Liquidity in Investing

The Need for Liquidity

Liquidity is key for everyone when evaluating any investment or overall portfolio position. The next two blog posts will address liquidity generally as well as specific liquidity concerns that arise for various stakeholders in any transaction.

As an investor, lender, or sponsor, it is essential that you understand the amount of liquidity required to be secure in your position. If you are contemplating a sizable investment, you should have enough liquid assets to cover both expected and unexpected expenses. As for lenders, it is important that borrowers have access to enough liquidity to reduce your risk. Sponsors also require liquidity among investors to fund and guarantee investments. In sum, understanding your liquidity needs given your role may keep you from making a costly error. 

What Is Liquidity?

No matter what role you take in an investment, you should understand what liquidity is, how it works, and what your liquidity needs are before taking part in an investment of any kind. Liquidity refers to the ease at which you can convert an asset into cash without affecting the asset's market price. Cash is the most liquid asset that a person can have since it can be converted into nearly any other asset. Stock and bonds are relatively liquid, and tangible assets may be considered the most illiquid investments (i.e., they require the most time or work to convert to cash). 

Investor

If you are preparing to make an investment of any consequence, you should consider its liquidity demands. Cash may be needed to fund an investment, and each additional investment may impact your overall portfolio liquidity. For instance, consider a long-term real estate investment. Real estate investors need a certain amount of cash (or ability to borrow cash against portfolio holdings) in order to close the initial transaction and manage the property. 

While this type of investment may seem to limit cash resources, you should keep in mind real estate investments often generate cash flow through rent, royalties, and other types of recurring payments. These funds can be used to help manage the subject property or diverted for additional investment in other properties.  

Nevertheless, it is important to remember life can be full of uncertainty. Issues may arise that require immediate funds in order to resolve. Without proper planning, you may be left with a problem you cannot afford to solve in a timely manner. Such delays may affect the long-term value of the subject property as well your relationship with various stakeholders (including tenants and partners).