By: Julio Perez, Graduate Research Assistant
So now you have your shares of stock in a public company, you have it in a diverse portfolio, and you hedged it just to make sure you don’t lose out on too much profit. Now what is liquidity, how does it apply to your stocks, and why does it matter to you?
A liquid market is defined as a market in which selling and buying can be accomplished with minimal effect on price. Many factors go into determining liquidity,.
For example, cash funds (dollar bills) are very liquid, since you can always exchange one dollar for another identical dollar and there are a lot of people with cash willing to exchange it and use it for other transactions. Also, if any person is asking for $40 in exchange for say, a chair or a share of stock, they will accept your forty bills in exchange for the product. In fact, cash is considered the most liquid of assets.
On the other end of the liquidity spectrum is, say, a house. Your house is a very specific product; everything from its location, to its size, to its color is one-of-a-kind. Not everyone wants or needs a house, and if they do, they might not want one at the price you offer or in your location.
So you don’t want to sell your house, or you don’t own one, or you understand how liquidity works but do not particularly care about it, how does understanding liquidity apply to you? Well, liquidity applies to practically anything you buy and sell, and it should be taken into account when you develop your portfolio to ensure you have the ability to meet your needs. Understanding the liquidity of your investments and how quickly and freely you are able to buy and sell them is an essential element to a personally-tailored investment portfolio congruent with your short and long-term investment goals.
Translation: “It’s hard to buy and sell real estate quickly and the price fluctuates a lot. Cash is much more liquid.”