What is ‘Liquidity’
Liquidity for retail investors, in simple terms, describes how easily and quickly you can convert your investment into cash or its equivalent.
Cash is considered most liquid as it can be quickly and easily converted to other assets. Let us say you want to buy a phone for Rs 10,000. Using cash to buy it is the easiest way. If you have no cash but a rare painting that is worth Rs 10,000, you are unlikely to find someone who is willing to trade the painting for the phone. Instead, you will have to sell the painting and use the cash to purchase the phone. Selling a rare painting will take time – may be a few months. But what if you only have a few days left to buy that phone? You then have to sell the painting for a discount, instead of waiting for a buyer who was willing to pay the full price. Rare painting is therefore considered an illiquid asset.
Liquidity of the typical investments
Savings Bank (SB) account
Considered highly liquid, as you can get cash easily
SB is considered highly liquid as you can withdraw the cash, almost anytime, as long as you can visit the bank or an ATM that allows withdrawing money from your account. But as you may have noticed, SB is not as liquid as cash in your pocket. You have to do something before you can use your money in bank as cash.
Fixed deposits (FD)
Considered reasonably liquid, as you can get cash after paying a penalty interest
Fixed deposits are reasonably liquid. If you need money, you can close your deposit before maturity. However, you have to pay a penalty, up to one percent of the interest amount. Further, the interest rate you get will depend on how long the deposit was held.
Let us look at an example. Two years ago, let us say you opened a 5 year FD with your bank for 9%. Now if you close your deposit after 2 years, you will only get 6% interest. Why so low you may ask? Because you are closing it premature after 2 years, the bank will find out what it was offering for a 2 year deposit. In this case, bank was offering only 7%. So after deducting 1% penalty, you will get 6% interest.
Equity Mutual funds
Considered reasonably liquid, as you can get cash after paying an exit-load
You can redeem open-ended equity mutual funds any time to get cash. You can typically get money in your bank account within a few days after the sale. You may have to pay an ‘exit-load’, depending on how long you had invested prior to redemption.
Liquid Mutual funds
Highly liquid and you can redeem quickly and without a penalty
As the name suggests, the liquid funds are liquid. You can get your money in your bank account typically the next day.
ELSS Mutual funds
Cannot be redeemed for 3 years after investment
ELSS funds cannot be redeemed for 3 years. So they are less liquid as compared to other funds.
Not liquid as it may take months to get money
Real estate is considered one of the least liquid assets. If you want to quickly generate cash from a real Estate investment, you may have to sell it for a deep discount. Otherwise you have to wait for a few weeks or months depending on how active the real estate market is. In addition, there are taxes and commissions to be paid.
Not too liquid – But can be sold at a pawn shop or you can get a loan at a bank
How to cover gold jewellery to cash? There are two options (1) Sell to a pawn shop and get money – Unlikely to get a good price (2) Take a bank loan with gold jewellery as collateral – At least you don’t have to sell your gold – but will have to pay high interest rate.
Stocks and ETFs
Reasonably liquid as you can easily sell it at a stock exchange and get money within a few days
Stocks and ETFs can be sold in the stock exchange any time and you can get money within a few days into your bank account.