Liquidity plays a key role in determining the appropriate portfolio investments when it comes to investing. We will examine illiquid and liquid investments today. When investing, you invest investments that can be converted into cash rapidly. You can never predict when you will need additional funds for an emergency or other significant event. Investing in illiquid investments is risky and could lead to financial difficulties.
What is a liquid Investment?
A liquid investment is one that can be quickly turned into cash without suffering a major investment in value. Cash, money market funds, and shares of publicly traded corporations that are actively traded on an established stock exchange are examples of liquid investments. These investments can be combined and compared to a company's short-term liabilities to determine whether there are sufficient liquid investments available to pay off the liabilities, a fundamental sign of corporate liquidity.
When it takes a large amount of time to turn an investment into cash, or if the act of selling it diminishes its value, the investment is not considered liquid. Real estate, for instance, might be difficult to sell and is therefore not considered a liquid investment. Or, thinly traded shares of a company cannot be sold in bulk without triggering a major decline in their price and are therefore not considered liquid.
Pros and cons of liquid investments
Pros of Liquid Investments
The greatest investment connected with liquid investments is that they are easily turned into cash. This allows investors to be flexible when other profitable investment possibilities present themselves, hence decreasing the opportunity cost.
Additionally, liquid investments lessen investor risk in emergency situations. In the event that an investor needs immediate liquidity, liquid investments offer a speedier cash-out than illiquid investments with a longer holding period. In such circumstances, liquid investments can shield an investor from incurring needless debt.
Cons of Liquid Investments
Although liquid investments may lower an investor's exposure to risk, many liquid investment opportunities limit an investor's ability to earn bigger profits. For example, real estate and private equity have regularly supplied investors with above-average returns. A longer-term, illiquid investment may be the best way for an investor seeking better returns to reach his or her financial objectives.
What does an illiquid investment consist of?
Liquidity is the capacity to trade an asset for cash. A non-liquid asset is one that cannot be readily turned into cash. It is understood that illiquid assets require a longer period of time to experience a considerable increase in value.
Real estate would be a prime illustration of an illiquid investment. Once an investor invests in a property, they must wait a set amount of time before earning a return on their investment due to the property's illiquidity. In numerous real estate syndication deals, this schedule is subject to vary based on market conditions.
This can imply that although a project is meant to be held for five years, it may wind up producing considerable returns in a single year, as has been the case with prior real estate syndications at Disrupt Equity. Despite the fact that some real estate projects require three to five years to complete, the enhanced stability and returns are highly enticing to many investors, especially when considering the cash flow potential during the asset's holding period.
In addition to real estate, there are numerous more examples of illiquid assets that can be extremely profitable for investors.
What is real estate?
Real estate consists of land, buildings, and any natural resources, such as minerals, waterways, and crops, found within the property's limits. There are four categories of real estate: residential, commercial, industrial, and land.
Residential properties consist of single-family homes, condominiums, townhouses, mobile homes, and holiday rentals, among others, that serve as private residences.
Commercial buildings include structures such as offices, retail, hotels, and other companies that generate income.
Factories, warehouses, and research facilities are examples of industrial properties. Typically, industrial refers to the manufacturing of commodities, whereas commercial refers to their distribution.
Examples of land properties include undeveloped land, farms, ranches, and reclaimed areas.
What is real estate investing?
When it comes to investing in real estate, you have a variety of possibilities. You can purchase a single-family home, rent it out, and collect monthly rent checks while waiting for the property's value to increase so that you can sell it for a substantial profit. Alternatively, you can own a small strip mall and receive monthly rent from hair salons, pizza restaurants, and other companies.
You can invest in a larger apartment building with dozens of apartments, collecting a steady supply of monthly rent checks from your renters.
The goal is to conduct a study to determine which sort of real estate investing is optimal.
REITs
Purchasing real estate investment trusts, or REITs is one of the simplest methods to invest in real estate. Why? With a REIT, you can invest in real estate without worrying about building maintenance or management.
