Liquidity is the ease with which an asset can be converted into cash. Cash itself is perfectly liquid. A savings account is nearly as liquid. A stock can be sold in seconds during trading hours. A house takes months to sell. A rare painting might take years. The faster and cheaper the conversion, the more liquid the asset.

Liquidity matters for individuals and institutions. A household needs enough liquid assets to cover emergencies. A business needs cash to pay wages and suppliers. A bank must hold enough liquid assets to meet withdrawals. When liquidity dries up, the consequences can be severe. During the 2008 crisis, banks stopped lending to each other because no one knew who was solvent. Credit markets froze. The Federal Reserve injected trillions to restore liquidity.

Markets have different levels of liquidity. Major currency markets trade trillions daily and are highly liquid. Small-cap stocks trade less frequently and have wider bid-ask spreads. Real estate and private equity are illiquid by nature. Investors demand higher returns for holding illiquid assets. That premium compensates for the risk of being unable to sell when needed. Liquidity is not free. It has a price.

Key measures

• Cash and equivalents
• Current ratio
• Quick ratio
• Bid-ask spread
• Trading volume