Liquid assets, such as cash or highly marketable securities, tend to offer lower returns than illiquid assets. This leaves the liquid-account owners vulnerable to two primary types of risk: purchasing power risk and opportunity costs. Other risks might be present or absent depending on the type of liquid asset.

Types of Liquid Assets

In modern market economies, cash is the most liquid asset. An asset's liquidity is based on its convertibility to cash; a savings account deposit is very liquid because it can easily be converted into cash. Other liquid assets include highly marketable securities, certificates of deposit, or CDs, and tax refunds. Illiquid assets range from long-term government bonds to real estate or collectible art.

Purchasing Power Risk

Liquid assets are often on the losing end of a time value struggle against inflation. When the rate of inflation outpaces the balance on a liquid account, the purchasing power of the balance declines. The chance of relative loss due to inflation is known as purchasing power risk.

For a simple example, consider a checking account that generates no interest. An individual keeps $1,000 in his checking account for a year; the same number of dollars are on his statement balance on Dec. 31 as there were for the preceding Jan 1.

If the rate of inflation for that year was 5%, the real purchasing power of the account declined from $1,000 on Jan. 1 to $950 on Dec. 31. Even though no loss of principal occurred, the individual's assets became less valuable.

Opportunity Cost

Economists are quick to point out that the real cost of any activity is the next-best alternative. In other words, the real cost of spending $1,000 on a new TV is whatever else that $1,000 might have accomplished. This concept is called "opportunity cost." The risk assumed by every liquid account holder is that a better opportunity exists elsewhere.

Consider the individual with $1,000 in the checking account. He might have instead purchased $1,000 worth of a technology stock or reduced his future interest payable by paying down the principal balance on a debt account.

  1. What is the difference between liquidity and liquid assets?

    Liquid assets can easily be converted into cash. Liquidity is the ability of a business to pay its debts using its liquid ... Read Answer >>
  2. What affects an asset's liquidity?

    Learn about what affects an asset's liquidity, including examples of liquid and fixed assets, and how a company's liquidity ... Read Answer >>
  3. How much liquidity is considered too much liquidity?

    Learn about the risks of holding too much cash or investing in assets that are too liquid, and discover how liquidity is ... Read Answer >>
  4. What Assets Are Considered Liquid And Non-Liquid?

    In this article, you'll learn what liquid assets are, what assets are considered liquid, and what investments are considered ... Read Answer >>
  5. How does securitization increase liquidity?

    Learn how securitization increases affects working capital and liquidity, and why it matters for a company seeking to increase ... Read Answer >>
  6. Are a bank's current assets counted as liquidity?

    Find out how bank assets are defined and how the Federal Reserve controls the definitions of, requirements for, and availability ... Read Answer >>
Related Articles
  1. Financial Advisor

    Small Cap Investing: How to Think About Illiquidity

    Do your homework, have a long term view, exercise patience, you'll find that investing in small market capitalization stocks is no riskier than investing in large stocks
  2. Managing Wealth

    When Introducing Illiquidity to Your Portfolio Makes Sense

    Find out when you should consider adding illiquid investments to your portfolio, such as real estate or locked-up investment funds.
  3. Financial Advisor

    Why Liquidity Matters in the Corporate Bond Market

    Professional analysis and constant monitoring of liquidity risk when investing in corporate bonds is highly important.
  4. Managing Wealth

    Retirement Wealth: The Place of Tangible Assets

    When building a retirement portfolio, you need to determine how tangible assets fit with traditional investment products in your wealth-building strategy.
  5. Investing

    Explaining the Liquidity Preference Theory

    According to the liquidity preference theory, investors demand interest in return for sacrificing their liquidity.
  6. Investing

    Dynamic Current Ratio: What It Is And How To Use It

    Learn why this ratio may be a good alternative to the current, cash and quick ratios.
  7. Financial Advisor

    Corporate Bonds and the Impact of Inflation Risk

    The impact of inflation risk affecting corporate bond returns can be significant. It may even result in a real loss of purchasing power.
  8. Retirement

    Introduction To Retirement Money Market Accounts

    Money market funds are used in retirement plans and accounts because they are liquid, stable and pay competitive rates of interest.
  9. Insights

    How Inflation Affects Your Net Worth

    When calculating your net worth, don't forget to take inflation into account.
  1. Liquid Asset

    A liquid asset is an asset that can be converted into cash quickly ...
  2. Net Liquid Assets

    Net liquid assets are a strict measure of an immediate or near-term ...
  3. Overall Liquidity Ratio

    Overall liquidity ratio is the measurement of a company’s capacity ...
  4. Liquidity Risk

    Liquidity risk refers to the marketability of an investment and ...
  5. Core Liquidity

    Cash and other financial assets that banks possess that can easily ...
  6. Financial Asset

    A financial asset is a tangible liquid asset that derives its ...
Hot Definitions
  1. Cryptocurrency

    A digital or virtual currency that uses cryptography for security. A cryptocurrency is difficult to counterfeit because of ...
  2. Financial Industry Regulatory Authority - FINRA

    A regulatory body created after the merger of the National Association of Securities Dealers and the New York Stock Exchange's ...
  3. Initial Public Offering - IPO

    The first sale of stock by a private company to the public. IPOs are often issued by companies seeking the capital to expand ...
  4. Cost of Goods Sold - COGS

    Cost of goods sold (COGS) is the direct costs attributable to the production of the goods sold in a company.
  5. Profit and Loss Statement (P&L)

    A financial statement that summarizes the revenues, costs and expenses incurred during a specified period of time, usually ...
  6. Monte Carlo Simulation

    Monte Carlo simulations are used to model the probability of different outcomes in a process that cannot easily be predicted ...
Trading Center