Liquidity is a crucial concept everyone should understand, whether you’re a die-hard saver or a bonafide investor (in stocks, real estate or any of the low-risk opportunities we offer on Investify). The concept is so crucial that it’s impossible to explore the world of investing and financial markets without encountering it a billion times. But what is liquidity exactly?

Liquidity is the ease with which you can buy or sell an asset in your portfolio (like cash, property and bonds) without causing a significant change in its price. In personal finance, it usually refers to the total amount of money you have available — both at hand and in your bank accounts.

Whether you’re a seasoned investor or just starting out, having a good grasp of liquidity can significantly improve your investment decisions. In this article, we’ll explore the fundamentals of liquidity, the different types of liquidity, why it’s important to investors, and how to improve your personal liquidity.

Understanding liquidity in financial markets

As we mentioned, liquidity is a concept that appears in many financial discussions — from crypto and investments to business and savings. So, let’s explore a broad explanation that covers all aspects.

Liquidity in financial markets is the ability to buy or sell an asset quickly and at a fair price. It’s directly related to market depth, a concept that measures how much an asset can absorb large buy or sell orders without significantly impacting its price.

In highly liquid markets, there are plenty of buyers and sellers — making it easier to trade without causing large price fluctuations. On the other hand, in illiquid markets, there is often an imbalance in the number of buyers and sellers — making it challenging to transact without impacting the asset’s price.

What does liquidity look like to you?

Liquidity can apply to businesses, foreign exchange and every other situation involving assets and transactions. However, in this section, we’ll focus on liquidity in relation to personal finance. So, let’s simplify things with an example.

Let’s say you’re planning a weekend getaway to Ibadan.

You then put your travel funds in your Piggyvest Flex Naira account — because why not? After all, with a few taps on your phone, you can transfer the money to your bank or PocketApp and book your accommodation, sort out transportation, and handle other expenses. In this situation, your Piggyvest Flex Naira wallet offers high liquidity because your funds are easily accessible.

What does low liquidity look like, then?

Instead of using Piggyvest, imagine your travel funds are in a traditional bank’s fixed deposit (FD) account.  You might have to pay a penalty for early withdrawal to access the money, and withdrawal might be tricky if you can’t find a physical bank branch.

These bottlenecks reduce liquidity because quickly converting your investment into cash can be difficult and potentially costly.

What are the types of liquidity?

There are various types of liquidity, and it will be difficult to cover all of them in this article. Therefore, we’ll stick to the three main types that concern individuals and businesses in Nigeria.

The types of liquidity are:

RELATED

Level Up Your Money Game At The Zikoko x Piggyvest Naira Life Conference This August!

Read

Level Up Your Money Game At The Zikoko x Piggyvest Naira Life Conference This August!

• Funding liquidity
• Asset liquidity
• Cash liquidity

Let’s see how they work.

Funding liquidity

Funding liquidity pertains to the availability and cost of borrowing money. As we explained in our article on capital markets, individuals, companies, and even financial institutions must have access to funding liquidity to meet their financial needs and obligations.

Borrowers with good credit and strong financial positions usually have better access to funding liquidity and can secure loans at lower interest rates. In contrast, borrowers with poor credit or financial instability may face difficulties obtaining funding liquidity.

They may also pay higher interest rates to compensate for the perceived risk. This also affects individuals, as banks and other lending institutions consider borrowers’ creditworthiness before granting them loans and setting the terms of the loans. 

Asset liquidity

Asset liquidity refers to how easily you can convert an asset into cash without affecting its price. Highly liquid assets (like stocks and bonds) can be quickly bought or sold in active markets. However, assets such as real estate or private equity may take longer to sell and could involve negotiating or incurring higher costs.

For example, the stocks listed on the Nigerian Exchange Group are highly liquid (since there are many buyers and sellers), enabling swift transactions with minimal price impact.

Compare that to real estate investments. Selling a piece of land may require time-consuming processes (including inspections and tons of legalese).

Cash liquidity

Cash liquidity refers to the availability of cash or how easily you can access hard cash to handle financial obligations. Remember: cash is the most liquid asset, providing immediate purchasing power without you needing to convert or sell it.

For instance, having cash in your Piggyvest Flex Naira savings account provides immediate access to funds for emergencies or unexpected expenses.

RELATED

How To Invest In Real Estate In Nigeria (Even If You’re Not Rich Yet): 5 Ways For Beginners To Get Involved

Read

How To Invest In Real Estate In Nigeria (Even If You’re Not Rich Yet): 5 Ways For Beginners To Get Involved

Maintaining sufficient cash liquidity is essential for individuals, businesses and financial institutions. They use this money to cover daily expenses, manage cash flow fluctuations and seize investment opportunities promptly.

What factors affect liquidity?

While liquidity cuts across different assets and markets, several factors can influence it.

