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Net worth tends to dominate discussions about personal finance.
While net worth is important, it is equally important to understand your liquid net worth.
Liquid assets are a vital part of any personal finance strategy. Your liquid net worth includes your liquid assets, such as cash and near-cash assets. Near cash assets include stocks, bonds, and any other asset you can quickly convert to cash.
Having a clear understanding of this type of net worth will allow you to properly plan for the future and any emergencies that may come with it.
Let’s take a closer look at net worth before moving on to liquid net worth. It’s essential to understand your net worth before calculating your liquid net worth. Your net worth is the number left over after you subtract your assets from your liabilities.
Examples of assets:
- The market value of your home
- Personal property such as cars, furniture, art, jewelry
- Investments such as stocks and bonds
- Money in your bank accounts
- Cash value of any insurance policies
- Business interests
Examples of liabilities:
- Credit card balance (if not paid in full every month)
- Student loans
- Car loans
- Current monthly bills (rent, utilities)
The equation for calculating your net worth is assets – liabilities = net worth.
As you can see, net worth isn’t always a true reflection of your financial standing, which is why understanding this type of net worth is essential.
Liquid Net Worth
The basic equation for calculating liquid net worth is similar to the net worth equation. However, when calculating liquid net worth, only your liquid assets are counted. Namely, this type of net worth is your assets’ value if they were sold immediately and converted to cash. The liquid net worth equation excludes anything that is not cash or a near-cash asset.
The equation for calculating your liquid net worth is:
liquid assets – liabilities = liquid net worth.
Liquid assets include all assets that can be quickly converted to cash. Cash is the most well-known liquid asset. Cash isn’t limited to the money you carry in your purse or wallet.
Any economic resource that could be quickly converted to cash is a cash asset. The defining characteristic of cash assets is that they can be converted to cash within three months or less while retaining its full value.
Now let’s take a closer look at some common liquid assets.
Cash includes the money you have on hand, in your checking, savings and money market accounts, and peer to peer payment apps.
Publicly traded stocks are considered highly liquid. Equities are traded daily and often sold almost instantly. You will usually receive cash from a stock sale within a few days.
Treasury Bills and Treasury Bonds
Treasury bills and treasury bonds are considered highly liquid investments. Both are fixed income securities issued by the U.S. government. They can be sold for cash on secondary markets before they reach their maturity date.
Unlike stocks, mutual funds are sold only once a day, making them slightly less liquid than stocks. You’ll typically receive the money from a mutual fund sale within one business day.
Certificates of Deposit (CD)
CDs earn a higher annual percentage yield than checking and savings accounts, but they also carry a penalty if you withdraw money before the maturity date.
Bonds are, to some extent, liquid investments. They can be traded on secondary markets, although some investors keep their bonds until they reach their maturity date.
Other examples of liquid assets include exchange-traded funds, money market funds (a type of mutual fund), and precious metals.
Non-liquid assets are all assets that cannot be sold quickly or converted into cash without a substantial financial loss.
Let’s look at some examples of non-liquid assets.
Real estate is a non-liquid asset because it could take months to sell the property and convert it to cash. Although real-estate may have significant monetary value, you cannot count on it for cash.
Although you may be able to sell your car quickly, cars are non-liquid assets because they significantly decrease in value when sold.
401(k)s & IRAs
Unless you’ve reached retirement age, 401(k)s and IRAs are considered non-liquid assets. You’ll incur a hefty tax penalty if you withdraw money from these accounts before you retire. Thus, 401(k)s and IRAs experience a significant loss of value when converted to cash before reaching retirement age and are not considered liquid assets.
Other examples of non-liquid assets include vehicles, art, collectibles, televisions, and land.
Calculating Liquid Net Worth
So what is liquid net worth, and how should you calculate it? There is no definitive definition for liquid net worth nor how to calculate it. Therefore, you get to decide which assets to include when calculating your liquid net worth. You can use the examples we’ve provided above as a blueprint as you determine what to include and exclude from this type of net worth calculation.
If you decide to include non-liquid assets such as retirement savings or a car, experts recommend subtracting between 10% and 30% from their current value. If you prefer, you can exclude all of your non-liquid assets. Alternatively, you could do two calculations: one including your non-liquid assets with a discount and one excluding them.
Either way, the equation remains the same. Your liquid net worth equals your liquid assets minus your liabilities.
While knowing your net worth is important, it also has some serious limitations. Your liquid net worth is the most accurate measure of your financial health and stability. This type of net worth tells us the amount of cash we have available on short notice. Without knowing our liquid net worth, we don’t know whether we’re adequately prepared for an unforeseen financial emergency.
Your liquid net worth represents the money you can count on if you lose a job or experience a medical emergency, it is your financial safety net. Calculating your liquid net worth will give you a deeper understanding of your finances and enable you to plan your financial future more effectively.