Why is liquidity important in investing?

Liquidity is crucial in investing because it directly influences an investor’s ability to quickly buy or sell assets in the market without causing significant changes to their price. When an asset is highly liquid, it means that there is a large number of buyers and sellers actively trading that asset, which allows for smooth transactions. This can lead to tighter bid-ask spreads and ensures that investors can exit their positions efficiently when needed.

For instance, in situations where an investor may need to sell an asset urgently—whether to take advantage of a market opportunity, recover from a loss, or access cash—high liquidity ensures that the sale can be done at a price close to the current market value. Conversely, assets with low liquidity can lead to larger price fluctuations when they are sold, as few buyers may be looking to purchase, or selling could require the investor to lower their asking price significantly. Thus, understanding liquidity helps investors make informed decisions about the timing and manner of their trades, aligning their investment strategy with their financial goals and risk tolerance.