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Sunday, April 21, 2024

What are financial assets?

What are financial assets?

05.05.2023

If you were to make a list of everything you have that's related to finances or money, you could categorize it all into two columns: things that add value and things that take it away. The things that go in the "adds value" column are financial assets. Things that go into the "takes value" column are liabilities.

For example, any equity you have in your home is an asset. Your mortgage is a liability. Learn more about what financial assets are, what characteristics you should know about them and why they're important below.

Types of financial assets

There are many types of financial assets, here are some of the main ones:

Cash and cash alternatives

Cash and cash alternatives are assets that are actually cash or can be easily converted into cash without significant time or loss in doing so. Cash refers to physical currency, such as bills and coins, as well as funds held in a checking or savings account. Cash alternatives are short-term, highly liquid investments that are easy to convert and have a maturity period of less than 90 days. Examples of cash alternatives include treasury bills, money market funds and commercial paper.

Stocks and bonds

Stocks represent ownership in a company; you might also hear them referred to as equities or shares. The value of stock can fluctuate based on a variety of factors, including the company's financial performance, industry trends, and overall market conditions. Stocks are often considered to be a more volatile investment than bonds, but they also offer the potential for greater returns over long periods of time — especially when you invest in a company that ends up becoming a rising star of sorts.

Bonds are a type of debt instrument. When you purchase a bond, you're lending money to the issuing entity, which can be a corporation, government agency or other organization. Bonds typically pay a fixed interest rate, and you may receive interest payments periodically when you hold the bond. Once the bond matures, you receive the bond issuance back. Bonds are generally considered a more conservative investment than stocks because they're less volatile and offer a more predictable return. However, they generally offer lower returns.

Real estate

Real estate assets can refer to real property, such as homes, land and rental units. If you own your own home and have any type of equity in it, that's a financial asset. If you own 13 acres in a rural area, that's also an asset, as is a duplex you rent to others.

You can also have real estate-related assets that are not tied to real property you own and oversee. For example, you might buy shares in a real estate investment trust (REIT). A REIT is a company that owns and operates income-generating real estate properties, such as apartments, hotels, office buildings and shopping centers. Investors can buy shares in a REIT, allowing them to invest in real estate assets without owning the property themselves. Other options for investing in real estate without owning it outright include real estate exchange-traded funds and real estate derivatives.

Commodities

Commodities are raw materials or certain agricultural products that can be bought and sold in specific markets. They're often used as inputs in the production of other goods or services. Silver is a commodity, for example, and it's used in the manufacturing of many electronic products. Gasoline and oil are commodities, and they're inputs into many manufacturing and energy processes. 

Examples of commodities include:

  • Agricultural products such as wheat, corn, cattle and soybeans
  • Energy products such as crude oil and natural gas
  • Precious metals such as gold and silver
  • Industrial metals such as copper and aluminum
  • Soft commodities such as sugar, coffee and cotton

Commodities can be traded through physical markets and financial markets. In physical markets, commodities are bought and sold in their physical form. For example, when a farm takes their cattle to market, they are selling in a physical market. In financial markets, commodities are bought and sold through futures contracts, options, and exchange-traded funds (ETFs). For example, if you buy or sell gold ETFs, you are trading commodities in a financial market. 

Certain personal property

In some limited cases, certain types of personal property might count as a financial asset. The items must have some sort of intrinsic value for this to be the case. Examples of personal property that might be deemed a financial asset include original fine art, collectibles such as coins or cards, fine jewelry and classic cars. 

Characteristics of financial assets

All financial assets have different characteristics. When engaging in financial asset management, it's important to understand the characteristics of various investments so you can balance your portfolio and make decisions in keeping with your budget and short-term and long-term investing and savings goals. Some of the factors to consider include liquidity, return, risk and marketability. 

Liquidity

Liquidity refers to the degree to which a financial asset can be converted to cash quickly, easily, and without loss. The most liquid asset is obviously cash, because there's no need to convert it. That includes cash that you hold in a checking or savings account. You can typically access those funds as if they were cash with a swipe of a card or by writing a check — it's fairly instant and doesn't come with any or much cost.

Cash alternatives come next on the liquidity scale. These may take a little bit of work to sell or convert to cash, but you can typically do so quickly although you may pay a penalty if you sell earlier than the stated terms. 

