We’ve dedicated a couple of past posts to the need to have an adequate emergency fund. Emergency funds need to be invested in assets that can be quickly converted to cash with no loss of principle. In other words they need to be liquid and safe. Therefore, emergency funds need to be invested in cash, money markets funds or very-short-term CDs.

In addition to being important for your emergency fund, liquidity can be important for other assets in your investment portfolio.

A recent Wall Street Journal article (“Ivy League Schools Learn a Lesson in Liquidity”, Wednesday, August 19th) noted that Harvard University and Yale University’s endowment funds were expected to report losses of 30% and 25% for their fiscal year, respectively. Both endowment funds have been leaders for many years.

So what went wrong at Harvard and Yale? Both endowment funds invested in private equity investments and hedge funds that don’t provide the liquidity of publicly traded stocks, bonds and mutual funds. The article stated: “ …in the midst of unprecedented market turmoil, many endowment managers learned the true meaning of ‘illiquid’. The exits for most private equity and venture-capital funds slammed shut.” The endowment managers couldn’t sell the illiquid investments and saw their asset allocations get “wildly out of balance”. The illiquid investments continued to drop in value, and they couldn’t do anything about it.

Individual investors need to keep the issue of liquidity in mind when they choose investments. Some investors like to invest in real estate. While real estate used to be a great investment and likely will be again in the future, the lack of liquidity can really hurt you in times like now.

Thinly-traded exchange-traded funds (ETF) sometimes have wide spreads between the buy and sell prices. Wide spreads can have a big impact of your returns. Limited partnerships often boast of high returns but can be difficult to sell if you need cash.

The bottom line? Make sure you consider the liquidity of any investment before buying. Not being able to sell an investment when you want or need to can offset most, if not all, of the good features of the investment in bad economic times.