Keeping a portion of your money in liquid form means you’ll have cash available when you need it. Liquid assets include cash as well as money in savings and checking accounts and investments that you can convert to cash relatively quickly without paying a penalty. There are pros and cons to keeping a large portion of your money in liquid form, but finding the right balance can help you reach your financial goals more quickly.
Holding your cash in liquid form gives the advantage of readily having money available to handle unexpected expenses and emergencies. The downside is you lose out on the tax benefits that putting your cash in retirement savings accounts can provide.
Definition of Liquid Assets
An asset is anything you own that has value and can be converted to cash. It includes your home's equity as well as objects of value, like antiques, artwork and jewelry.
The problem with property assets is that you would have to sell the property to get your hands on its cash value. Especially with real estate, you may even lose some money if you’re forced to sell at the wrong time.
In contrast, funds you have in bank accounts and invested in CDs and money market accounts are assets that can be converted to cash more quickly. These are your liquid assets.
Importance of Liquid Assets
Your liquid assets are there for you in case of an emergency or unexpected expense. Financial experts say that people who don’t have a liquid emergency fund are only a paycheck or two away from serious financial problems. A car repair or trip to the emergency room doesn’t have to be a disaster if you have some liquid savings on which to fall back. It also saves you from using a credit card and running up unnecessary debt.
How Much Liquidity to Have
Opinions vary widely when it comes to the amount of money you should have in liquid savings. A rule of thumb you’ll often hear is three to six months of your average monthly expenses. Money expert Suze Orman takes this a step further, stating that the only way to really feel secure about the risk of being out of work due to job loss or disability is to have eight to 12 months of expenses in liquid savings.
Disadvantages of Liquid Assets
Liquid assets are good, but like other things you can have too much of a good thing. Long-term savings for retirement should be maintained in 401(k) or IRA accounts to take advantage of tax benefits. Assets in these accounts are not completely liquid since you may be penalized for early withdrawal, so you’ll be less tempted to touch them before you really need them.
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