Financial Liquidity Explained & Why It’s Important

by • September 17, 2022 • MoneyComments (0)207

The global forex market represents a high growth entity, and one that achieved a cumulative daily trading volume of $6.6 trillion in April 2019. This was up from just $5.1 trillion three years’ previously, and it highlights the immense and growing appeal of this market across the globe.

However, this market is also highly volatile and hard to navigate as a beginner, with the use of complex terms and jargon making it hard for investors to achieve success either in the short or longer term.

One such term is ‘financial liquidity’. In this post, we’ll look at precisely what this means and how you can incorporate this into your portfolio.

What is Liquidity?

The term ‘financial liquidity’ describes how easily assets can be bought, sold and converted into cash. Each financial asset has its own unique level of liquidity, which in turn should help to inform your individual investment decisions.

For example, fiat cash is thought to be the most liquid financial asset, while international currencies (which can be traded on the global forex market) are also relatively easy to trade in real-time.

This is particularly true in the case of the seven major currency pairs, which account for 68% of all daily forex trades and benefit from significant demand on an hourly basis.

Public stock, inventory and some receivables are other examples of highly liquid assets, while long-term fixed assets or private securities are considerably harder to sell.

What are the Most Liquid Assets?

As we’ve already touched on, cash is the ultimate liquid asset in the financial market, while major currency pairs can also be bought and sold with incredible ease.

We also like Treasury bills and Treasury bonds as liquid assets, which are highly stable and backed by the full faith and credit of the US government. Because of this, they can be instantly sold for cash on the secondary market before they mature, making them particularly popular during times of economic tumult.

Publicly traded stocks are also incredibly liquid, thanks to the profile of the underlying financial instrument and the level of demand that typically exists.

In fact, you’ll usually receive cash from your equity sale within a few days, although whether this yields a profit depends on the precise nature of your holdings.

How to Build Liquid Assets

Ultimately, holding some of your total net worth and capital in the form of liquid assets is central to any sound investment plan. This ensures that you can convert some of your portfolio into cash as and when required, such as during a sustained economic downturn.

It’s recommended that you have between three to six months of your expenses in liquid assets as part of an emergency fund, just in case your financial circumstances change at any time.

To achieve this, you may want to consider liquidating some of your alternative assets, in order to boost your accessible funds and create a more balanced portfolio,

Once you’ve built your liquid funds, the next step is to keep them in a high-yield savings account that can deliver optimal returns.

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