Liquidity describes how easily you can access the cash you put into an investment. Some investments are more liquid than others. For example, investing your cash surplus in a money market account is very liquid. You can pull cash from a money market account when you need it without incurring any penalties for withdrawing the funds. Other investments offer less liquidity and have penalties for withdrawing early. A CD (certificate of deposit) is an example of an investment that has this type of penalty if the CD is not held for its full term.
When investing your cash surplus, be sure to consider the investment's liquidity. If the amount and duration of your cash surplus are uncertain, then you should consider only those investments that offer a high level of liquidity. On the other hand, if the amount of your cash surplus and the duration of the surplus are fairly certain, then less liquid investments should be considered. Preparing a cash flow budget should help you determine the amount and the duration of your cash surplus.
The liquidity of your investments also affects the yield of your investment. An investment that is highly liquid, such as a checking money market account, will generally result in a lower yield on your investment. On the other hand, an investment with a low level of liquidity, such as a CD, will generally provide you with a higher yield.