Illiquid assets are assets which cannot be readily converted into cash, in contrast with liquid assets, assets which are either in the form of cash, or easily convertible into cash. People often try to avoid maintaining a large balance of illiquid assets in their portfolios, as these assets can become serious liabilities, especially if the market becomes unstable. Some examples of illiquid assets include: real estate, huge blocks of stock, antiques, and collectibles.
There are a number of reasons why an asset can become illiquid. One common reason is uncertainty about the value of an asset, which can be caused by general financial instability, or issues specific to the asset. For example, in a period of declining property values, a home is an illiquid asset, because the value is unclear, and this can make buyers reluctant. Likewise, stocks can become illiquid if the company is reorganizing or changing hands, as the value of the stocks will be impacted by the changes in the company, but no one knows whether the value will go up or down. Likewise, the sale of a huge block of stock can cause a change in values, making such sales difficult to handle.
Another reason for assets to become illiquid is because they are rarely or infrequently traded. Things like works of art and antiques are often illiquid because they are unique, and it can be difficult to find a market for these items, and to determine what the fair value of such items might be. A Picasso painting, for example, is tough to value because it's the only example of that painting in the world, and qualified buyers for unique and high-value works of art can be tough to find.
The advantage of an illiquid asset, for someone who is willing to sit on it, is that it can sometimes achieve a very high value. Homes, for example, have values which can fluctuate wildly, but if people hang on in a period of falling values instead of selling in a panic, they may be able to net a profit in the future when home values recover. Likewise, the value of an original Bruegel painting is not going to decline in the long run, even if the painting is difficult to sell and the values fluctuate in the short term.
The clear disadvantage to these types of assets is that when someone needs money in a hurry, illiquid assets are not up to the task. Someone might sell such assets at a steep discount in desperation if no other ways to raise funds are available, or someone might struggle to sell illiquid assets in time to meet other obligations or take advantage of an opportunity. This issue is an excellent illustration of why it is extremely important to diversify investments and holdings for maximum flexibility and profit potential.
