We often say that stocks are “liquid”, meaning basically that they can be bought and sold easily through the various stock markets. This is not a truism. Stocks (and corporate bonds) are “marketable”, but they do not fit the definition of “liquid”. I will explain the difference.
A security is liquid if it can be converted to cash quickly without any loss of value. You can go to your ATM and withdraw $300 in crisp $20’s and your bank account will only be debited $300. (Except for maybe the $3 fee you pay if you use the ATM of a bank different than your own, but that is a different topic.) A CD at a bank also will not lose value. US Treasury Bills also are considered liquid – you redeem them for the face amount without loss of value. Same with money market funds. A rule of thumb for financial planners is that clients should have the equivalent of 3 to 6 months of salary saved and kept in liquid assets. That means in bank and money market deposits or in T-Bills. In the event of an emergency, the client can draw down on this emergency fund of liquid assets without worrying about a loss of value. The trade-off for liquidity is that the client likely won’t earn much on their liquid assets, but they are not taking risk, either.
Stocks and bonds are considered to be marketable, but not liquid. Marketable means that the security can be easily sold, but that it could suffer a loss of value when you sell it. Say you own a stock, and you look and see that it last traded for $42 per share. If you decide you want to sell it at that time, you likely won’t get $42 per share. Depending on the depth of the market for that stock, you may get $41.99, meaning your loss of value was only a penny, but you still lost that penny of value. You can easily sell it – just a click! – but because of the “bid/ask spread”, you probably won’t sell it for what the previous person sold it for. So, just because you have money invested in stocks, don’t make the mistake of thinking that those are liquid assets. They are not. What if you need to sell that stock right when everyone else wants to sell that same stock? The loss of value will probably be greater than that penny. Keep your emergency funds in liquid assets – in the Bank!
More Marketable vs. Less Marketable
There are, of course, varying degrees of marketability. One way to measure marketability is the bid/ask spread. Ever try to haggle with a merchant? Ever try to buy event tickets from a scalper? Then you know about the bid/ask spread. You want to buy what the seller has, but you don’t want to overpay, or you think what the seller is asking is too high. So you say, “I’ll give you x for that”, x being a lower price. The x is your Bid, and the seller’s price is the Ask. Same thing in stock trading. If the difference between a stock’s bid and ask is very small, say one or two pennies, then you can deduce that the stock is highly marketable. The greater the spread, the less marketable the stock becomes. Marketability is also a function of the volume of trades. More trading = more marketability. The largest company stocks and the largest ETFs such as the S&P 500 ETF (SPY) are considered to be the most marketable stocks or securities. But they are still not considered to be liquid. Real estate as an investment is not nearly as marketable – although real estate’s marketability changes over time.
If you want to have your cake and eat it too – in other words, if you want to have relative liquidity yet still earn a decent return on your investments, then investing in highly marketable index ETF’s are probably for you. Examples are the SPY and the NASDAQ 100 Index (QQQ). However, invest in these only after you have stashed away the 3 to 6 months of emergency funds in the Bank! Maybe you can trend toward the 3 months of savings rather than 6 months if you have a large stock or ETF portfolio, but you still need the liquid emergency funds. Understanding the difference between liquidity and marketability may seem like splitting hairs, but it can be a very important distinction when something bad happens and you need that money.