General Question

StillWoodpecker's avatar

What does "liquidity" mean in a basic economic terms?

Asked by StillWoodpecker (22points) December 18th, 2010

I am 23 and have gone through a financially turbulent life since graduating, therefore I decided to research, study, and learn as much as possible about personal finance and general economic theory in order to improve my habits and understanding. One word I heard/read often is “liquidity” and while I’ve read a few definitions, I feel I have yet to comprehend the term and its modern applications. I would appreciate any advice. Thank you.

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12 Answers

koanhead's avatar

“Liquidity” is the ease with which assets can be converted, usually into cash.
More “liquid” assets are ones which can be sold or traded more easily (like a bicycle), less liquid ones are more difficult to sell or trade (like a house).

world_hello's avatar

@koanhead Is totally correct.

iamthemob's avatar

What @koanhead said. Basically, liquidity becomes an issue when a debtor has liabilities the payment on which are coming due…(e.g., you have to pay your credit card bill)...and you cannot pay it, although you own disposible property that covers the bill (e.g., you’re selling your old xbox on ebay), you don’t have the cash equivalent to make the payment, perhaps, when it is due.

Now, in terms of improving your habits, liquidity may come into play in that if you’re very liquid, it’s easy to spend your money. Further, liquid assets are often those that don’t really give you a return on the investment. So if you’re looking to save and grow, you generally move your income into less liquid property as you do so.

rapraprapraprapraprap's avatar

@koanhead That’s how it was taught to us too in accounting.

CyanoticWasp's avatar

Well, I wouldn’t be too down on liquid assets as a class, @iamthemob. Stocks, options and commodities futures, among other financial assets, are quite liquid when traded on their respective exchanges, and can give very good returns to those who know what they’re doing – and have the courage and perseverance to do it.

iamthemob's avatar

@CyanoticWasp – They are definitely more liquid than other assets…but not as liquid as cash. You still can only liquidate them at certain times (e.g., when the market is open), there are fees associated with some liquidations, and if you are forced to sell at a loss, they loss associated can be considered a feature that reduces the liquidity.

anartist's avatar

It is money that is not “locked in”—whether to real property, valuable objects, the stock market, 401ks, IRAs or even CDs with a penalty for early withdrawal. It is cash you can move about as you wish without penalty.

Yes you can sell stock, objects, your car, or even your home but that takes time and may deprive you of a home or transportation or income earnings for retirement, and if done in need may well be at a loss.

It also should not be money not tied into basic monthly commitments such as mortgage, rent, car, or student loans, unless you want trouble. It is discretionary income/funds.

Brian1946's avatar

So if I have a case of beer, and none of the containers have been opened, those wouldn’t be considered liquid assets? ;-p

gasman's avatar

”...My accountant says I did this at a very bad time. My stocks are down. I’m cash poor or something. I got no cash flow. I’m not liquid, something’s not flowing. They got a language all their own.”Manhattan (Woody Allen,1979)

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shirleylopez's avatar

Liquidity the way I understood it is simply having the available cash at any time. If you are liquid, you can easily draw cash and use it for whatever purpose. Having assets such as house, car, investments, etc. may not necessarily make you liquid if these assets can’t provide the cash you need at any particular time.

NickFlyte's avatar

Although the term ‘liquid’ is used more generally to refer to the ease with which assets can be converted to cash, in terms of financial securities and derivatives (things like stocks and futures) it refers purely to the number of available buyers or sellers with whom you can transact.

Suppose that you offer to sell your very nice house at a very reasonable price, and buyers are queuing up to purchase it, falling over one another with offers, but due to the highly bureaucratic nature of real estate transactions in your country it’s going to take a heck of a long time for the sale to complete. . . In general terms most people would consider your house to be ill-liquid, but in securities/derivatives market terms your house is highly liquid because there are loads of counter parties willing to buy it.

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