What does liquidity refer to in financial terms?

Liquidity in financial terms refers to the ease and speed with which an asset can be converted into cash without significantly affecting its market price. This concept is crucial for investors because it determines how readily they can access cash when needed. For example, cash itself is considered highly liquid since it can be used immediately for transactions. On the other hand, real estate or collectibles may take more time to sell and often involve transaction costs, making them less liquid.

Understanding liquidity is important when managing investments and planning for potential expenses. Investors often prefer liquid assets so that they have the flexibility to respond to financial needs or market opportunities quickly. In contrast, investments with lower liquidity may offer higher returns but come with the trade-off of longer wait times to sell or convert them into cash.