Tag: Cash

What is Liquidity?

As part of our educational series we want to acquaint our readers with terms that are in common use in investing but may not be completely understood by the public.  One of those terms is “liquidity.”  The Dictionary of Finance and Investment Terms says liquidity “is the ability to buy or sell an asset quickly and in large volume without substantially affecting the asset’s price.”  Stocks in large blue-chip stocks like General Electric, Microsoft or Apple are liquid because they are actively traded in large volumes and therefore the price of the stocks will not be affected by a few buy or sell orders.

However, shares in small companies with relatively few shares are not considered liquid because a few large orders can move the price of the stock up or down sharply.

A house is another example of an illiquid asset because it can’t be sold quickly, its price can fluctuate widely because it’s not traded regularly on an exchange and the price is set by bidding between one or a few buyers and a single seller.

Liquidity also refers to the ability to convert to cash quickly.  Examples are money market mutual funds, checking accounts, bank deposits or treasury bills.

A Deposit In A Bank Is Not A Riskless Form Of Saving

This is a good time to remind our readers of something.    Via ZeroHedge

Cyprus has reminded us of a couple of awkward truths:

  1. A deposit in a bank is not a riskless form of saving.We may not see eye to eye with the FT’s Martin Wolf on many aspects of modern economics and central banking in particular, but he described banks well last week:
    “Banks are not vaults. They are thinly capitalised asset managers that make a promise– to return depositors’ money on demand and at par– that cannot always be kept without the assistance of a solvent state.”

  2. When states become insolvent, the piper must ultimately be paid. Fatal, embarrassing insolvency is not a problem that can be perpetually or painlessly deferred.

Why do we have FDIC?  Because banks can fail,, and when they do, without someone else like the FDIC, depositors can lose part or all of their money, which is what happened in the Great Depression of the 1930s.  For a lesson in banks, watch “It’s a Wonderful Life.”

And even if the bank does not fail, if the interest they pay does not exceed inflation after taxes, the money in the bank is worth less over time because you can’t buy as much with the money as you did in the past.  The simple truth is that there is no “safe” place for money, even under the mattress.  Whenever you have money there is risk of loss.  Cash can be stolen.  Banks can go bust and investments can lose money.  For serious money, get professional help.

Tools for getting out of debt

Getting out of debt is easy, stop spending and pay off your bills.  The overweight person gets very similar advice: eat less and exercise.  They are both pieces of good advice, but they rarely work all by themselves because we are creatures of habit, whether it’s spending or eating.  So here are my twin tools for helping you with the debt issue (for the dieting part, you’re on your own.)

First, get a copy of Dave Ramsey’s book    “The Total Money Makeover.”  It’s a virtual 12 step process designed to get you debt free and build wealth.  The book costs about $25.00 and is worth every penny.  Dave Ramsey has built a business around personal finance advice that includes books, a radio program and courses that are being offered throughout the country.  The course is offered by many churches and is both entertaining and filled with outstanding information.

Second, if you have a computer, get a copy of “Quicken.”  It is the number 1 selling personal finance software.  If you are in debt you have to know where your money is going before you can fix your problem.  Quicken allows you track every penny that you spend.  In addition it makes balancing your checkbook a snap and has other features that are useful once you begin to accumulate wealth.  The program costs less than $50.

What is an asset class?

Financial professionals constantly talk about asset classes, but what does that mean?  In the broadest sense, asset classes refer to a group of securities that have similar risk/return characteristics.  So, for example, in the broadest terms, stocks, bonds and cash represent the three most common asset classes.  Each has different risk and return characteristics and behave differently in response to a variety of economic and political events.  Stocks react most to corporate profitability, bonds to interest rates and cash to inflation.     That does not mean that these are the only issues that these assets react to but they are the predominant ones.

Most managers divide these broad assets classes into subgroups that act differently at different times.  Stocks, for example, can be divided into large cap, small cap, foreign or domestic.  Bonds can be subdivided into government, agency, municipal, corporate, foreign or domestic.  These classes can be divided again into their own subgroups.   The challenge for the investor is to find ways of participating in these investments.  This is where the expertise of the professional investment advisor comes into play.

Why is this important?  Because investment management is often about risk control and this is often achieved by balancing various assets classes to achieve the degree of risk to which a portfolio is subjected.  Modern portfolio theory demonstrates that investment with low correlation to the rest of the portfolio can lower over-all volatility even if the underlying investment itself is volatile.

 

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