What Is a Financial Asset?
A financial asset is a liquid asset that gets its value from a contractual right or ownership claim. Cash, stocks, bonds, mutual funds, and bank deposits are all are examples of financial assets. Unlike land, property, commodities, or other tangible physical assets, financial assets do not necessarily have inherent physical worth or even a physical form. Rather, their value reflects factors of supply and demand in the marketplace in which they trade, as well as the degree of risk they carry.
Understanding a Financial Asset
Most assets are categorized as either real, financial, or intangible. Real assets are physical assets that draw their value from substances or properties, such as precious metals, land, real estate, and commodities like soybeans, wheat, oil, and iron.
Intangible assets are the valuable property that is not physical in nature. They include patents, trademarks, and intellectual property.
Financial assets are in-between the other two assets. Financial assets may seem intangible—non-physical—with only the stated value on a piece of paper such as a dollar bill or a listing on a computer screen. What that paper or listing represents, though, is a claim of ownership of an entity, like a public company, or contractual rights to payments—say, the interest income from a bond. Financial assets derive their value from a contractual claim on an underlying asset.
This underlying asset may be either real or intangible. Commodities, for example, are the real, underlying assets that are pinned to such financial assets as commodity futures, contracts, or some exchange-traded funds (ETFs). Likewise, real estate is the real asset associated with shares of real estate investment trusts (REITs). REITs are financial assets and are publicly traded entities that own a portfolio of properties.
The Internal Revenue Service (IRS) requires businesses to report financial and real assets together as tangible assets for tax purposes. The grouping of tangible assets is separate from intangible assets.
- A financial asset is a liquid asset that represents—and derives value from—a claim of ownership of an entity or contractual rights to future payments from an entity.
- A financial asset’s worth may be based on an underlying tangible or real asset, but market supply and demand influence its value as well.
- Stocks, bonds, cash, CDs, and bank deposits are examples of financial assets.
Common Types of Financial Assets
According to the commonly cited definition from the International Financial Reporting Standards (IFRS), financial assets include:
- Equity instruments of an entity—for example a share certificate
- A contractual right to receive a financial asset from another entity—known as a receivable
- The contractual right to exchange financial assets or liabilities with another entity under favorable conditions
- A contract that will settle in an entity’s own equity instruments
In addition to stocks and receivables, the above definition comprises financial derivatives, bonds, money market or other account holdings, and equity stakes. Many of these financial assets do not have a set monetary value until they are converted into cash, especially in the case of stocks where their value and price fluctuate.
Aside from cash, the more common types of financial assets that investors encounter are:
- Stocks are financial assets with no set ending or expiration date. An investor buying stocks becomes part-owner of a company and shares in its profits and losses. Stocks may be held indefinitely or sold to other investors.
- Bonds are one way that companies or governments finance short-term projects. The bondholder is the lender, and the bonds state how much money is owed, the interest rate being paid, and the bond’s maturity date.
- A certificate of deposit (CD) allows an investor to deposit an amount of money at a bank for a specified period with a guaranteed interest rate. A CD pays monthly interest and can typically be held between three months to five years depending on the contract.
Pros and Cons of Highly Liquid Financial Assets
The purest form of financial assets is cash and cash equivalents—checking accounts, savings accounts, and money market accounts. Liquid accounts are easily turned into funds for paying bills and covering financial emergencies or pressing demands.
Other varieties of financial assets might not be as liquid. Liquidity is the ability to change a financial asset into cash quickly. For stocks, it is the ability of an investor to buy or sell holdings from a ready market. Liquid markets are those where there are plenty of buyers and plenty of sellers and no extended lag-time in trying to execute a trade.
In the case of equities like stocks and bonds, an investor has to sell and wait for the settlement date to receive their money—usually two business days. Other financial assets have varying lengths of settlement.
Maintaining funds in liquid financial assets can result in greater preservation of capital. Money in bank checking, savings, and CD accounts are insured against loss of up to $250,000 by the Federal Deposit Insurance Corporation (FDIC) for credit union accounts. If for some reason the bank fails, your account has dollar-for-dollar coverage up to $250,000. However, since FDIC covers each financial institution individually, an investor with brokered CDs totaling over $250,000 in one bank faces losses if the bank becomes insolvent.
Liquid assets like checking and savings accounts have a limited return on investment (ROI) capability. ROI is the profit you receive from an asset divided by the cost of owning that asset. In checking and savings accounts the ROI is minimal. They may provide modest interest income but, unlike equities, they offer little appreciation. Also, CDs and money market accounts restrict withdrawals for months or years. When interest rates fall, callable CDs are often called, and investors end up moving their money to potentially lower-income investments.
Liquid financial assets convert into cash easily.
Some financial assets have the ability to appreciate in value.
The FDIC and NCUA insure accounts up to $250,000.
Highly liquid financial assets have little appreciation
Illiquid financial assets may be hard to convert to cash.
The value of a financial asset is only as strong as the underlying entity.
Illiquid Assets Pros and Cons
The opposite of a liquid asset is an illiquid asset. Real estate and fine antiques are examples of illiquid financial assets. These items have value but cannot convert into cash quickly.
Another example of an illiquid financial asset are stocks that do not have a high volume of trading on the markets. Often these are investments like penny stocks or high-yield, speculative investments where there may not be a ready buyer when you are ready to sell.
Keeping too much money tied up in illiquid investments has drawbacks—even in ordinary situations. Doing so may result in an individual using a high-interest credit card to cover bills, increasing debt and negatively affecting retirement and other investment goals.
Real-World Example of Financial Assets
Businesses, as well as individuals, hold financial assets. In the case of an investment or asset management company, the financial assets include the money in the portfolios firm handles for clients, called assets under management (AUM). For example, BlackRock Inc. is the largest investment manager in the U.S. and in the world, judging by its $6.84 trillion in AUM (as of June 30, 2019).
In the case of banks, financial assets include the worth of the outstanding loans it has made to customers. Capital One, the 10th largest bank in the U.S., reported $373,191 million in total assets on its first-quarter 2019 financial statement; of that, $240,273 million were from real estate-secured, commercial, and industrial loans.
View more information: https://www.investopedia.com/terms/f/financialasset.asp