Liquidity: what it means, why it matters & examples

Types of liquidity

There are two familiar flavors you’ll see in finance: market liquidity and accounting liquidity. They’re related, but they’re not the same thing.

Market liquidity

Market liquidity is the ease with which an asset can be bought or sold at a fair price without moving the market. FINRA puts it plainly: liquid investments can generally be bought and sold more easily without a significant change in price. FINRA

A few signals of strong market liquidity:

• Lots of buyers and sellers (deep order books)
  
  
• High trading volume
  
  
• Tight bid-ask spreads (the “gap” between what buyers pay and sellers want)
  
  
• Fast execution with minimal “price slippage”
  
  

Examples (often liquid):

• Large public stocks and major ETFs
  
  
• U.S. Treasuries (usually very liquid—but not always, as 2020 reminded everyone) Federal Reserve Bank of New York
• Widely traded crypto assets (can be liquid, but spreads can widen fast in volatility)
  
  

Here’s the punchline: market liquidity is not guaranteed. During periods of stress, markets can become crowded exits. This risk becomes even more pronounced in private markets, where exits may depend on timing and buyer availability, as discussed in the benefits of entering private markets closer to the finish line. The New York Fed describes how March 2020 triggered a global “dash for cash” that disrupted even sovereign bond markets. Federal Reserve Bank of New York

Accounting liquidity

Accounting liquidity is the ability of an individual or business to meet short-term financial obligations.

Think: rent, payroll, interest payments, upcoming bills, stuff that doesn’t care about your long-term investing thesis.

A simple way to frame it:

• If market liquidity is “Can I sell this quickly?”
  
  
• Accounting liquidity is “Can I pay what’s due soon?”
  
  

Common measures (you’ll see these in company financials):

• Current ratio (current assets / current liabilities)
  
  
• Quick ratio (a stricter version that focuses on the most liquid assets)
  
  

Even if a company owns valuable long-term assets, low accounting liquidity can still cause near-term problems.

Liquid vs. illiquid assets

If you’re learning about liquidity, it helps to picture assets on a spectrum from “cash in hand” to “might take months.”

Liquid vs illiquid assets isn’t about “good vs bad.” It’s about tradeoffs:

• More liquidity often means more flexibility
  
  
• Less liquidity can mean more potential upside (an “illiquidity premium”), but also more constraints

Why Liquidity Matters in Investing

Liquidity is the quiet feature that makes your portfolio feel usable, not just impressive on paper.

1) Liquidity affects your ability to act

In investing, liquidity is everything. Liquidity determines whether you can:

• Raise cash quickly for an emergency
  
  
• Rebalance when markets swing
  
  
• Take advantage of opportunities (buying when prices drop)
  
  
• Exit a position if your thesis changes
  
  

It’s hard to “buy the dip” if your money is trapped behind lockups and redemption windows.

2) Liquidity changes your real risk level

Two investments can have the same expected return yet feel very different due to liquidity.

Example:

• A public ETF might drop 15%, but you can sell in seconds.
  
  
• A private investment might mark down slowly, but you can’t exit quickly when sentiment shifts.

Sometimes the riskiest part isn’t volatility, it’s being stuck. This is a common issue in pre-IPO investing, where limited exit options can matter more than short-term price swings, as outlined in how accredited investors are unlocking liquidity in the pre-IPO market.

3) Liquidity shapes how you diversify

Diversification isn’t just “own different stuff.” It also has distinct time horizons.

A balanced portfolio usually blends:

• Highly liquid assets (for near-term needs)
  
  
• Medium-liquidity assets (for growth + optionality)
  
  
• Illiquid assets (for long-term compounding, if appropriate)
  
  

A real-world example: the “can’t exit fast” problem

Some private real estate vehicles and private funds allow redemptions only:

• Quarterly
  
  
• With limits (“gates”)
  
  
• Or not at all during stress periods

That’s not automatically bad, just something you want to know before you invest.

