A financial plan has many moving parts. When developing their financial plan, people often focus on specific things, such as saving for retirement and ensuring they’re adequately insured. Although these are essential parts of a solid financial plan, other important aspects of your finances also deserve attention.
One area of financial planning people often don’t consider is how much they should hold in liquid assets versus less liquid assets. Having easily accessible liquid assets can help you make it through a rough financial patch without making major financial mistakes.
But how are liquid assets defined and what percentage of your assets should be liquid? Here’s some helpful guidance.
What are liquid assets?
Liquid assets is a term that doesn’t have a strict definition. It might vary slightly depending on whom you ask. For personal finance purposes, liquid assets are things you can quickly and easily convert to cash.
Some people take that definition one step further and state you should be able to convert the asset to cash quickly without losing value. The prime example of a liquid asset is cash because you can use it immediately and its value is consistent.
What types of assets are considered liquid?
Liquid assets may have varying degrees of liquidity. For instance, you can get cash in your wallet immediately if you withdraw it at an ATM. Here are several types of assets and where they fit in the liquidity spectrum.
- Cash: This is the ultimate liquid asset because you can use it immediately to buy other things without potential loss of value.
- Checking accounts: You can usually access cash within a Federal Deposit Insurance Corp.-insured checking account the same day you need it. You may be subject to ATM fees or other fees to access it immediately if the bank is closed.
- Savings accounts: You may be able to make a cash withdrawal from a savings account or transfer money from a savings account to a checking account for quick access, depending on which bank you use and how your account is structured.
- Money market accounts: Money market accounts mix interest-bearing and limited monthly withdrawal features of savings accounts with the check-writing or debit card abilities of checking accounts. This gives you quick access to funds on a limited basis each month.
- No-penalty certificates of deposit: CDs with no early withdrawal penalty allow you to access your cash when you need it within a short period of time.
- Treasury bills: These assets are short-term U.S. government debt of a year or less that are easy to convert to cash.
Assets with less liquidity:
- Certificates of deposit: Most CDs come with set term lengths and have early withdrawal penalties that require you to forfeit some of the interest you earned to access your cash, which makes them less liquid.
- Stocks: You can usually sell publicly traded stocks and other marketable securities in a short period, but the price on any given day may fluctuate. If stocks are down the day you need to sell, you could lose money or have to wait for the stock to recover. This makes stocks less liquid.
- Exchange-traded funds: ETFs have similar characteristics as stocks for liquidity. As with stocks, they trade throughout the day, so you can sell them, if necessary. But again, their value can fluctuate based on market conditions and other factors.
- Mutual funds: Mutual funds are slightly less liquid than stocks and ETFs because they trade only once per day. The risk of loss of value is similar. Mutual fund types could include money market funds, income funds, bond funds, balanced funds, and several types of equity-based funds.
- Government bonds: U.S. government bonds are longer-term U.S. debt obligations that are historically stable and easy to sell on the open market. This makes them reasonably liquid assets.
- Retirement accounts: Retirement account earnings are generally illiquid for people younger than 59 1/2. Withdrawing money from these accounts early often results in a 10% early distribution penalty. However, with certain accounts, such as Roth IRAs, you may be able to withdraw your own contributions without penalty.
- Houses: Houses are considered non-liquid assets. You can sell a house, but it may take months to find a buyer willing to pay the right price. You usually have to pay a real estate agent a percentage of the sales price and incur other fees in the process.
- Cars: Cars are more liquid than houses but still take time to sell. You could sell a car immediately by trading it into a dealership, but you might lose more value than if you took the time to sell it privately.
- Collectibles: Collectibles, such as art, trading cards, and coins, require finding a buyer interested in the collectible who is willing to pay the current price. If you need to sell a collectible quickly, you could run the risk of getting less than the full market value from the sale. Some collectibles may not have active marketplaces, resulting in a long lead time before you can arrange a sale.
