Assets are commonly known as anything with a value that represent economic resources or ownership that can be converted into something of value such as cash.
Financial assets are intangible liquid assets such as bank deposits, bonds and stocks the cost of which is derived from a contractual claim of what they represent. In contrast to property or commodities they are not tangible physical assets apart from the documents’ paper.
BREAKING DOWN 'Financial Asset'
As financial assets are intangible, they have no physical presence except for the existence of a document that represents the ownership interest held in the asset. It is essential that the papers and certificates that represent these financial assets do not have any intrinsic value until it is converted into cash. The document certifying the ownership derives its value from the value of the asset that is represented. Regardless of the fact that financial assets do not exist in the physical form, they are still written in the balance sheet, to represent the value that is held by them.
Types of Financial Assets
Common types of financial assets include certificates, bonds, stocks, and bank deposits.
A certificate of deposit (CD) is an agreement between an investor and a bank in which the investor agrees to keep a set amount of money deposited in the bank in exchange for a guaranteed interest rate. The bank may offer a higher amount of interest payment since the money is to remain untouched for a set period of time. If the investor withdraws the CD before the end of the contract terms, he or she will lose out on the interest payments and be subject to financial penalties.
Another popular type of financial assets is bonds, which are usually sold by companies or government in order to help fund short-term projects. A bond is a legal document that states how much money the investor has lent the borrower and when it needs to be paid back (plus interest) and the bond's maturity date.
Stocks are the only type of financial assets that do not have an agreed upon ending date. Investing in stocks gives to depositors a part ownership of a company and share in the company’s profits and losses. Stocks can be kept for any period time until the shareholder decides to sell it to another investor.
Pros and Cons of Financial Assets
The key task of financial assets, which were discussed above, is the process of generating income. The ability to produce a steady income in the process of investment or operating activities is a key characteristic of the financial asset.
It is important to understand that the values that are in the process of use of assets, have a direct relationship to the factor of liquidity. We are talking about the principle that assets should be liquid. This means that you can convert them into cash at fair market value. This characteristic is very important because it ensures restructuring of enterprises under adverse conditions.
Such financial assets as checking accounts, savings accounts and money market accounts are easily turned into cash for paying bills and covering household financial needs, such as plumbing works. Ill-considered investments in illiquid assets may result into lack of cash and usage of a high-interest credit cards to cover bills, inevitably leading to debts increase and negatively affecting overall financial status of investor. In the case of stocks, to receive cash investor has to sell stock and wait for the settlement date and it’s worth doing to have another financial asset available for emergency cases.
On the other hand, keeping money in savings accounts results in greater preservation of capital. All financial risks related with bank accounts in all financial institutions are typically covered by the Federal Deposit Insurance Corporation (FDIC) and insure deposits against loss. More investments in liquid assets give investor an opportunity to purchase aggressive assets such as real estate or trade in Forex market with greater confidence.
Despite the fact that checking accounts and savings accounts refer to liquid assets, they have more limited return on investment. At the same time, CDs and money market accounts restrict withdrawals for months or years. When interest rates fall, callable CDs are often called, and investors face moving their money to potentially lower-income investments.
Distributing portions of your money among different types of investments could benefit in case some of them don’t measure up. Each type of investment has its own potential rewards and risks. By owning a mix of different investments, you vastly diversify your portfolio. It is worth doing to minimize the risks you’d assume by putting all of your money in a single type of investment.
2022-11-25 • Updated