Liquidity risk
What is it?
It is the risk of being unable to buy or sell an asset quickly without incurring significant losses. Liquidity risk refers to the difficulty of converting an asset into cash due to the lack of buyers or sellers in the market. When a market or asset has low liquidity, transactions may take longer to execute or require a price discount to complete the sale, affecting the value the investor can obtain from that asset.
This risk is more evident in less liquid assets, such as real estate, alternative assets, or investments in markets with lower transaction volumes. Investors should be aware of how easy or difficult it is to sell an asset when needed, as this can impact profitability and the ability to access capital quickly.
Key aspects to consider
Liquidity risk is an important factor to evaluate when making an investment, especially if there is an expectation of needing to convert an asset into cash in the short term. Assets with high liquidity, such as stocks traded on major stock exchanges, allow investors to buy and sell quickly without large price fluctuations. In contrast, assets like real estate or investments in startups may have a limited secondary market, making it more difficult to sell quickly without a significant price discount.
It is crucial for investors to consider their time horizon and cash needs before committing to less liquid assets. Additionally, some investors may choose to diversify their portfolios with a mix of liquid and illiquid assets to balance liquidity risk with the potential for long-term returns.