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What Are the Most Liquid Accounts? Liquidity vs. Yield
A liquid bank account is one that lets you take out cash quickly without penalties or fees. When it comes to picking an account, it’s typically a trade-off between liquidity and yield, the interest rate you earn on your money.
Checking accounts, for example, are very liquid because they do not limit withdrawals, whereas CDs are less liquid accounts because they can charge an early withdrawal penalty. That being said, the average CD earns a higher yield than a checking account. In this article, we explore why liquidity matters as well as which accounts are most — and least — liquid.
What is a liquid account?
If you are wondering “what is the definition of liquidity?” the Federal Reserve describes liquid assets as “cash and assets that can be converted to cash quickly if needed to meet financial obligations.” Most bank accounts fit the liquid assets definition because you can take out money quickly. Real estate, on the other hand, is not liquid because it takes time to sell your property.
Another part of the liquid definition is that you can convert the asset to cash without it losing value. So while the different types of bank accounts all meet the first part of the definition of liquid assets, in that they can be turned to cash quickly, some are more accessible than others because of fees and early withdrawal penalties.
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Why is liquidity important?
Liquidity is important to cover your day-to-day expenses. If you had to wait several days to take out money, it would be a headache for shopping and paying your bills. Liquid accounts can also help you deal with financial emergencies. If you need money for a surprise bill, you can withdraw from your liquid accounts without penalty, versus turning to payday loans, credit cards or other expensive options.
With that being said, there is a trade-off for liquidity. Generally, the more liquid the account, the lower the yield. If you keep all of your savings in cash or other liquid accounts, your savings will not grow much for the future.
Ideally, you would find a balance between keeping some money in liquid accounts — enough for day-to-day spending and your emergency fund — while putting the rest in higher earning accounts, even if they are less liquid.
Liquid assets examples: Accounts in order of liquidity
To help you understand what is an example of a liquid asset, we’ve ranked assets in order of liquidity along with their yields. Let’s see which one of the following is the most liquid:
|Account Type||Level of Liquidity||Average Rate of Return|
|Checking account||Highest||0.140% APY|
|Savings account||Decent||0.201% APY|
|Money market account||Decent||0.237% APY|
|Certificate of deposit||Low||0.254% APY on a 3-month CD 0.649% APY on a 1-year CD 1.130% APY on a 5-year CD|
|Brokerage and retirement accounts||Moderate for brokerage accounts, low for retirement accounts||5% to 6% per year for bonds 10% per year for stocks|
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What has low liquidity?
High liquidity occurs when there an institution, business, or individual has enough assets to meet financial obligations. Low or tight liquidity is when cash is tied up in non-liquid assets, or when interest rates are high, since this makes it expensive to take out loans.
Can investments be liquid assets?
There are some liquid investments that can be quickly turned into cash. Liquid stocks and bonds are a good example, because you can sell them for cash immediately in a trade whenever markets are open. Mutual funds are also liquid, but they take a little more time to convert to cash: You’d need to wait until the end of the trading day to sell your mutual fund. During this time, it could have lost value. Still, these funds are quite liquid.
Other investments like real estate and land are much less liquid. It can take days, weeks or even months to find a qualified buyer, negotiate a sales price and turn your investment into cash.
Here is a list of liquid assets to nonliquid assets when it comes to investments:
- Stocks (very liquid)
- Bonds (very liquid)
- ETFs (very liquid)
- Mutual funds (liquid)
- Physical gold, silver and jewelry (somewhat liquid)
- Collectibles (not liquid)
- Real estate (not liquid)
- Land (not liquid)
- Small businesses (not liquid)
While some investments are liquid, they are not a good fit for handling day-to-day cash needs. In the long run, investments can earn a higher yield than bank accounts, but they are riskier short-term. For example, you could lose money during a stock market crash. If you put all your money in investments, this could mean selling at a deep loss. It’s better to keep liquid cash in the bank to cover your day-to-day needs, while using investments to build long-term wealth.
By understanding the liquid account definition and how it applies to the different accounts, you can find the right balance of liquidity and yield for your savings.