Saving money is important, but you have to know what to do with it to build long-term wealth. There are many ways to grow your money, from savings accounts to physical assets.
Many people understand that investments are the best way to build wealth due to the potential yield they offer, but investing involves taking on a certain level of risk. If you decide to invest most of your savings, it’s a good idea to keep some liquid money aside that’s easily accessible when you need it.
Imagine if you were to suddenly lose your job or got hit with some other type of financial hardship. It might take a while to pull your investments out to gain some cash, and you don’t want to rely on selling your non-liquid assets, such as your home. If this potential scenario is a concern for you, you might ask yourself which type of account is typically the most liquid?
The easy answer to this question is a checking account, but several other liquid bank accounts can provide you with your money as soon as you need it. Keep reading to learn what those accounts are, how to pick the best one for your money, and what a great financial strategy looks like.
What is Liquidity?
In simple terms, liquidity refers to how fast you can convert any asset to cash. A liquid account is one where you can withdraw your money quickly, at any time, without any restrictions, penalties, or fees. Another component of liquidity is whether you can convert an asset without losing its value. A car is one of the least liquid assets because it takes a while to sell, and you typically lose part of its value. In contrast, cash is the most liquid asset possible.
By this logic, the most liquid accounts are cash accounts, such as checking and savings accounts. For the most part, most checking accounts don’t have withdrawal limits, and your money doesn’t lose its value when you withdraw it. However, not every account can be considered a liquid account. For example, although you can consider certificate accounts liquid, they are one of the least liquid types of accounts because of the early withdrawal fee and penalties you may face from your financial institution.
Liquid accounts are an important part of a successful financial plan that helps you build wealth while maintaining a necessary money supply. Let’s talk about why that is.
Why are Liquid Accounts Important?
Liquidity is important to cover everyday expenses as well as unexpected emergencies. It’s inconvenient to have to wait days to access your money or for your assets to convert to cash. The option would be to borrow money in the form of credit card debt or other loans, which puts a dent in your overall wealth in the form of high interest.
Here are some examples of the most liquid accounts:
- Checking account: The most liquid account and typically the quickest place to access your cash.
- Traditional savings account: Almost as liquid an option as checking accounts. Typically offer low yield and limits on certain transactions within the account and can be opened in-person at a bank or credit union or through an online bank.
- Money market account: An interest-bearing account with debit card and checking features at a bank or credit union. Virtual banks and the ease of opening an online savings account have rendered money market accounts less popular in recent years.
- Liquid stocks and bonds: Can be sold immediately for cash in a trade whenever the markets are open.
- Mutual funds: Not the most liquid asset as you have to wait for the end of the trading day to sell, at which point your mutual fund might have lost its value.
- Mobile payment services: This includes services such as PayPal and Venmo.
When choosing an account, there’s usually a tradeoff between liquidity and yield. So let’s now discuss what yield is.
What is Yield?
Yield is the earnings from an investment over a particular period, usually expressed by a percentage. Many times, financial institutions refer to an annual percentage yield.
The yield is determined by three main factors:
- The invested amount.
- Market value.
- Face value of security.
You find yield on stocks, bonds, and other investment options. To calculate yield, take the net realized return and divide it by the principal amount. For certain investments, such as stocks, yield is calculated as the price increase plus dividends, then divided by the purchase price.
Yield is just as important as liquidity to a successful financial strategy.
Why is Yield Important?
Although a liquid account is the least risky to keep your money, it shouldn’t be the only place you keep it. If your goal is to create a long-lasting financial plan, you must have some of your money in high-yield accounts.
For the most part, the more liquid the account, the lower the yield. This is great for the security of your short-term savings, but adding yield to your financial strategy is a crucial part of long-term finances.
That said, it is possible to have the best of both worlds, like a high yield savings account or deposit account that’s easily liquidated. For example, certain investments, such as a mutual fund or liquid stocks, bonds, and ETFs can provide you with higher returns.
