What does liquidity risk involve?

Liquidity risk refers specifically to the possibility that an asset cannot be sold quickly enough in the market without causing a significant drop in its price. This type of risk is particularly pertinent in financial markets where the demand for certain investments may fluctuate, making it challenging to find buyers when the need to sell arises. For example, if you own a property, it may take time to find a buyer, and you could face price concessions if you need to sell quickly.

Understanding liquidity risk is essential for managing investments and crafting a strategy that aligns with one’s financial needs. It is crucial for investors to evaluate how easily they can access their funds when required and what the real cost of selling an illiquid asset might be. This concept helps inform decisions on investment types, taking into consideration how quickly one might need to convert assets to cash without incurring large losses.