Liquidity risk is the risk you incur by putting all your money into investments that cannot be redeemed quickly. If a medical emergency comes along or some other unforeseen event, you could be forced to sell investments in order to get some cash. If you are a real estate investor you would be in a particularly bad way because it could take months to get your money. The fastest way to get your money in this case would be to remortgage a house, but this is expensive and still can take weeks, even if the bank gives you no trouble in doing so.

You should only sell investments when it suits you, never put yourself in a situation where you will have to realise a capital gain (and get taxed when you weren't planning on being taxed) or crystallise a loss in a temporarily tough market.

This is one reason why I am so keen on mortgage offset accounts (for people with a mortgage). Not only do they save you a fortune in interest expenses but it doesn't cost you any tax to make a withdrawal. I prefer them to line of credit mortgages and redraw facilities because offset accounts are separate, often fee free accounts where you pay nothing to get some money out.

I like mortgage offset accounts even when you don't need to borrow money, since they remove liquidity risk entirely. It would be better to set up a loan with an offset account, invest the borrowings but put the same amount back into the offset account rather than invest directly, as it means you always have a completely liquid pool of money sitting around ready for you to immediately call upon. Should it be necessary.

Some types of investments, like managed funds with exit fees, term deposits and mortgage trusts have fees for early redemption. You have to invest defensively if you want to stay in the game, so even the longest term investors need to guard against the risk that they will need to withdraw money in a hurry.

Many people have come unstuck because even though they were long term investors, they failed to plan for short term contingencies. The fact that Australians are so stuck up on investing in direct residential property means this particular risk is especially significant in our country. In an emergency the value of your real estate is only what it will summon from a hastily called auction. Auctions are a bad way to sell property even at the best of times, if word gets out that this is a desperate vendor who needs the money to fly to Europe to be with a dying family member, then the vultures will have a field day.