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What Is Liquidity?
The Importance of Liquidity.

Liquidity is the term used to describe how easy it is to convert assets to cash. The most liquid asset, and what everything else is compared to, is cash. This is because it can always be used easily and immediately.

Liquidity is a concept that many investors fail to take into account or understand and as a result their financial plans fail to come through in such critical times as retirement or college funding for a dependent. However, the fact is liquidity or a lack thereof causes more financial problems than almost any other aspect of finance. People either lose money, which they needed in the short term because of improper investments or they find they have insufficient funds upon retirement because of years of investing in short term investments for a long-term goal.

The term liquidity refers to how fast something can be turned into cold, hard cash; the kind you stick in your wallet or cash exchange for something else.  Liquid assets are those that are thought to be turned to cash or purchasing power immediately.

From a financial perspective, liquidity refers to the accessibility of an investment. The best way to find the liquidity of something is to determine how long it would take to arrive into your pocketbook if you happened to need it today.

Scenario 1:
Suppose you need 10 lakhs of funds urgently (with in a week), will you or can you sell of your property worth crores as and when needed, this state is called liquidity of investment.

Investments shall be kept in such a form that remains smooth to exit or reinvest elseware.

Scenario 2:
Suppose you had invested in some property expecting good returns, but few years later you realised (due to some policies) given area is not developing at good rate, and thus you decided to exit your invested money, but you are not getting desired buyer as area is already under negative sentiments among investores. You are stuck with your investment.

Liquidity is important for both individuals and companies.

While a person may be rich in terms of total value of assets owned, that person may also end up in trouble if he or she is unable to convert those assets into cash. The same holds true for companies. Without cash coming in the door, they can quickly get into trouble with their creditors. Banks are important for both groups, providing financial intermediation between those who need cash and those who can offer it, thus keeping the cash flowing. An understanding of the liquidity of a company's stock within the market helps investors judge when to buy or sell shares. Finally, an understanding of a company's own liquidity helps investors avoid those that might run into trouble in the near future.

Bottomline Suggestion:
1. Always have a portion of your investments in near-cash state. This should be available virtually instantly, and not be subject to any significant shifts in value. While the amount may vary from person to person, it should be no less than the lower of either three months take-home salary or 5% of your investable assets.

2. Of your remaining investable assets, somewhere between 60%-80% should be in liquid investments, including individual stocks and bonds, as well as mutual funds and certain alternative investment funds that provide at least monthly liquidity (meaning you are able to cash in on at least a monthly basis).