What’s a financial asset?
Financial assets may be classified as liquid assets that possess value based on contractual rights or ownership claims. Financial assets encompass a range of instruments, such as cash, shares, bonds, mutual funds, and bank deposits. In contrast to tangible assets such as land, property, and commodities, financial assets lack inherent worth or physical substance. The value of the subject in question is contingent upon several factors, including market dynamics such as supply and demand as well as the inherent level of risk associated with it.
Understanding Financial Assets
Assets are often classified as actual, financial, or intangible. Real assets include precious metals, land, real estate, and commodities like soybeans, wheat, oil, and iron.
Intangible assets are valued as non-physical property. These include patents, trademarks, and IP.
Financial assets are between the other two. Financial assets may appear ethereal, with only their worth visible on a dollar bill or computer screen. However, that document or listing reflects a claim to ownership of a public corporation or contractual rights to payments like bond interest. Contractual claims on underlying assets are what determine the value of financial assets.
This asset may be tangible or intangible. Example: Commodities refer to actual assets underpinning financial assets like futures, contracts, or exchange-traded funds.
In a similar vein, the asset that is connected to REIT shares is real estate. Real estate investment trusts, sometimes known as REITs, are types of financial assets that are traded publicly.
For tax purposes, the IRS requires businesses to report their financial and real assets in the same way as their physical assets. The distinction is made between tangible and intangible assets.
Common Financial Asset Types
According to IFRS, financial assets consist of:
- An entity’s equity instruments, such as a share certificate,
- Receivables are contractual rights to financial assets from third parties.
- A contract to swap financial assets or obligations with another organization under advantageous terms
- Contracts that settle in an entity’s equity instruments
The phrase encompasses financial derivatives, bonds, money market accounts, equity investments, stocks, and receivables. Financial assets do not possess a predetermined monetary value until they are converted into cash, particularly in the case of shares, which exhibit price volatility.
Other than cash, investors typically encounter:
- Stocks are financial assets with no expiration date. Stockholders share in a company’s earnings and losses. Stocks can be sold or kept forever.
- Companies and governments fund short-term initiatives via bonds. The bondholder is the lender, and the bond specifies the amount owing, interest rate, and maturity date.
- A CD enables investors to deposit money at a bank for a set term with a fixed interest rate. CDs pay monthly interest and can be stored for three to five years, depending on the contract.
Highly Liquid Financial Assets: Pros and Cons
Checking, savings, and money market accounts are the purest financial assets. Paying payments and meeting urgent needs is easy with liquid accounts.
Other financial assets may be less liquid. The capacity to swiftly convert financial assets into cash is known as liquidity. Stock investors can purchase or sell on a ready market. Liquid marketplaces have many buyers and sellers and no transaction execution delays.
Investors must sell stocks and bonds and wait for the settlement date to collect their money, often two business days. Settlement times differ for other financial assets.
Holding cash in liquid assets can help preserve capital. Credit union checking, savings, and CD accounts are FDIC-insured up to $250,000. For bank failure, your account is covered dollar-for-dollar up to $250,000. FDIC protects each financial institution separately; therefore, an investor who has brokered CDs above $250,000 in one bank faces damages if the bank fails.
Limited ROI exists for liquid assets such as checking and savings accounts. ROI is the product of an asset’s profit and its cost. Checking and savings accounts have a low ROI. They provide small interest but offer limited appreciation, unlike stocks. CDs and money market accounts limit withdrawals for months or years. Investors tend to switch to lower-income assets when interest rates decrease and callable CDs are called.
- Cash is readily converted from liquid assets.
- Some financial assets appreciate.
- FDIC and NCUA insure up to $250,000.
- Financial assets with high liquidity appreciate a little.
- Financial assets that are illiquid may be hard to cash.
- Financial assets are only as robust as their underlying entities.
Pros and Cons of Illiquid Assets
Illiquid assets are the antithesis of liquid assets. Illiquid financial assets include real estate and antiques. These things are valuable but slow to sell.
Low-volume stocks are another illiquid financial asset. Penny stocks and other high-yield, speculative investments may not have a buyer when you sell.
Too much money in illiquid assets entails risks, even in normal times. Using high-interest credit cards to pay payments can lead to increased debt and hinder retirement and investment goals.
Real-World Financial Asset Example
Individuals and businesses have financial assets. Financial assets for an investment or asset management firm comprise client portfolios, termed assets under management. As of June 30, 2019, BlackRock Inc. is the largest investment manager in the U.S. and the globe, with $6.84 trillion in AUM.
Banks’ financial assets include client loans. In the first quarter of 2019, Capital One, the 10th largest U.S. bank, reported $373,191 million in total assets, with $240,273 million coming from real estate-secured, commercial, and industrial loans.
- Financial assets are liquid assets that indicate ownership of a business or contractual rights to future payments from an entity.
- Market supply and demand affect a financial asset’s value, which may be based on a tangible or real asset.
- Financial assets include stocks, bonds, cash, CDs, and bank deposits.