Investment liquidity: what is it and what are the risks?

Understand what investment liquidity is and the importance of knowing this when investing

Knowing what investment liquidity is is essential for you to choose an investment aligned with your financial goals.

In other words, profitability, although it is also very important, is not the only factor you should take into account when making investments.

And that's why in today's article, we're going to talk more about this concept and explain exactly what liquidity risk is.

Read on to find out more.

What is investment liquidity?

Liquidity is the capacity of an investment to be transformed into money, that is, the possibility of redeeming the invested resources.

In practice, the faster you can convert an asset into cash, the greater its liquidity.

This means that if an asset has low liquidity, turning it into cash may take a little longer.

You can invest your capital in highly liquid assets (which can be easily redeemed) or investments with less liquidity (the investment is “locked in” until the maturity date.

In the financial market, each investment has certain characteristics. Some can be withdrawn at any time, while others have a set date to be converted into cash for you.

Some financial institutions use the letter D+some number to show the liquidity of that investment.

The letter D means redemption day. The number is the number of business days in which it will be possible to redeem the amount.

For example, D+0 means that the financial investment can be redeemed on the same day. D+2 means that the investment can be redeemed two business days after the request.

Why is liquidity important?

As you can see, knowing what investment liquidity is is essential when making an investment.

When making a new investment, you have probably already defined your short, medium or long-term goals.

Therefore, considering liquidity is very important when choosing a financial product.

For example, if you have a very short-term goal or want to build up your emergency fund, it is recommended to choose a highly liquid asset so that you can easily withdraw the money as soon as you need it.

However, if you are focused on a long-term goal, such as retirement, for example, liquidity may not be as important to you.

Stockbrokers show you the maturity date of the security. It is essential that you pay attention to this so that you can choose the investment that best suits your goals.

What is daily liquidity?

Applications with daily liquidity are those in which the investor can request the redemption of the amount invested (with the income) at any time.

So if you see an investment with daily liquidity, means that the redemption of the invested resources can be done whenever you wish.

If something unexpected happens, just make the rescue.

However, it is very important that you analyze all the rules and costs involved in the process.

What is liquidity risk?

Liquidity risk can be defined as the risk of not being able to liquidate or redeem an asset within the desired time.

Despite being a fundamental factor, unfortunately, this risk is not always analyzed by investors.

Consequently, they end up acquiring low-liquidity assets, and, in their desperation to sell the asset, they end up losing money.

To help you understand better, let's use a simple example.

Imagine someone who has bought a property with the aim of making a good profit from its appreciation. However, due to a major emergency, the person needs to sell it as quickly as possible.

Therefore, she will have to considerably lower the value of the property to be able to sell it as soon as possible.

The main difference between a highly and low liquidity asset is the ease or difficulty of converting an asset into cash quickly and without losses.

• High investment liquidity risk: An investment presents a high liquidity risk when the time frame for trading it is longer or when there are fees for redeeming it before the deadline.

• Low investment liquidity risk: A highly liquid investment (low liquidity risk) is one in which the investor can easily make a withdrawal quickly, often on the same day.

What are the types of liquidity risk?

In addition to term and rates, there are other factors that increase or reduce liquidity risk:

Market liquidity risk

 Refers to the risk of only being able to redeem an application with a considerable loss of value.

Funding liquidity risk

It occurs when the institution does not honor its financial obligations due to lack of funding.

Examples of highly liquid investments

Investments with daily liquidity (low liquidity risk) tend to be of greater interest to investors who want to build up an emergency reserve, have a short-term goal or want to pay off their debts.

A good example of this is the Tesouro Selic. As it is a highly liquid security, you do not lose money if you need to make an early withdrawal (before the maturity date).

And savings, despite not being considered a good investment, since it does not offer good profitability, is also an investment with daily liquidity, since you can withdraw the money saved in it at any time.

Conclusion

Understanding what investment liquidity is is as important as analyzing the profitability of an investment.

After all, if you invest in a low-liquidity asset, you will have difficulty making the withdrawal before the deadline, should an emergency occur.

Therefore, before acquiring any financial product, in addition to analyzing your current financial situation and knowing your investor profile, it is also important to know the deadline for withdrawing the money and the costs of making the withdrawal before the maturity date.

This way, you can make choices that are more appropriate to your short, medium and long-term financial goals.