Other investments have various levels of liquidity. Stocks and bonds can usually be quickly sold on the market, for example, making them fairly liquid when compared to something like real estate. Real property is one of the least liquid assets you can own; it takes a lot of time, work and expense to sell a home.

Return

Return refers to what you get from the financial asset. If you buy a home for $100,000, put $25,000 into fixing it up and sell it for $200,000, your return is $75,000. If you have a savings account with a 1% interest rate, your return is 1%.

Return is typically expressed as a percentage of the initial investment. There are several types of returns, including:

  • Capital gains, which is the difference in value over time and is measured by taking the difference between the purchase price and the selling price of the investment — this would be a measure relevant to real estate or personal property assets. It can also be relevant to stocks, as some stocks do not pay dividends so you only experience a gain through selling a stock for a higher price than you bought it for.
  • Dividends, which companies pay to shareholders — this is a measure relevant to dividend paying stocks 
  • Interest, which borrowers pay to lenders — this is  a measure relevant to bonds
  • Rental income paid by your tenants

In some cases, you may need to consider the total return of an investment, which includes both capital gains and any income generated by the investment while you held it. For example, if you buy a home and rent it out for three years before selling it for more than you paid for it, your return would include rental profits plus the profit from selling the property.

Risk

Risk is a critical factor to consider when managing your financial assets. It refers to the potential for any investment to fail to return any value. If you buy stock thinking that the company in question is rising in the market and it ends up going bankrupt, for example, you likely won't receive any return. There is always a risk of loss when dealing with financial assets, but some are obviously riskier or more volatile than others. Interestingly — or perhaps frustratingly — riskier assets tend to come with the potential for higher returns.

Marketability

Marketability refers to how easily you can find buyers and sellers for your asset if you want to convert it to cash. When there are plenty of buyers and sellers and they're ready to make purchases all the time — such as in the major stock markets — marketability is high. If you're dealing with a specialty asset, such as a classic car, marketability might be lower.

Liquid vs. illiquid financial assets

As previously mentioned, liquid assets are those that are very easy to convert to cash. Highly liquid assets include cash, cash alternatives, stocks and bonds. Illiquid assets are those that you can't easily convert to cash. Examples include real estate, classic cars and collectibles, antiques, and anything else of monetary value that might be sold for a profit given enough time and effort. For example, businesses might consider specialty equipment as an illiquid asset. 

Pros and cons of liquid assets

Pros

Cons

Usually come with lower risk.

Easily convert to cash for easy access to value.

Make financial asset management more flexible, as you can easily convert to cash to make other purchases.

Usually come with lower returns than other types of assets.

Inflation and other market factors can lead to reduced value or loss of buying power.

Trying to hold too much cash or highly liquid assets can leave you overlooking investments that would generate higher returns.

 

Pros and cons of illiquid assets

Pros

Cons

May provide a much higher return than liquid assets.

Factors that reduce the spending power of cash assets may drive up the value of illiquid assets.

Can offer creative ways to diversify your asset portfolio.

Often come with a higher risk.

Are difficult to convert to cash, which can make it harder to access value when you need it.

Provide less flexibility in managing your financial assets overall.

May come with higher costs that many liquid assets.

The importance of financial assets

Financial assets are important to consider no matter where you are in the process of building and saving for the future. Some reasons financial assets are important include:

  • They help you build wealth. All of the financial assets and types mentioned in this article are potential ways for saving for the future. They can help you create retirement savings or build value so that you can pay for a home or other large purchase. 
  • They may provide income. When you manage your financial assets correctly, you may be able to derive an income from them. For example, a rental property generates rental income. Careful stock investments can turn into regular income via dividends. 
  • They help you diversify your portfolio. Having multiple types of financial assets helps you diversify your portfolio. That can help protect your savings against market and economic factors. If one of your assets isn't doing well in the market, the other assets in your portfolio may be doing fine and be able to pull the extra weight. 
  • They help you meet financial goals. When you choose the right financial assets and manage them well, you can work toward large and small financial goals — for the short-term and the future. 

Final takeaways

Educating yourself about financial assets and asset management is a great first step to saving for the future and protecting your interests.

For a full view of your financial assets and how they work together, consider using the Empower Personal Dashboard. It offers free tools such as the Investment Check Up Tool and a Retirement Planner, and can be a valuable tool on your journey to financial empowerment.

 

 

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