Here are some high yield assets that are not easily liquidated:
- Certificate accounts: Although you can liquidate a certificate account before maturity, you often face a hefty fee.
- Real estate and land: The process of selling a property can typically take months, and you can potentially lose part of its value if forced to sell too soon, making real estate one of the least liquid assets.
- Small business: Selling a small business is another process that takes months.
- Gold, silver, and jewelry.
- Physical collectibles.
- Automobiles: Typically a depreciating asset.
Pros and Cons of Liquid Accounts
When thinking about which type of account is typically the most liquid, consider the benefits and drawbacks of keeping your money liquid.
The most obvious benefit of a liquid savings vehicle is accessibility. As an account holder, you have the comfort of knowing that you have access to your money when you need it without facing any hefty penalties or fees. This access can save you in situations when you need cash fast, like a sudden medical bill.
Keeping liquid accounts also means that you have money available whenever a new investment opportunity arises without selling your other investments. This gives you a method of continuing to grow your funds while keeping control of your money.
When you apply for a loan or a mortgage, liquid assets can increase your chances of being approved because they demonstrate that you have the discipline to save your money and manage it well. If you’re looking for a place to rent, showing that you have up to 6 months worth of expenses in a savings account improves your chances of getting approved for a lease.
Lastly, keeping your money in a liquid account is less risky than keeping it in any other type of account. At the time of an emergency, you can access this asset right away. What’s more, you don’t have to depend on the market to ensure that your liquid assets remain valuable. In the event of a market crash, the money in your liquid account remains safe.
At the same time, there are a few downsides to keeping your money in a liquid account, the most obvious being that your money doesn’t grow as much as in non-liquid form. For example, even though real estate can take weeks or even months to sell, the equity in your home can surpass the money you can make in a liquid account. The same goes for the tax benefits of adding money to a retirement account.
Liquid accounts have their pros and cons, and so do higher-risk non-liquid options. The best way to ensure financial stability and growth is by holding a mix of liquid and non-liquid assets.
The Perfect Compromise – Liquid and Yield Accounts
When figuring out which type of account is typically the most liquid, you must know how you want to use such accounts.
Keeping all of your cash and assets in liquid accounts isn’t the best way to ensure growth. On the other hand, you don’t want to risk all of your money in high-yield investments. In the event of a market crash, you may find yourself stuck for cash.
A fair compromise is to split your money between liquid and high yield accounts and assets as part of a proper financial plan for your future.
Real estate, stocks, tax-sheltered accounts such as a 401(k), or any other investments are a great way to ensure that your money continues to grow. It’s important to keep adding to your investments to see the most growth, but you must monitor them to make sure they are still working for you.
For example, it’s a good idea to hold three to six months’ worth of pay as a minimum balance in an emergency fund in case you lose your job or experience any other type of financial rough patch. This cash should be kept in an account that’s as liquid as possible, such as a savings account.
Better yet, keep your emergency fund in a high yield savings account so that you can make some interest off of it as well. If you don’t have enough for an emergency fund right now, look at your assets and determine if you have a high amount of non-liquid assets. It may be worth liquidating some of your current assets to establish a solid emergency fund.
Once you have an emergency fund in place, you can use your additional funds to invest in less-liquid assets, such as real estate, stocks, or a small business. One of the top investments you can make is adding money to a 401(k) plan or other retirement accounts. These accounts are generally not considered liquid as you’re limited in your ability to take out money except for medical bills. When you withdraw early from a retirement plan, you not only have to pay taxes on the money you withdraw, but you also face hefty penalties from the IRS.
Final Thoughts – The Importance of Liquid Accounts
The answer to which type of account is the most liquid is easy: a checking account. However, having a complete and healthy financial portfolio isn’t as simple as keeping a savings account.
To reach your longer-term financial goals, you need to have a combination of liquid and non-liquid assets as part of your portfolio. Start by establishing an emergency fund in a liquid account to keep a safety cushion and establish financial security.
Once you fund your emergency account, you can move on to adding money to investment accounts to fund your future and build lasting wealth.