Updated on March 15, 2023
The term illiquid refers to the inability of an asset to be sold or converted to cash or cash equivalent when required by the investor. It is the outcome of a lack of demand for the asset which means that there are no significant buyers present in the market that are willing to purchase the asset. This lack of demand results in a fall in prices for the asset as well. If the asset is still not gaining enough buyers it means that the asset cannot be exchanged for cash easily making it illiquid.
Illiquidity is not restricted to assets alone. A business can be illiquid as well when it does not have enough cash to run its daily operations and meet its financial commitments.
Impact of illiquidity
Illiquid assets can lead to losses as they cannot be sold at a profit due to a lack of demand and the difference between the asking price and the value that can actually be received for the same. Liquidity risk is, therefore, part of risk declarations for many products like mutual funds. Such declarations ensure that investors are aware of the risk of investment in potentially illiquid assets and can therefore make informed decisions.