What is Liquidity of Stocks and Why Does It Matter to Investors?
The stock market invokes different kinds of emotions in people. It can be thrilling, addictive, scary, exciting and disheartening, all at once. Now that stocks are available in many forms – big and small, expensive and cheap, safe and risky, people are taking more interest in investing in the stock market. Large market capitalisation stocks and small market capitalisation stocks are relatively common in the global market. The ASX provides a unique and rewarding mishmash of small and large stocks that give equal opportunity to almost all kinds of investors.
Liquidation and liquidation premium
Over the years, investors have come to observe a relationship between market capitalisation and stock trading. Larger stocks are much easier to trade as compared to smaller market capitalisation stocks. Large market capitalisation stocks are liquid, and the smaller ones always receive a liquidity premium. The concept of liquidity premium in the ASX is quite simple. That is the premium most investors demand when it is difficult to convert any security into cash instantly for its respective fair market value.
Quite understandably, when the liquidity premium is high, the stock or the asset becomes illiquid. Illiquid assets and illiquid investments can take many forms according to the ASX. The most common types include loans, certificates of deposit and real estate. They have long-term high returns.
Why do some investors prefer liquid assets?
The investments which are easy to convert to cash at their respective fair market value are the liquid investments. It is usually possible due to the presence of a ready second market which is accepting of the investment terms or the investment terms make it super easy for the investor to trade the stocks for cash. This kind of liquid investment can include bonds, stocks, mutual funds and money market funds.
The ASX XJO is the investable benchmark for ASX. It is the same as the S&P/ASX 200 index. It presents the top 200 ASX stocks from the market. It only includes the performance of the company stocks that are liquid and are appropriate for institutional investment. All the companies that are a part of the ASX 200 list are part of the comparative market capitalisation process. The ASX Indices categorise the companies as per their GICS or Global Industry Classification Standard. All the 11 GICS sectors usually represent the ASX 200 index in Australia.
Which one to choose during investment?
While investing for a secure financial future, we must not forget to keep some liquid assets at hand. Investing in a few illiquid assets is not bad, but it is smarter to save a few liquid assets for emergencies. Illiquid assets represent long-term investments for high gains. They can be your retirement funds or your kids’ college funds. So cracking them open for unexpected big expenses is not such a good idea. On the other hand, liquid assets provide better fair market value prices. They also have a persistent seller’s market. Therefore, utilising them during emergencies to generate fund is more profitable and straightforward.