Some of the key factors that affect liquidity include:

• Market conditions. Economic downturns or financial crises tend to reduce liquidity as investors become more cautious and liquidity providers (like banks) reduce their activities.
• Regulatory changes. Changes in financial regulations can impact liquidity by imposing stricter capital requirements on financial institutions (like the CBN raising the capital base for megabanks to ₦500 billion) or altering the trading rules for certain asset classes.
• Investor sentiment. Negative market sentiment or a lack of confidence can decrease liquidity as investors hesitate to trade or withdraw their funds from specific markets or assets.
• Market structure. Different market structures can affect liquidity. For instance, centralised exchanges tend to have higher liquidity than decentralised markets or over-the-counter trading.
• Geopolitical events. Political instability or major geopolitical events can disrupt markets and reduce liquidity as investors seek safer assets or stay on the sidelines.
• Supply and demand dynamics. The balance between supply and demand for a particular asset directly affects its liquidity. When there are more buyers than sellers (or vice versa), it can impact the ease with which the asset can be bought or sold without even affecting its price.
• Information availability. The availability and quality of information about assets — such as financial reports, market data and news — can affect liquidity. Investors are more likely to trade assets when they have access to accurate and timely information.
• Transaction costs. Transaction costs (including brokerage fees and taxes) can influence liquidity. Higher transaction costs can deter trading activity and reduce liquidity — especially for smaller investors.
• Macroeconomic factors. Macroeconomic indicators such as interest rates, inflation and monetary policy can affect liquidity by influencing investor behaviour, credit conditions and overall market conditions.

These factors highlight the dynamic nature of liquidity and the need for investors (like you!) to stay informed and adapt their strategies accordingly.

Why does liquidity matter to investors?

We’ve gone through the basics of liquidity — particularly how it relates to individuals and businesses. But what’s the point? Why does liquidity matter?

Here are some of the reasons liquidity matters to investors:

RELATED

What Is Diversification In Investing? Tips For Building A Lasting Portfolio In Nigeria

Read

What Is Diversification In Investing? Tips For Building A Lasting Portfolio In Nigeria

• It allows for quick and efficient execution of trades, reducing the impact of transaction costs. In liquid markets, buyers and sellers can easily find counterparties to trade with — enabling them to complete transactions promptly and at fair prices.
• Liquidity reduces price volatility. Large transactions are unlikely to cause significant price movements in liquid markets. This stability is particularly important for investors who want to buy and hold assets long-term, as it minimises the risk of sudden price fluctuations destroying their investment value.
• It also provides flexibility. Investors in liquid markets can quickly enter or exit positions as needed and easily build diversified portfolios.
• Liquidity also helps with risk management. Investors rely on the ability to quickly convert their assets into cash in case of emergencies or unforeseen circumstances. In illiquid markets, selling assets can be challenging, potentially leading to losses or missed opportunities.
• It can impact companies’ cost of capital. Businesses with liquid stocks may enjoy lower capital costs due to increased investor confidence and lower risk premiums. This can give them a competitive advantage in raising funds for expansion or investment in new projects.

Now you know!

What is liquidity management?

Liquidity management involves effectively managing cash inflows and outflows to ensure that you or your organisation has sufficient liquidity to meet financial obligations.

Proper liquidity management involves assessing cash flows, forecasting liquidity needs, and implementing strategies to maintain an optimal financial position. These strategies may include maintaining cash reserves (saving), establishing lines of credit (taking loans), or negotiating favourable borrowing terms (practising debt management).

Liquidity management is crucial for financial stability and growth.

By effectively managing liquidity, you can take advantage of investment opportunities, weather financial downturns, and maintain a positive reputation with creditors and investors.

Liquidity management also allows for strategic decision-making (like expanding operations or investing in new ventures) with the confidence that you have sufficient liquid assets to support these endeavours.

What is the difference between liquidity and solvency?

One key aspect of liquidity management is understanding the difference between liquidity and solvency.

While liquidity refers to the ability to meet short-term obligations with available assets, solvency focuses on overall financial health and your ability to meet long-term obligations. Effective liquidity management ensures you can meet your short-term financial goals without compromising your long-term solvency.

How to improve liquidity

Improving personal liquidity requires careful planning, sound financial habits and smart decision-making — even if you’re Ezra Olubi, co-founder and CTO of Paystack. Fortunately, you can learn how to improve your liquidity and ball like a rich tech bro. 

Here’s how you can become unbelievably liquid like Ezra:

1. Create an emergency fund. Set aside a portion of your income in your Flex Naira account to cover unexpected expenses or periods of income instability.
2. Minimise debt. Reduce high-interest debt and focus on paying off outstanding loans to improve your overall financial position. This will simultaneously reduce future interest payments.
3. Diversify your investments. Spread your investments across different asset classes to reduce risk and increase the likelihood of having liquid assets you can easily convert when needed.
4. Monitor your spending. Track your expenses and identify areas to cut back or eliminate unnecessary spending to free up more cash. This should be a breeze if you use PocketApp for your transactions.
5. Build multiple income streams. Explore opportunities to generate additional income through side hustles, freelancing or investments. These will help supplement your primary source of income.

You can learn more strategies in our article about how to break into financial prosperity.

Summary

Liquidity is king in financial markets, affecting investors (and even savers) in various ways. Understanding its effects and measurement methods can help you make well-informed investment decisions—even if you’re not the Oracle of Omaha.