01
Trading Volume
Higher trading volume can indicate more active participation in a market. Lower volume can make it harder to find a buyer at a desired price.
MARKET ACTIVITY
INVESTMENT RISK
Liquidity Risk and How It Can Affect Investment Decisions
Liquidity risk is the possibility that an investment cannot be sold quickly at a reasonable price. Understanding trading volume, bid-ask spreads, market depth and exit conditions can help investors manage this often-overlooked investment risk.
01
Market Depth
02
Bid-Ask Spread
03
Exit Flexibility
MARKET LIQUIDITY
MARKET ACTIVITY
Trading Conditions
LIQUIDITY LEVEL
MARKET DEPTH
Lower
Higher
Potential Exit Difficulty
Variable
WHAT LIQUIDITY RISK MEANS
Being able to sell an investment matters just as much as owning it
An investment may have an attractive expected return, but that does not necessarily mean it can be sold quickly when you need access to your money.
01
What is liquidity risk?
Liquidity risk occurs when an investor cannot sell an investment quickly without accepting a significantly lower price than expected.
Highly liquid investments generally have many buyers and sellers, frequent trading activity and relatively narrow bid-ask spreads. Less liquid investments may have fewer market participants and larger differences between the prices buyers are willing to pay and sellers are willing to accept.
During periods of market stress, liquidity can deteriorate quickly. An asset that normally trades easily may become harder to sell when investors simultaneously try to reduce risk.
Key idea
Liquidity is about how easily an investment can be converted into cash without materially affecting its price.
LIQUIDITY
How easily can you exit?
KEY LIQUIDITY FACTORS
Four factors that can influence how easily an investment can be sold
Liquidity is not determined by one number. Trading activity, market participation and the characteristics of the investment can all influence the ability to exit a position.
02
Bid-Ask Spread
A narrow bid-ask spread generally indicates stronger market liquidity, while a wider spread can increase the cost of entering or exiting a position.
TRANSACTION COST
03
Market Depth
Market depth reflects the number and size of buy and sell orders available around the current market price.
ORDER AVAILABILITY
04
Market Conditions
Liquidity can change during economic shocks, market sell-offs, financial stress or periods when investors become more cautious.
MARKET ENVIRONMENT
EXIT FLEXIBILITY
Plan Before You Sell
WHY LIQUIDITY MATTERS
An investment can look attractive until you need to sell it
Liquidity becomes particularly important when an investor needs cash unexpectedly or wants to rebalance a portfolio quickly.
If buyers are limited, selling may take longer or require accepting a lower price. This can be especially relevant for investments that trade infrequently or have limited secondary markets.
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Consider how frequently the investment trades.
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Check the typical bid-ask spread.
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Understand the available secondary market.
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Keep emergency cash needs separate from long-term investments.
LIQUIDITY SPECTRUM
Different investments can have very different exit conditions
Liquidity varies across asset classes and individual securities. The examples below are simplified and actual liquidity can change with market conditions.
Generally Higher
Large, actively traded securities
Moderate
Less frequently traded securities
Generally Lower
Thinly traded or specialized assets
01
Publicly Traded Securities
Securities with active markets can generally offer more opportunities to buy or sell, although liquidity is never guaranteed.
02
Less-Traded Bonds
Some bonds trade less frequently than major stocks, which can make execution prices and timing more important.
03
Specialized Investments
Certain investments can have limited buyer pools or more complex transaction processes, potentially increasing exit difficulty.
LIQUIDITY IN PRACTICE
Watch how market conditions can influence your ability to exit
Liquidity is dynamic. When market participants become more cautious, trading activity can decline and spreads can widen. Understanding this behavior can help investors think about exit risk before placing an investment.
01
Trading activity changes
02
Spreads may widen
03
Execution can become harder
MARKET LIQUIDITY
WHEN LIQUIDITY RISK RISES
Situations that can make selling an investment more difficult
Liquidity conditions can deteriorate for several reasons, especially when market participants become less willing to transact.
01
Market Stress
During sharp market declines, many investors may try to sell at the same time, while buyers become more selective.
02
Low Trading Volume
Limited trading activity can make it harder to execute large transactions without affecting the market price.
03
Wide Bid-Ask Spreads
A wider spread can increase the difference between the price a seller receives and the price a buyer is willing to pay.
04
Limited Buyers
Investments with a smaller pool of potential buyers may take longer to sell or require greater price concessions.
MANAGING LIQUIDITY RISK
Build an investment strategy that leaves room for unexpected needs
Managing liquidity risk is less about eliminating it and more about understanding how quickly different parts of your portfolio can be converted into cash.
01
Maintain a Liquidity Buffer
Keeping appropriate cash or highly liquid assets available can reduce the need to sell longer-term investments at an inconvenient time.
CASH ACCESS
02
Know Your Investment's Exit Conditions
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03
Understand how and where an investment is traded before buying.
Review Trading Activity
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04
Look at market participation and typical trading patterns.
Consider Stress Scenarios
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05
Think about what could happen if markets become less liquid.
Diversify Your Portfolio
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Avoid relying too heavily on one asset or market for future liquidity needs.
RELATED INVESTMENT RISKS
Liquidity risk rarely exists on its own
A single investment can be exposed to several types of risk at the same time. Understanding how they differ creates a clearer picture of portfolio risk.
FREQUENTLY ASKED QUESTIONS
Common questions about liquidity risk
Liquidity risk is the possibility that an investor cannot sell an investment quickly at a reasonable price. Low trading activity, limited buyers and wide bid-ask spreads can contribute to liquidity risk.
Liquidity risk can affect many types of investments. It tends to be more noticeable in securities or assets that trade infrequently, have limited buyers or have less developed secondary markets.
The bid-ask spread is the difference between the price buyers are offering and the price sellers are asking. A narrower spread often indicates stronger liquidity, while a wider spread can increase transaction costs.
Yes. During periods of market stress, many investors may try to sell while potential buyers become more cautious. This can reduce market depth and widen bid-ask spreads.
Investors can consider maintaining appropriate liquid assets, diversifying holdings, understanding exit conditions and avoiding excessive concentration in investments that may be difficult to sell quickly.
No. Market risk relates to losses caused by movements in market prices, while liquidity risk relates to the difficulty of buying or selling an investment without significantly affecting its price.
BUILD A MORE INFORMED INVESTMENT APPROACH
Understand liquidity before you need to exit
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