Financial assets aren't the same as tangible assets or real assets. They exist in a class all by themselves and play an important role in your net worth. Understanding what they are and how they work is an important part of your financial plan.
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What Are Financial Assets?
Financial assets are assets you own that you can convert to cash quickly. Financial assets aren't tangible assets, like real estate or commodities. They are often just a piece of paper, but when traded or sold, they turn into cash. Financial asset values change based on the market. When supply is high and demand is low, their value decreases, but when demand is high, and supply is low, prices increase.
Real assets or tangible assets are things like property and precious metals, and intangible assets are property you can't touch or see, such as a trademark. Financial assets are a combination of tangible and intangible assets. They're not completely intangible. For example, you can hold a dollar bill or a stock certificate. However, these pieces of paper have an underlying value. The dollar bill or stock certificate has value or proves ownership of a real asset, such as ownership in a company.
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Types of Financial Assets
- Certificates of Deposit - CDs are money held by a bank for a specified period. In exchange, you receive interest if you leave the money until maturity.
- Stocks – Stocks are pieces of the company and may earn dividends; the value increases and decreases throughout the years based on the company's performance. However, stocks never expire. The people who hold these stocks are called stockholders.
- Bonds – Bonds are money lent to the government or corporations for a specified period. The people who hold these bonds (bondholders) earn interest on the loan and receive the principal back upon maturity.
- Insurance - An insurance policy bought in order to protect you financially from a specific event. If or when that event occurs, you turn the policy into cash.
Pros and Cons of Highly Liquid Assets
Highly liquid assets are those that convert to cash immediately. Cash is the most liquid asset; other examples include checking or savings accounts, CDs, or money market accounts. There are pros and cons to having highly liquid assets:
- You can immediately convert the assets to cash.
- Some liquid assets earn interest, increasing their value.
- Most liquid assets, such as checking, savings, and money market accounts, are FDIC insured, protecting your investment up to $250,000 per account.
- There's little risk with highly liquid assets, which means little return.
- Investing in a non-FDIC insured account could put your money at risk.
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Pros and Cons of Less Liquid Assets
Assets that aren't highly liquid can still be converted to cash, but not as easily. They require a willing market to trade to convert them to cash. Investors must sell the investment and wait for the settlement to occur, which may take days, weeks, or even months, depending on the asset.
There are pros and cons to these assets, as well.
- The higher risk creates higher rewards. Stocks and bonds, for example, usually have a much higher rate of return than a checking or savings account.
- Assets like stocks and bonds can appreciate, which results in much higher returns.
- If there isn't market demand for the asset, it's hard to convert to cash right away.
- There's no guarantee that stock or bond value will increase.
Financial Assets FAQ
What Is the Role of Financial Assets?
Financial assets help the flow of money. They transfer funds from people who have excess funds to those who need funds, whether that be individuals, companies, or even the government. Financial assets are a promise or claim on future cash.
Are Loans Financial Assets?
If you are the loaner, then yes, loans are considered financial assets because they are a liability that's owed to you. If you have a contract or even an I.O.U., it's a contract that you can convert to cash when the borrower repays the loan. Conversely, if you have a loan that you must repay, that does NOT count as a financial asset for you.
Which Financial Assets Are the Safest?
Besides cash, bonds are the next safest financial asset. Specifically, government bonds are the safest because they have little risk of default. In exchange for an almost guaranteed return, however, they have the lowest rate of return.
What Is the Risk of a Financial Asset?
Except for cash, all assets have risk. The financial asset risk is the chance you take of losing money on the investment. Stock prices can drop, bonds may default, or banks fail. The result of any of these things happening can be a loss of capital.
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Financial assets are something we all have. Bank deposits, cash, stocks, bonds, and other investment assets reflect financial assets or assets you can convert to cash. Some financial assets convert to cash immediately, and others take a while based on the market's performance.