What Are the Advantages & Disadvantages of Holding Your Money in a Liquid Form?

Cash remains the most liquid form of money, although people routinely use debit cards.

Cash remains the most liquid form of money, although people routinely use debit cards.

Holding your money in liquid form means keeping it in cash or investments that are converted easily to cash. More cash or cash accounts means you have a high level of financial liquidity, which has advantages and disadvantages. Typically, you need enough cash assets to cover your necessary expenses and some that are unexpected.

Liquidity Basics

Basic checking, savings and money market accounts are among the most liquid ways to hold your money. Stock and real estate are investment opportunities that tend to have lower liquidity. A liquidity ratio is a way to measure your ability to keep up with household expenses for a certain period of time. Divide cash or easily converted cash assets by your monthly expenses to determine your liquidity ratio -- the number of months' expenses you can cover with your current cash assets.

Quick Access

The most significant advantage of liquid cash is that you have quick access to your money as needed. Cash accounts are important to everyday budgeting, but they also come in handy when you have an unexpected bill or need money for car repairs or renovation projects. Keeping your money in less liquid, low-return accounts makes little sense if you have to pay for routine purchase or unexpected bills -- such as car repairs, medical fees and home repair services -- using a high interest rate credit card. Building a rainy day savings fund in a more liquid account can provide protection against this type of situation, giving you quick access to cash.

Lower Risk of Loss

Another advantage of keeping your money in more liquid accounts is that they tend to have a lower risk of loss. Typically, more liquid accounts and investments are more conservative. While you could lose cash, bank accounts have very little risk. By budgeting in a way to protect money you need to live on in more liquid accounts, you can invest your excess in more aggressive ways -- such as stocks, real estate or Forex -- with greater peace of mind.

Limited Returns

One disadvantage of more liquid accounts is limited investment return opportunities. Holding cash yields no investment return aside from standard rates of inflation over time. Basic checking and savings accounts usually have very minimal interest yields. Banks offer better returns in exchange for longer access to your funds. Certificates of deposit, for instance, commonly yield annual returns slightly higher than regular savings accounts, but you cannot withdraw the funds without penalty for the term of the CD -- anywhere from six months to several years. Good stock investments can produce nice returns, but you have to sell the stock and wait for the trade to settle to get cash.

About the Author

Neil Kokemuller has been an active business, finance and education writer and content media website developer since 2007. He has been a college marketing professor since 2004. Kokemuller has additional professional experience in marketing, retail and small business. He holds a Master of Business Administration from Iowa State University.

Photo Credits

  • Stockbyte/Stockbyte/Getty Images