may be fewer buyers or there may be huge procedures involved in selling them.
Comparison Table Between Liquid and Illiquid Assets
| Parameters of Comparison | Liquid | Illiquid |
| Conversion to Cash | Easy | Difficult |
| Financial Security | High | Low |
| Accessibility to Investors | Easily Accessible | Comparatively Low Accessibility |
| Stability | Not stable during Inflation (Fluctuations) | Quite Stable for longer period of time |
| Examples | Cash, Stocks, Bonds, etc. | Penny Stocks, Hedge Funds, etc. |
What is a Liquid Asset?
Aforementioned, a Liquid Asset is a type of Asset that can be readily converted into real/ quick cash without any significant loss. A Liquid Asset is quite useful in emergencies and Liquid Assets also prove that a company has a good inflow of cash and will not suffer soon. More Liquid Assets also ensure that the company has a good net worth.
In an emergency when a company needs to pay back instant cash Liquid Assets like a small property, a gold watch, some antique jewelry proves to be quite useful as by easily selling them the cash could be paid back without the company suffering a huge loss.
A company always ensures that the amount of Liquid Assets is more than any other asset because they prove to be useful and also maintain the financial stability of the company.
For instance, if we take the example of a Bank, a bank is expected to maintain Liquidity throughout the year as they always need to fund new loans, account withdrawals, etc. A bank with the highest liquidity fulfills all these expenses only with Liquid Assets possessed by it.
At a consumer level, a person can achieve Liquidity by earning a monthly income that can fulfill all his expenses without borrowing a loan or selling anything precious. A few more examples of Liquid Assets are Mutual Funds, Exchange Trade Funds (ETFs), Cash, Certificates of Deposits, etc.
What is an Illiquid Asset?
As mentioned above, Illiquid Assets are those assets that cannot be easily converted into quick cash without any significant loss. These assets usually hold more value in the long run as they carry huge value and do not suffer fluctuations even during inflations.
The challenging part of selling an Illiquid Asset maybe since more buyers won’t be interested in buying the asset or they may back out due to the expense involved in buying the Illiquid Asset. An Illiquid Asset is not bad on its own, it is just advised that a company should not possess too many Illiquid Assets or Investments as they may prove to be detrimental during bad times.
An Illiquid Asset has few benefits too they are one-time investments that guarantee that a company wouldn’t suffer in the long run, for instance, a real estate property will not suffer the impact of inflation and will always be of great value with no practical fluctuations. So, giving up the Liquidity of your company may have some pros too.
The overall value of these Assets improves with time and hence possessing some Illiquid Assets is quite significant. This benefit is compensation for the loss of Liquidity of a company. Illiquid Assets ensure the diversification of your investments as it is not a safe option to have all your investments as Liquid Assets.
Illiquid Assets prove to be quite useful in down markets as they minimize your portfolio losses. The only con of an Illiquid Asset is the Longer Lock-Up Time as you won’t be able to sell them quickly and also, they take up more time to grant returns with some Illiquid Assets taking up to 10 years. Some more examples of Illiquid Assets are Real Estate, Houses, Antique instruments/ articles, Investment in a Private Company, etc.
Main Differences Between Liquid and Illiquid Assets
- Liquid Assets are those assets that can be easily sold without any loss whereas Illiquid Assets are those assets that cannot be sold without any significant loss.
- Liquid Assets are easily accessible to all the investors, on the other hand, Illiquid Assets are almost inaccessible to all the investors due to the expense involved in the sale of these assets.
- Liquid Assets may face fluctuations in the long run, in contrast, Illiquid Assets guarantee stability even during inflation.
- Liquid Assets may grant instant returns while Illiquid Assets grant returns after a few years ranging from 5 to 10 years.
- Possessing a higher amount of Liquid Assets ensures good financial security as well as good net worth, whereas possessing a higher amount of Illiquid Assets may prove to be a disaster during a huge crisis.
- A Liquid Asset is easy to be sold off and get rid of but Illiquid Assets are not easy to get rid of as they carry a long lock-up period.
Conclusion
From the above-mentioned points, it is clear that both Liquid and Illiquid Assets have their own set of pros and cons which makes them unique. Nevertheless, owning both Liquid and Illiquid Assets may prove to be beneficial for the company. Possessing a greater number of Liquid Assets may guarantee financial capital and security for the company while possessing a greater amount of Illiquid Assets minimizes portfolio losses when the market is down.
It is very important to maintain a good balance between Liquid and Illiquid Assets as owning more of even one of them can prove to be damaging as they possess their disadvantages. Thus, it is advised to diversify your investments to minimize the loss to be faced in the long run.
References
- https://www.bc.edu/content/dam/files/schools/cas_sites/economics/pdf/workingpapers/wp446.pdf
- https://www.nber.org/papers/w12633