Liquidity is an important element to understand when you are getting involved in investments; in the simplest terms, this refers to the ease with which you can sell or purchase an asset.
If you want to invest in stocks, bonds, real estate, commodities, etc., then you should consider the liquidity of each asset class.
The less liquid an asset class is, the harder it is to trade.
We took a closer look at liquidity, and the best investments to have for those looking to minimize liquidity – read on for all you need to know.
What Is Liquidity?
Liquidity refers to how easily an investment can be traded. For example, if you own shares in a company, you may not be able to immediately sell them because they’re locked up in your portfolio.
However, you could sell some of the shares that you hold, and buy more shares from another investor who wants to sell theirs. This process is known as trading.
The opposite of liquidity is illiquidity. Illiquidity means that it’s hard to get rid of an asset.
It’s difficult to find someone willing to buy your shares, or it takes a long time to sell them.
The most liquid assets tend to be:
- Stocks
Stocks are one of the most common types of investment and are also among the easiest to trade. When you buy a stock, you’ll pay money to the seller, and receive shares in return.
When you sell a stock, you’ll give the buyer the cash they paid plus any dividends that were earned while owning the stock.
- Bonds
Bonds are debt instruments issued by governments and companies. A bond pays interest every month and has a fixed price.
So, if you buy a $1,000 bond, you’ll get back $1,000 plus whatever interest was paid over the course of the year.
What Is Low Liquidity?
Low liquidity means that it’s difficult to trade an asset. There aren’t many buyers or sellers available, and it takes a lot of effort to move the asset.
If you want to invest in low-liquidity investments, you should avoid individual securities.
Instead, you should put your money into a mutual fund – these are pools of money that are invested together.
They usually offer diversification, which means that they have a variety of different investments.
You can use ETFs (Exchange Traded Funds) to gain access to low-liquidity assets.
An ETF is similar to a mutual fund, except that it trades like a security instead of being managed by a third party.
What Are The Advantages Of Low Liquidity Assets?
Investing in low liquidity assets has several advantages over traditional investments. Here’s why:
- Diversification
When you invest in low liquidity assets, you get the benefit of diversification.
Diversification helps reduce risk, which is good news for your portfolio. It also allows you to spread out your investments across multiple sectors.
- Lower Risk
Because low liquidity assets are less liquid than others, they carry lower risks. For example, an investor might lose money when selling a house, but he won’t lose his entire life savings.
- Higher Returns
Because low liquidity assets are harder to sell, they tend to generate higher returns, and this is usually because there are fewer available buyers and sellers, meaning fewer of that particular asset active in the market at one time.
- More Flexibility
Another advantage of low liquidity assets is that they offer greater flexibility.
When you invest in a mutual fund, you can decide how much of your money goes into each investment.
With low liquidity assets, you can only invest so much in any one security.
This gives you more control over your investments, which is great for your financial future.
What Are Some Examples Of Low Liquidity Assets?
There are a number of examples of low liquidity assets, and some of the most popular include:
- Real Estate
One of the most popular types of low liquidity assets can be found in real estate – land, houses, commercial buildings, and so on.
These properties take a long time to sell, and it can be difficult to find a buyer, this makes them low liquidity assets.
- Hedge Funds
Another type of low liquidity asset can be found in hedge funds. Hedge funds are private investment vehicles (see also ‘What Is An Investment Vehicle?‘) that focus on specific areas of expertise. They don’t follow trends, and their strategies are often complex.
Because of this, it can be difficult to predict what will happen to the value of a hedge fund.
- Precious Metals
Gold, silver, platinum, palladium, and diamonds are all examples of precious metals.
Precious metals tend to hold their value well, and they’re not subject to inflation.
However, they do have a limited supply, and it can be hard to find someone who wants to purchase them. This makes them low liquidity assets too.
- Mutual Funds
A mutual fund is a collection of stocks or bonds that is managed by a professional manager.
Mutual funds are easy to buy and sell, and they allow investors to diversify their portfolios.
However, because mutual funds aren’t traded like other securities, they’re considered low liquidity assets.
- EFTs
Electronic Fund Transfers (EFT) are similar to bank accounts. You deposit money into an EFT account, then you withdraw it later.
EFTs are used to transfer money between different banks, credit unions, and brokerage firms.
While these transfers are convenient, they’re also low liquidity assets because they’re not traded like other securities.
Final Thoughts
Assets such as mutual funds, ETFs, and real estate are a great way to get involved with low liquidity assets, but, as with any investment, it is important that you take the time to do your research and make sure that you understand the risks before investing.
When traded correctly, low liquidity assets can be very profitable – so make sure you take the time to do your homework!
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