Illiquid Assets: Overview, Risk and Examples


While it’s still ordinarily possible to sell your shares in these funds, doing so typically incurs a steep penalty. While some investors can diversify by buying shares of a publicly-traded REIT. Other investors prefer to place capital in a real estate private equity firm. Ultimately with the goal of outperforming both the broader market and industry specific REITs. Before investing in any asset, it’s important to keep in mind the asset’s liquidity levels since it could be difficult or take time to convert back into cash.

You may wind up holding an illiquid asset for longer than you want, or you could be forced to sell it at a steep discount. These are assets that cannot be quickly sold, that are difficult to sell or that cannot be sold without incurring a significant loss in value. Having a diversified portfolio means finding that sweet spot where you’re comfortable with how your investments and your risk align.

An illiquid asset is an asset that takes time to convert into cash quickly without incurring significant expense. If you have an unexpected expense, you may need to sell assets to raise cash. But some assets are more difficult than others to sell quickly without taking a major loss. Each plot of land is singular, with no other exactly like it on the market. While you can reference the last price for which this land sold, that data will typically be years out of date, and may not reflect new construction or other changes. This deal must be struck anew each time, with the fair market price for the asset determined between buyer and seller rather than by the market at large.

  1. A private equity real estate investment strategy like this can help to lower the risk with the potential for strong upside performance.
  2. For example, a 401(k) would not typically be considered a liquid asset for a preretirement individual, since converting it into cash would incur a significant tax penalty.
  3. By participating in illiquid investments, Real estate investors can diversify part of their overall portfolios across a wide range of property types.
  4. Many of these financial assets do not have a set monetary value until they are converted into cash, especially in the case of stocks where their value and price fluctuate.
  5. All opinions, analysis, or predictions expressed and data provided herein are subject to change without notice.

A private equity real estate investment strategy like this can help to lower the risk with the potential for strong upside performance. Even for investors with little or no experience investing in real estate. Illiquid refers to the state of a stock, bond, or other assets that cannot easily and readily be sold or exchanged for cash without a substantial loss in value. As a result, illiquid assets tend to have lower trading volume, wider bid-ask spreads, and greater price volatility. The current ratio (also known as working capital ratio) measures the liquidity of a company and is calculated by dividing its current assets by its current liabilities.

The asset should be one you are comfortable holding in your portfolio for five years or more. As well as the real estate private equity firm should be one that has a proven track record of success. Illiquid securities also may demand a liquidity premium added to their price to compensate for the fact that they may difficult to dispose of later on. Liquidity is important in financial markets as it ensures trades and orders can be executed appropriately. Within financial markets, buyers and sellers are often paired based on market orders and pending book orders.

Before chosing to put money into an illiquid investment, there are several things you need to consider. Your liquidity needs over the investment timeline, the expected rate of return over the holding period, and your individual tolerance for risk. Single-family home and small multifamily property are also considered medium-liquid investments. Best etf to day trade In most real estate markets across the U.S., the demand for housing significantly outpaces the available supply. This is provided you can take the time to wait to realize the full market value. Examples of medium-liquid investments include assets such as precious metals, classic cars, rare art, fine wine, watches, and jewelry.

Pros & Cons of Illiquidity

SmartAsset Advisors, LLC (“SmartAsset”), a wholly owned subsidiary of Financial Insight Technology, is registered with the U.S. Liquidity is the amount of cash you have readily available and accessible to meet financial responsibilities like spending or investing. It’s always a good idea to have an appropriate level of liquidity available for a rainy day fund so you’re prepared for anything that may pop up, especially those unexpected expenses in life. New construction on single-family homes could exceed 1 million this year. Industrial real estate is also considered a good defensive, countercyclical investment.

Assets like stocks and bonds are very liquid since they can be converted to cash within days. However, large assets such as property, plant, and equipment are not as easily converted to cash. For example, your checking account is liquid, but if you owned land and needed to sell it, it may take weeks or months to liquidate it, making it less liquid. Maintaining funds in liquid financial assets can result in greater preservation of capital. Money in bank checking, savings, and CD accounts are insured against loss of up to $250,000 by the Federal Deposit Insurance Corporation (FDIC) for credit union accounts. If for some reason the bank fails, your account has dollar-for-dollar coverage up to $250,000.

Financial Liquidity Measurements

If a specific security has no liquidity, markets cannot execute trades, security holders can not sell their assets, and parties interested in investing in the security can not buy the asset. Some individuals or companies take peace of mind knowing they have resources on hand to meet short-term needs. Instead of having to force-sell assets in a short-term timeframe, liquidity is important as it helps foster a strategic, thoughtful proactive environment as opposed to a reactionary environment. If an exchange has a high volume of trade, the price a buyer offers per share (the bid price) and the price the seller is willing to accept (the ask price) should be close to each other. In other words, the buyer wouldn’t have to pay more to buy the stock and would be able to liquidate it easily. When the spread between the bid and ask prices widens, the market becomes more illiquid.

Companies often have other short-term receivables that may convert to cash quickly. Unsold inventory on hand is often converted to money during the normal course of operations. Companies may also have obligations due from customers they’ve issued a credit to.

Financial Asset Definition and Liquid vs. Illiquid Types

In this example, the company’s net working capital (current assets – current liabilities) is negative. This means the company has poor liquidity as its current assets do not have enough value to cover its short-term debt. Other investment assets that take longer to convert to cash might include preferred or restricted shares, which usually have covenants dictating how and when they can be sold. In addition, specific types of investments may not have robust markets or a large group of interested investors to acquire the investment.

What Is Illiquid?

The cash left over that a company has to expand its business and pay shareholders via dividends is referred to as cash flow. Land, real estate, or buildings are considered among the least liquid assets because it could take weeks or months to sell them. Fixed assets often entail a lengthy sale process inclusive of legal documents and reporting requirements. Compared to public stock that can often be sold in an instant, these types of assets simply take longer and are illiquid. They typically trade on over-the-counter exchanges, rather than on a major stock exchange like the New York Stock Exchange (NYSE) or NASDAQ. A penny stock typically has a low trading volume compared to a stock issued by a larger company, which means you may have trouble selling a penny stock at the time and price you want.

An investor will expect a higher return, or an “illiquidity premium.” For example, if you invest in an asset that cannot be sold for five years or more. You would expect a higher potential return compared to an asset that trades daily, weekly, or monthly. An illiquid asset is an asset that lacks a ready pool of buyers, so the seller may have to sell it at a discount if you need funds quickly.

Some investments are easily converted to cash like public stocks and bonds. Since stocks and bonds have public exchanges with continual pricing, they’re often referred to as liquid assets. Illiquidity is essential to many aspects of both accounting and investing. From an accounting perspective, reporting liquid assets is a requirement of many different forms of financial disclosures. A liquid asset is one that can be quickly sold without a significant loss in value; an illiquid asset is one that can’t be quickly resold without a significant loss in value.

Capital assets, including real estate and production equipment, often have value but are not easily sold when cash is required. They generally include any property owned by the company that is outside of the products produced for sale. They’re any assets that can’t be quickly or easily sold or converted into cash without assuming a significant loss in value. Alternative investments such as venture capital, private equity and real estate are illiquid in that they can be difficult to sell. This difficulty can be due to a lack of buyers who are willing to purchase, or because of the expense involved in the sale.

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