What does the term "liquidity" refer to in finance?

The term "liquidity" in finance primarily refers to the ease with which an asset can be converted into cash without significantly impacting its market price. This is crucial because it determines how quickly and efficiently an investor can access cash from their investments. For instance, cash itself is considered the most liquid asset, while investments in real estate or art can be much less liquid due to the time it takes to sell those assets and the potential for price fluctuations during that process.

A focus on how liquidity affects investment strategies is important: investors often prefer more liquid assets because they can respond quickly to market changes or personal cash needs. The significance of liquidity in overall financial health and decision-making cannot be overstated, as it allows for flexibility and financial security in various situations.