REITs are companies that own real estate, including retail properties, residential complexes, hotels, office buildings, and warehouses. When you invest in a REIT, you buy a portion of these buildings. A REIT is similar to investing in a mutual fund, but instead of stocks, it focuses on real estate.
There are two ways to earn money with a REIT: First, REITs pay monthly dividends to shareholders. Second, if the REIT's value rises, you will be able to sell your investment for a profit.
REITs are listed on the major stock markets, allowing investors to purchase them similarly to stocks. About 145 million Americans have REIT holdings, per the National Association of Real Estate Investment Trusts.
Residential Properties
Investing in real estate can also be profitable, albeit it requires investment. Initially, you purchase a residential property, either a single-family home or a multifamily structure, typically with a mortgage loan.
You can then either reside in the property or rent it out while you wait for its value to rise. It's possible that you may use the rent money to pay off some or all of the mortgage if you rent out your property. Once the property's worth has increased sufficiently, you can sell it for a substantial profit.
The difficulty is, of course, that the value of the property you acquire is not certain to rise. You can reduce the likelihood of a disastrous investment by researching local neighborhoods with rising home values. You should work with real estate agents and other professionals who are familiar with the neighborhoods you're interested in and can supply you with price appreciation data.
You must be aware of your location. A home on a busy street may be less expensive, but it may not appreciate as quickly as one on a quiet side street. The value of an apartment building adjacent to public transportation may increase more rapidly than the value of an apartment building located miles distant from the nearest commuter train station.
Paying for a property management firm is necessary if you do not wish to get late-night phone calls from renters with complaints about broken furnaces or leaking roofs. These services are responsible for the everyday maintenance and operation of properties. In addition, they will dispatch repair professionals to properties that require urgent upkeep.
Commercial Properties
Similar to investing in residential real estate, you can generate money by purchasing and investing in commercial properties: First, you buy the property. Then you charge tenants monthly rent. The business property could yield a large return upon sale if its market value rises.
You can invest in numerous varieties of business properties. You can purchase an office building and charge businesses for office space. You can acquire strip centers or other retail sites and charge business owners monthly rent. You can also own a warehouse and charge manufacturing companies or shops that require storage space for their products.
Investing in commercial real estate carries the same dangers as investing in residential real estate: There is never a guarantee that the value of your business properties will improve, which is why it is essential to conduct extensive research on the properties and surrounding communities. You may also have difficulty finding enough tenants to occupy the office property or retail center you've acquired.
House Flipping
When seeking a quick profit, investors frequently turn to house flipping. This is when a home is purchased at a discount, renovated quickly, and then sold for a profit. The secret is, of course, to buy the ideal property. When flipping a property, you have no interest in monthly rent. Instead, you must purchase a home at the lowest possible price if you wish to sell it for a profit.
Again, research is essential. You wish to locate a residence in an enticing community that draws many buyers. And you must ensure that the necessary repairs are not so expensive that they would negate any possible profit.
If you are handy enough to tackle improvements on your own, your prospects of making excellent profits through property flipping will be significantly increased.
Why is liquidity important? Should I have liquid assets?
The greater an asset's liquidity, the lower the risk associated with retaining it. For example, having cash in your pocket is plainly less dangerous than investing in the stock market. It is quite unlikely that you would lose the cash in your pocket, but a decline in the market could cause you to lose the value of your investment.
Having the appropriate proportion of liquid assets to less liquid assets in your investment portfolio mitigates your overall risk exposure. Whether you should hold liquid assets depends solely on your risk tolerance and long-term investment objectives.
The brief response is no. Real estate is not a liquid asset class. However, there is a catch - this is actually a plus.
People, according to common sense, desire liquid investments. You want the ability to change items into cash if necessary, right?
This is one of the reasons why individuals have participated in the stock market for so long. Through the stock market, you can transform your ownership in a company into cash by pressing the sell button.
Statistical evidence suggests, however, that it is not such a good thing. Because we possess feelings. We are emotional beings, and our emotions frequently motivate us to act in illogical ways.
People tend to buy during the peak of asset cycles and sell during the trough.
