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Liquidity risk is the risk of being unable to sell an asset fast enough to avoid loss.

There are two types: funding liquidity risk and market liquidity risk.

Funding liquidity risk is the inability to pay your liabilities, leading to default. For example, an accountant will worry about her company’s ability to pay its bills.

Market liquidity risk is the inability to exit a position before an asset’s price falls. For example, in real estate, it may take longer than you expect to sell your house, or the market may set a lower value for your house than you believe it’s worth.

In contrast, you could sell a stock or bond if you needed cash immediately to pay a large medical expense. Stocks and bonds usually carry lower liquidity risk because they’re bought and sold every day.

However, you may face higher liquidity risk if there are few takers for your stock. Wide bid-ask spreads, the gap between a buyer’s and a seller’s prices for an asset, are common with high liquidity risk.

Time also plays a part, as more time to sell an asset or find funds can lessen liquidity risk.

Liquidity risk is usually associated with micro-cap or small-cap stocks, though it may receive larger offerings during times of crisis. Liquidity should be considered with every investment.

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