|'Liquidity' means 'How easily can
you get at your cash'
If you have money in a current account you can withdraw it at any
time without penalty and with little effort. Your current account
is said to be highly liquid.
If you have a 30-day building society account there
will be certain restrictions on drawing out your money with less
than 30 days notice: either it will be absolutely forbidden or there
will be some sort of financial penalty. Either way, a 30-day notice
account is said to be 'less liquid' than a current account.
Some investments have such restrictive repayment terms
that they are described as 'illiquid'. This means 'jolly difficult
to get your money out unexpectedly'.
Reward for illiquidity
If your current account pays the same rate of interest as a 30-day
notice account, would you put any money in the latter, all other
things being equal? Obviously not. Why place restrictions on your
money when you can avoid them at no cost?
So, 30-day notice accounts need to have higher interest
rates than current accounts for people to use them. Generally, less
liquid investments need to offer higher returns than liquid ones.
This is the reward to the investor for giving up liquidity.
The lesson for the investor
If you are prepared to give up liquidity you can expect to earn
a higher return. More than that, if you give up liquidity you must
expect a higher return.
If you want a bit more discussion about liquidity
before moving on: Hanging