Liquidity – What is it and how to keep it high? - August 09, 2015
The ability to convert assets into cash without huge losses can be quite important sometimes. As well as having high personal/company liquidity to easily meet our short-term or unforeseen obligations. If we have all our money in illiquid assets (eg. a long-term bond or real estate), we cannot use our resources as we intend to for a specified period of time, and that can lead to a liquidity crisis. How can we avoid this serious problem?
We can always choose liquid instruments to invest in. That way, it becomes a lot easier to convert our assets into cash, and use it whenever we feel like, or in a worse case, whenever we need to. Or, in case of an economic crisis, liquid instruments are usually still easier to sell, so we can react almost immediately to the unforeseen circumstances, and maybe even achieve extra profit through a reorganized investment portfolio. Even if we do not get higher return, we still avoid locking our money in illiquid instruments, with a probable loss.
These liquid instruments can include currencies, gold, stocks, etc. - these assets usually can be sold immediately, with very little or no loss at all. (They can be sold with profit as well, but in that case, we are trading with them, and their selling is not needed to maintain our liquidity.)
There might be some arguments against liquid assets, like long-term investments have higher returns or less risk. That might be true, but in that case, we have to pay the price of that high profit by not being able to use our money to its full potential. It’s worth mentioning that a long-term investment is usually at least 5 years long or longer, and we have to “give up” our money for that period.
Therefore, we should not put all our money in one long-term investment because that will have quite an impact on our liquidity.
Probably the best solution is to create or buy diversified portfolios for ourselves. That way we are able to get the best of both worlds. We will be able to trade liquid assets, and if we need our money immediately, we can convert those to cash. Because of the diversification, we are also able to achieve higher profit than investing only in one instrument. In the meantime (if we want) we can also put some of our resources in long-term investments, waiting for the higher return, but still playing safe with our liquid investments.
Disclaimer: Innovative Securities’ Profit Max has a highly diversified portfolio, which contains only liquid instruments. This way, our partners can maintain their liquidity, while achieving high returns on their investments, thanks to the diversification.