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2018-03-27T12:00:00+00:00

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Moneon

Liquidity โ€“ meaning & importance

We tell you about a phenomenon that should become a measure of all things for a financially sound person.

Major purchases are, first of all, bring with themselves the joy of fulfilling desires. And joy can stay with you for a long time if the purchase has been approached wisely. You are here to give a rational touch to your spending patterns ๐Ÿ‘Œ And here's the advice: before spending a lot of money or taking out a loan evaluate the liquidity of your future acquisition. Perhaps you will have to reconsider the purchase.

What is liquidity?

Liquidity is the ability to sell goods quickly at a price, that is close to the market one. The concept of liquidity is applicable to any asset that can be purchased for money.

All assets can be divided into three groups by the degree of their liquidity:

  1. Highly liquid assets. If the asset can boast high liquidity, it can be sold quickly and with a profit. Due to high demand for suchlike assets, it is easier to capitalize on them. Highly liquid assets include but are not limited to stocks, bonds, and bank deposits.
  2. Medium liquidity assets. The concept of medium liquidity is quite subtle: we can say that these assets can be sold, but not without a hassle. For example, goods with highly specialized or seasonal demand are usually assigned to this category.
  3. Low liquidity assets. This type of assets loses a significant portion of their value over time. It is unlikely that you will be able to sell them quickly at the original price. Ultimately, low liquidity assets include real estate, as its sale can last from weeks to several years. Perhaps, in order to sell the asset, you will also have to offer the buyer a significant discount.

Each group, in turn, has the subdivisions of its own. Real estate has low liquidity when compared with other asset types. However, a comfortable apartment in a well-located high-quality new house will be much more liquid than an abandoned dwelling in a vacant lot or in the middle of an industrial zone. It will be easier to sell the former, while its price will increase in time.

Liquidity shows how fast you can turn your assets into the money

It is worth remembering: if you buy an apartment to spend your life in, its liquidity is probably irrelevant. After all, liquidity is more important when selling the asset and when you donโ€™t want to lose money.

Liquidity and our purchases

It is great when purchases meet our expectations. When choosing something for years to come, pay attention to its quality. If you believe that sooner or later the acquisition will be resold, keep its liquidity in mind. Getting money from the sale is much easier in case of high and medium liquid assets.

A bank loan is generally irrational from the point of view of liquidity. As a rule, the asset begins to become obsolete even before you have fully paid the loan. Yes, the mortgage cannot be liquid if the payment terms are 10, 15, or even 30 years. During this time, the house will already begin to become cheaper and you will still pay for it like it was still new. And donโ€™t forget the upcharge. If only liquidity is considered, the most economically viable option is to pay for the real estate in cash.

Technology slaves. Buying an iPhone with borrowed money is another low-liquid acquisition. Within one year after the purchase, it will lose up to 70% of its value. And you will still be probably paying for it. Turns out that you pay 70% extra for an opportunity to own a fashionable gadget. It's up to you whether you need it or not. This purchase, however, canโ€™t be called rational. On the contrary, buying an iPhone for cash is quite liquid, as it can be sold any time.

Marriage on a budget. What is truly illiquid is the loan for the wedding. Of course, pleasant memories and photos of touching moments can be much more valuable than the money itself. Think about your budget and donโ€™t turn to borrowed capital. Saving more now will mean more opportunities in the future for your newly created family ๐Ÿ˜‰

Vehicles included. Car purchase cannot be called an illiquid acquisitionโ€” it's easy to sell a vehicle if it is in a decent condition. But do not forget that as soon as you leave the dealership it will immediately lose 10% (or more) of its value. In addition to this, the aging of the car (considering all the possible damage) rapidly reduces its liquidity. Additional costs of services should also be taken into account!

The question then arises: can any purchases be liquid at all?

Of course, but take into account additional factors when assessing liquidity. Even if the purchase loses a portion of its price over a one year period, it can still be acceptable to you. The benefit from the acquisition and the pleasure of ownership can be more important. Nonetheless, a rational approach to personal finance requires responsible calculations, at least sometimes. Therefore, choose what is best for you โ€” cold-blooded premeditation or fleeting desires.

About author
I write texts. Once I get a task, I do the following: I find every significant book on the topic, I read 'em all and then I synthesize something, that my readers can actually read and understand. Works like a charm.
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