When trying to understand investments or investment options, it is easy to become lost in the terminology. The terms, while not completely outside a normal vocabulary, are used in a way that are unfamiliar to people who are not investment bankers or work for a brokerage. A term like liquidity, might mean what happens to ice in a warm room, but in the world of finance, though, the term has an altogether different, yet oddly similar, meaning.
An asset is anything that has value. It does not have to be thing, like a painting or money, but it can also be ideas, like an organizational structure within an office building. The idea is that there has to be an added value to a business, or household, in order for it to be considered an asset. The opposite would be a liability. Liabilities are those things which reduce the value of a business, or household, such as credit card interest, a lease or wages that need to be paid.
So assets are those things that have an inherent value. In the terms of a household, all the things in the house make up the assets of that family structure. The house itself, the grass in the front yard, the furniture inside, and even the people that reside in the house could be considered assets. With all of these assets, people capable of making decisions on the part of the household will choose to use these assets in a manner that is most beneficial to the household at large.
In this particular household, imagine a dining room table with six chairs around it. If the household is made up of three family members, there are three chairs that remain empty at each meal. Those who make up the household will have to make a decision on how best to use those additional assets. One option would be to simply keep the chairs and do nothing with them. Another option would be to turn them into firewood and burn them as fuel in the fireplace. A third option would be to sell the chairs, or even barter them away for goods or services. Each of these options reflect the possible outcomes that could exist, and the household will choose the option that provides the most value to the household as a whole.
Most people would think that they would never sell the chairs, since they are part of a set, and the set loses value if separated. That would normally be true, unless the circumstances of the family change. What if the family members lose their jobs? What if all of the heat to the house were cut off? In these instances, the family would have to re-evaluate how best to make use of their assets.
Not all assets are the same, though. A box of gold coins has a value equivalent to a supposed amount of dollars (or other currency). An original Picasso painting has a value, and so does a glass of water. In order for that value to be realized and useful, it has to have the ability to become liquid. A liquid asset is one that can easily be converted into cash. The Picasso painting may be extraordinarily valuable, but if no one is willing to buy it, how valuable is it in real terms?
A liquid asset, then, is one that can be turned into cash without losing much, or any, of its value before the transaction occurred. While the house is an asset, as well as the dining room set, it would be difficult to purchase anything with a chair. These were the means of barter based economies, and they worked well as long as you had something to trade that other people wanted. With the use of money, though, it allows an economy to have a basic standard of trade which can be regulated and easily used in all businesses, which is why the term “liquid” is used to describe, since it flows easily.