Almost anything you own can be classified as an asset. An asset is either liquid or illiquid. A liquid asset can be sold quickly for cash, and the transaction generally won't affect the asset's price. An illiquid asset is just the opposite; it cannot be easily converted to cash, and its sale may affect the price of other, similar assets. As with all investments, there are advantages and disadvantages to owning only liquid assets.
Examples of Liquid Assets
A liquid asset isn't just the cash in your pocket or what's sitting in your checking account. Liquid assets also include certain investments, like certificates of deposit. Stocks and bonds that have low bid-ask spreads are liquid because they're easily converted to cash, according to the Financial Dictionary. Some define a liquid asset as one that can be converted to cash within 20 days, while others say that an instrument is liquid if it matures within a year.
Changes in Price
The biggest risk you take by having too much invested in liquid assets is that your asset portfolio may drop precipitously in a short period of time. For example, if your entire net worth is in stocks, and the stock market drops 20 percent over the course of a year, then you've just lost 20 percent of your entire net worth. Illiquid assets -- also called fixed assets -- are not generally subject to sudden or violent decreases in value.
Negotiators Need Not Apply
Another disadvantage to owning too much in liquid assets is the lack of flexibility in price. Liquid assets are worth what they're worth; for example, you can't call your bank and say, "I don't want to buy this certificate of deposit at 1.5 percent return, I want to buy it at a 3 percent return." Fixed asset sales require time and negotiation, which means you may get a better price than you originally anticipated.
Pride of Ownership
Many investors keep a substantial amount invested in what's probably the biggest and most popular fixed asset: the home. There are other types of fixed assets as well; jewelry, artwork and automobiles are all fixed assets. While having a valuable liquid asset portfolio is undoubtedly nice, it doesn't provide a level of comfort, function or beauty for your life. Fixed assets accomplish this nicely, while also meeting basic needs. Keep in mind that just because an asset is fixed, that doesn't mean its value won't decrease over time. For example, the housing market decreased significantly from 2007 to 2011.
Lisa Bigelow is an independent writer with prior professional experience in the finance and fitness industries. She also writes a well-regarded political commentary column published in Fairfield, New Haven and Westchester counties in the New York City metro area.