What Is Liquid Net Worth?
Liquid net worth is the difference between a person’s cash and cash equivalents and their total liabilities. A positive liquid net worth means a person has more liquid assets than liabilities, while a negative liquid net worth means the person has more liabilities than liquid assets.
Liquid Net Worth vs Net Worth
While liquid net worth focuses on liquid assets, net worth is the difference between total assets (both liquid and non-liquid) and liabilities. In other words, net worth includes assets even if they aren’t easily converted to cash.
Why Is Liquid Net Worth Important?
Liquid net worth is a measure of the ability of a person or household to meet obligations. A Federal Reserve Bank study from 2020 found that around 36% of Americans would have difficulty paying for a $400 emergency. Households that are struggling to meet obligations should focus on increasing liquid net worth.
Examples of Liquid Assets
Cash and assets like stocks and bonds that can be readily converted to cash are considered to be liquid assets.
The sale of a stock or bond often creates a large tax obligation, due to capital gains. The level of liquid assets should be adjusted to account for potential tax obligations.
The early redemption of some bonds and some bank CDs may involve the loss of some interest payments. In these instances, the level of the liquidity of the financial asset can be reduced by the loss incurred from penalties on an untimely transaction.
Whether retirement assets are liquid or illiquid depends both on the type of retirement asset and the age of the owner. Distributions from traditional 401(k) plans and deductible IRAs prior to age 59 ½ are typically fully taxed and subject to a 10% penalty. These assets are generally considered illiquid prior to age 59 ½ and liquid after this age. It should be noted that many people do tap their traditional 401(k) plans prior to age 59 ½.
Contributions to Roth accounts can be withdrawn without penalty or tax at any age while investment returns in the account withdrawn prior to age 59 ½ are subject to penalty. The contribution component of the Roth account should be considered a liquid asset since it can be disbursed without penalty.
Examples of Non-Liquid Assets
Non-liquid assets are assets which cannot be easily converted to cash. These include houses, cars, boats, tangible goods, and collectibles.These assets are not liquid. They are difficult to sell and often sell for less than market value. For example, a person selling a car could engage in a relatively quick transaction with a dealer but may realize less than a person selling through a private transaction.
Houses are not considered liquid because selling real estate can be a lengthy and complex process, due to legal and financial factors. House transactions do not immediately settle and a buyer may need time to secure financing. Though, real estate crowdfunding sites are making this process much easier for investors.
How Is Liquid Net Worth Calculated?
Liquid net worth is the difference between liquid assets and liabilities. It’s calculated by adding up all cash and cash equivalents, and then subtracting all liabilities. Mortgages, car loans, credit card debt, student loans, and other expenses are all examples of liabilities.
Summary
Liquid net worth is the difference between a person’s cash and cash equivalents and their total liabilities or debts. This is a measure of the ability of a person or household to meet obligations. The liquidity of an asset is determined by the ease of selling the asset and the cost and risk of selling the asset. Cash, checking and saving accounts, and money funds are the only purely liquid assets, although most publicly traded financial assets can be sold quickly.
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