Liquidity risk: what investors should know

Liquidity risk is the risk that you won’t be able to buy/sell or access funds quickly enough at a reasonable price.

It shows up in a few ways:

Market liquidity risk

You can sell, but only by accepting a worse price (wide spreads, slippage). FINRA notes that liquidity can decline when trading becomes more difficult due to buyer-seller imbalances or volatility. FINRA

Funding liquidity risk

This is more “system-level,” but it matters because it can spill into markets. BIS commentary distinguishes market liquidity from broader liquidity conditions and discusses how liquidity can become more expensive in both time and cost. Bank for International Settlements

Structural liquidity risk

Your investment has lockups, limited redemption windows, or transfer restrictions, so you can’t access cash on your schedule. Understanding these constraints is a key part of due diligence for private investments, as outlined in the importance of due diligence in secondary market transactions.

Liquidity risk in market stress: 2008 and 2020 (two different flavors)

• 2007–2008 era: The Federal Reserve described liquidity shortages and the actions taken to keep markets functioning. Federal Reserve Bank of San Francisco 
• March 2020: a “dash for cash” hit global markets, impacting market functioning and triggering central bank intervention. Federal Reserve Bank of New York

The lesson is consistent: when everyone wants liquidity simultaneously, it becomes more expensive.

How to assess liquidity before you invest

Use a simple checklist:

• How fast can I turn this into cash? (days, weeks, years)
  
  
• What’s the spread/slippage likely to be? (especially in volatility)
  
  
• Are there lockups, gates, or redemption limits?
  
  
• Who are the natural buyers? (many, or a very specific niche group?)
  
  
• What happens in “risk-off” markets? (don’t assume the best-case scenario)
  
  

For regulated funds, liquidity risk is taken seriously. The SEC’s liquidity risk management framework for certain funds (Rule 22e-4) underscores the importance of “convertible to cash” considerations.

Managing Liquidity in Your Portfolio

You don’t need to obsess over liquidity. You just need a plan that won’t force you into bad decisions at the worst time.

The 3-bucket strategy (simple, effective, boring but in a good way)

Bucket 1: Short-term (sleep-at-night money)
Use for: emergencies and near-term spending
Typical assets:

• Cash, checking, HYSA
  
  
• Money market funds
  
  
• Very short-term Treasuries
  
  

Bucket 2: Mid-term (flexible growth money)
Use for: goals 3–10 years out, opportunistic rebalancing.
Typical assets:

• Public stocks, ETFs
  
  
• Bonds / bond funds (liquidity varies by type)
  
  

Bucket 3: Long-term (patient capital)
Use for: long-horizon growth where you can tolerate lockups
Typical assets:

• Real estate exposure
  
  
• Private market investments
  
  
• Other alternatives

The idea here isn’t to “avoid illiquids.” It’s “don’t fund your emergency plan with them.”

How fintech is improving liquidity (without pretending everything is instant)

Historically, private assets have been illiquid because there hasn’t been an easy way to find prices and match buyers/sellers.

Fintech platforms are changing pieces of that puzzle by improving:

• Access to market data and transparency
  
  
• Discovery of potential buyers/sellers
  
  
• More standardized processes around transfers
  
  

That doesn’t magically remove all restrictions, but it can make private markets feel less like a black box. To see how this plays out in real transactions, explore how platforms structure access and liquidity in how secondary markets improve access to private investments.

If you want to see how different investments trade and settle in the private market, explore the Augment Collective and marketplace.

Final thoughts

Liquidity is financial flexibility. It’s the difference between “I’m invested” and “I’m invested and prepared.”

In practical terms:

• Liquidity in investing helps you rebalance, seize opportunities, and handle surprises.
  
  
• Understanding liquid vs. illiquid assets helps you align investments with real-world timelines.
  
  
• Asking “what is liquidity for this specific asset?” is one of the most underrated due diligence habits.

Want to keep building your investing vocabulary? Check out the Augment glossary, and for a quick pulse on which companies investors are paying attention to, browse The Power 20.