- Non-publicly traded securities: Stock in private companies you may own through a workplace benefit is typically illiquid. You generally cannot sell these securities to anyone and, in some cases, a company must agree to repurchase the stock. If the company isn’t buying the stock back, you’re stuck with it until they decide to do so or the company goes public.
Why it’s important to keep some liquid assets
Having liquid assets could potentially help you financially. This type of asset offers a financial buffer should you find yourself in a financial emergency that requires quick access to cash. For instance, you might lose your job, have your car break down, get sick and need to call out for work, or your child may break their arm. All of these events have costs associated with them.
If you have liquid assets, you could potentially avoid taking out a loan or putting these expenses on a credit card that you won’t necessarily be able to pay off. Many financial experts suggest saving three to six months’ worth of expenses in liquid assets in an emergency fund. The best savings accounts often offer higher-than-average interest rates and are generally a suitable place to store cash for these potential emergencies.
The amount you need to or are able to set aside in a bank account may be more or less depending on your situation. For instance, a couple with two secure jobs and no dependents might need less money saved than a family of five relying on a single income.
Emergencies aren’t the only reason to have liquid assets, though. You can also use liquid assets to take advantage of unique opportunities that may not come around often. For instance, the coronavirus pandemic caused a sharp sell-off in stocks in early 2020. Investors who had cash on hand might have been able to take advantage of that sell-off by buying lower-priced shares of stock to hold for the long term. It’s worth keeping in mind that although those investments could grow over time, all investing comes with the risk of loss.
What percentage of your assets should be liquid?
There is no good rule of thumb that details what percentage of your assets should be liquid. If you think about it, this makes a lot of sense considering two people could have very different financial situations.
A person with a $100 net worth would likely need to keep their entire $100 liquid to cover daily expenses. Whereas a person with a $1 million net worth may want to keep 10% of their net worth liquid for emergencies and to take advantage of any unique investment opportunities. Instead of thinking of liquid assets on a percentage basis, it’s often better to think of liquid assets as a dollar amount.
You may have periods in your life where you want more access to liquid assets, too. If you plan to buy a house soon, keeping your home down payment fund liquid allows you to make an offer with a substantial money deposit if the house of your dreams comes on the market.
Having a substantial down payment set aside in an easily accessible account might also show lenders that you are financially able to afford the home. And you don’t have to worry about not having access to that money if the stock market crashes the day before you find your dream home, either.
What is the most liquid asset?
The most liquid asset you can have is cash in your hand. You can use it immediately and don’t have to wait for a bank or brokerage to deliver it to you.
What is the least liquid asset?
The least liquid asset is one you cannot sell. Bitcoin you own in a digital wallet but do not have the password to access would be illiquid because you cannot access its value. Similarly, stock in a privately held company that you cannot sell is also illiquid.
Is a 401(k) a liquid asset?
401(k) investment accounts could be a liquid asset if you have cash in the account and you are old enough to withdraw money from the account without an early withdrawal penalty. That said, you likely have to pay taxes on the withdrawal, which reduces the amount of money you end up with.
Some employers offer in-service withdrawals for current employees in the case of serious financial hardship. But even if you have this option, you’d have to pay a 10% early withdrawal penalty to access the money, plus regular income taxes. These factors make a 401(k) a highly illiquid asset for most people.
Is a credit card a liquid asset?
Some people may consider an unused credit line a liquid asset because they can use it immediately. However, using that credit line results in accumulating debt, so a credit card is not considered an asset of any kind.
The bottom line
Liquid assets are assets you can convert to cash on short notice, ideally while getting the asset’s total value. The best checking accounts and savings accounts could be great places to store money you want to keep liquid while earning interest at the same time.
Ultimately, you must decide how much you want to keep in liquid assets based on your financial plan and your family’s current circumstances. After you’ve built adequate liquid asset reserves, you may want to take the next step and learn how to invest money you have above and beyond that reserve limit.