Observe the 2008 housing market collapse if you need proof. In the preceding years, when a massive bubble was forming, prices were exorbitantly high, yet people were purchasing like crazy.
After the crash, every home and apartment complex was practically for sale, but nobody wanted to buy because they were afraid. They acted based on their emotions. They were purchasing it at a premium and selling it at a discount.
Therefore, the illiquidity of real estate is an advantage since it protects you from making emotionally-driven decisions that are detrimental to your long-term financial health.
In September of 2021, there was excellent information regarding the 20-year average of the stock index S&P 500. If you purchased the S&P 500 on January 1 and sold it 20 years later on December 31, the average return was 7.7%.
However, what kind of financial performance did the average investor encounter? The typical investor earned 4.8%. Why is this so? Because they purchased when the price was high and sold when it was cheap.
Therefore, even when the market performed at a given pace, the ordinary investor only experienced roughly 50 to 60 percent of that rate due to their emotions.
Therefore, our recommendation is to stick with illiquid assets that do not permit emotional investment investments.
Are there liquid real estate investments?
An investment in real estate in which you own the property directly is illiquid. Consider indirect exposure if you're interested in real estate investment but want an easy exit strategy. Rather than buying and owning a property, buy in real estate firm stocks. You can invest in real estate ETFs. It is simple to buy and sell stocks and ETFs. Additionally, you can begin investing with lesser sums of money than you would need for a down payment on a home.
Why is asset liquidity important?
In times of financial emergency, liquidity is vital. You may not have the time to put your home on the market or sell your collection of priceless artwork if you are faced with adversity. You'll need quick access to finances to pay for necessities and keep up with your payments.
In a terrible financial scenario, your net worth and how wealthy you appear on paper are irrelevant. What is important is whether you have immediate access to funds.
When you apply for a mortgage, your lender will likely take this scenario into account. They will examine the liquid status of your assets and decide if you have enough readily available funds to fulfill your mortgage payments in the event of a brief financial emergency.
Types of liquid investments
In addition to cash, the most prevalent liquid investment, the following investments are also liquid.
Checking accounts
While maintaining funds in a checking account, you may earn a small amount of interest. You can withdraw money at any moment and receive it promptly.
Savings or High-Yield Savings Accounts
The majority of savings accounts, including all high-yield savings accounts, pay interest on deposits. You invest your money by lending it to the bank, but you may withdraw or liquidate your investment at any time.
Currency Exchange Accounts
Money market accounts resemble a combination of a savings account and a checking account. They have higher APYs and minimum deposit requirements (often higher than regular accounts). You are able to write cheques against the account and withdraw monies as needed.
Bonds
On the open market, you can buy government and corporate bonds. Governments and corporations use bonds as "loans." The issuer pledges to repay the debt with interest in exchange for the funds.
They are liquid because they can be sold at any time on the open market at their present value.
Stocks
Additionally, stocks are liquid since they can be bought and sold at any moment during market hours. If you purchase shares now and sell them tomorrow, you will receive the stock's value at the time of sale.
Mutual Funds and ETFs
ETFs and mutual funds are both bundles of securities. They are diverse investment portfolios in which you invest alongside other people. Mutual funds are marginally less liquid than ETFs due to the fact that they can only be sold after the market closes, whereas ETFs can be traded during market hours.
What are some excellent liquid investments for all investors?
Because no single investment is ideal, investors are urged to diversify their portfolios. You can diversify your portfolio across several investment products or in terms of liquidity. For long-term investments, illiquid assets such as real estate or art funds may be the best option. Cash, equities, exchange-traded funds (ETFs), and bonds are the most liquid assets if you want to invest but have access to your funds almost immediately if necessary.
Final thoughts
Liquid investments are a crucial component of any sound financial portfolio. You can employ them to attain your short-term investments while diversifying your portfolio. Real estate investments necessitate a greater amount of capital than other assets with a limited pool of suitable buyers. The speed with which a deal can be struck and all contracts finalized, the cost of consummating the agreement, and the temperature of the local market are all factors that investors must consider when evaluating a potential investment.
Real-time News
