Just last week Elon Musk surpassed Jeff Bezos as the richest guy on earth, with a net worth of $197B USD. While yes, he certainly can buy whatever he likes, that money is not sitting in a Scrooge McDuck vault gathering dust. Elon has to grapple with liquidity, like every investor.
What is liquidity?
Liquidity refers to how easily your investments can be turned into cold, hard cash. Speed is a big factor.
You may own a million dollar home ‘free and clear’ or perhaps have a million dollars in home equity. Either way, unlike the Capital Markets where buyers and sellers are generally transacting in real time, real property often requires a considerable amount of time and effort to transact. The money is not instant as it is with stocks, generally speaking. This asset therefore has less liquidity than your usual investment portfolio, for example.
Why should this matter?
Liquidity exists on a spectrum, and it is a core component of investing and everyday financial life. Bought a car? That purchase was an exchange of liquidity for illiquidity: cash (very liquid) in exchange for a depreciating asset (much less liquid).
Understanding liquidity is a core component of financial literacy and making informed choices about money.
How does liquidity affect investments?
When deciding on an investment, it’s important to examine if it’s in an active market and the liquidity is healthy.
Insufficient liquidity means an unexpected bump in the road can be disastrous, whereas a company with too much liquidity is likely not maximizing its business potential, or is perhaps inefficiently managed. Understanding this context is helpful when assessing your personal risk tolerance and financial goals.
How can liquidity be a stabilizing force?
Set your time machine for the 2008 Great Recession to see the fallout from a lack of liquidity. Banks were on the cusp of running out of money because they didn’t have the cash on hand to pay their short-term obligations. Their collapse would have set off a domino effect for smaller banks and the American financial landscape, had the Feds not stepped in with a burlap sack of bailout money.
It’s safe to say that healthy liquidity is important for financial stability, and having a portfolio with a range of illiquid, less liquid, and liquid investments can lead to less volatile performance over the long haul.
Find out how DigitalAMN angel investors can access liquidity
2021 is shaping up to be a banner year for crowdfunding. If you’re curious to learn more about investing in and via equity crowdfunding, check out TruCrowd’s online investment portal
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