The concept of liquidity in investments refers to the accessibility and convertibility of the investments into cash. Liquid investments are low-risk investments with high volume in trading major exchanges, making them a preferred investment option for those seeking immediate funds. Stocks, exchange-traded funds, and bonds are some liquid investment options. Illiquid investments, on the contrary, are not marketable for their complexities, restrictions on trading, and unique nature. Hedge funds, venture capital, private equity, real estate, direct business ownership, and many others fall into the category of illiquid investments.
This article intends to discuss the concept of liquidity in investment and the investment that has the least liquidity.
Unveiling the Concept of Liquidity
Liquidity is the efficiency through which an asset, security, or stock can be converted into cash without affecting its market price. The more swiftly an investment is converted into cash, the more is its liquidity. Investment liquidity is fundamentally measured by trading volume and the time taken to sell. Assets that are sold quickly are considered good liquid investments and vice versa.
Factors Influencing Liquidity
Several factors are responsible for influencing investment liquidity. Let us have a look at these factors:
- Market Conditions: When a market observes high trading activities, the liquidity increases. Whereas when markets have fewer participants in trading, it reduces the investment liquidity. A high supply and demand of any asset in a market makes it easier to buy or sell.
- Nature of Assets: Different assets have different levels of liquidity. For example, stocks have high liquidity compared to real estate.
- Fund Accessibility: More availability of funds increases the options of potential buyers and sellers, increasing the liquidity of a market.
- Trading Volume and Time to Sell: The higher the trading volume, the higher the investment liquidity. An asset sold swiftly is likely to increase liquidity. Hence, the time taken to sell an asset affects its liquidity in the market.
- Regulatory Environment: Policies and regulations can significantly affect liquidity, making the asset sell either slow down or heighten.
- Accessibility to Market Information: Data concerning the market empowers investors to make informed decisions while investing. Good accessibility to a large volume of market data can help investors identify viable liquid and least liquid assets.
Illiquid Investments
Here is a glimpse at the most popular non-liquid or illiquid investments –
Direct Ownership of Business
Private companies have no liquidity, making them hard to buy or sell. Direct ownership of a private company has little or no liquidity and has no marketability of its shares. The transaction of buying a private company can take months to process. It also associates some regulatory restrictions that make it hard to sell.
Real Estate
The liquidity of real estate depends on its type and location. A residential property in a prime location can be sold quickly compared to a commercial property in a less desirable location. These properties are significantly subject to market conditions, transaction processes, and regulatory limitations that affect their liquidity to a large extent.
Private Equity
In private equity investment, investors invest in companies not traded publicly on stock exchanges. Investors in private equity funds need to be committed for a period of five to ten years or more. Institutional investors and wealthy individuals invest largely in private equity. Although high returns balance its liquidity, it is likely to have lesser liquidity due to its securities and long-term commitment.
Venture Capital
Similar to private equity, venture capital also requires a long-term commitment. However, this investment is often considered extremely risky and illiquid for its longer locking period.
Art and Collectibles
The liquidity of art and collectibles depends on the buyer’s availability, trends, and appraisals. It has an unpredictable market, with buyers limited to collectors only. Artworks and collectibles are hard to sell and take a long time, making them illiquid investments.
Which Investment has the Least Liquidity?
Although many investments have little or no liquidity, direct ownership of a private business has the least liquidity compared to other illiquid investments. The complex and protracted transactions in this investment make it a restricted option. The buyers are hard to find, and transactions last for a longer period, making it the least liquidity investment.
Next comes real estate investment with minimal liquidity in the market. As discussed earlier, the liquidity of real estate is subject to location and its type. The time-consuming transaction process fails to convert it to cash quickly. It is a multi-staged process that makes this investment complex and reduces its liquidity in the investment market.
Art and collectibles also have the least liquidity due to the associated limitations. From finding potential buyers to persuading them to purchase the works, this investment is more challenging than real estate.
Liquidity plays a crucial role in investment decisions, helping investors choose the right type of investment as per their preferences. Balancing liquid and illiquid investments is a thin line to cross. It requires thorough evaluation and a strategic investment approach to choose the right investment option. Identifying risks and making informed decisions is what investment is all about. Choose your investment option by considering your liquidity and other preferences.
