How does liquidity impact investment strategies?

Liquidity significantly influences how investors approach their investment strategies. Low liquidity restricts access to cash for investments because it makes it more difficult to buy or sell assets quickly without affecting the asset's price. In less liquid markets, investors may face challenges in executing trades, which can lead to larger price swings and increased transaction costs. As a result, investors may be hesitant to invest in less liquid assets due to the risk of not being able to exit a position without incurring a loss or delays.

This understanding shapes investment strategies; for example, an investor may favor more liquid assets, such as stocks from larger companies or government bonds, which can easily be transformed into cash without significant loss. Thus, liquidity plays a crucial role in shaping investors' risk appetite and their overall portfolio strategy, as it influences how quickly and efficiently they can respond to market changes or cash needs.