What are Financial Assets?

Posted by Frank Gogol

Financial assets are non-physical assets, and they usually result from contractual claims. But in order to know how to manage any financial asset, you need to understand what they are and differentiate between the various types of financial assets. In this article, you will discover the different asset types, as well as the pros and cons of illiquid and liquid assets, and more.

Financial Assets Explained

Financial assets are liquid assets with a value obtained from an ownership claim or a contractual right. Usually, financial assets consist of things such as mutual funds, bonds, stocks, cash, and many others.

The difference between a financial asset and a physical asset is that financial ones do not have a physical form or any inherent physical worth. Instead, their value shows the demand and supply factors in the marketplace they trade-in. It also shows how risky they are.

For the most part, assets are classified as either intangible, real or financial. Intangible assets refer to valuable property that is not physical, such as intellectual property or trademarks. Real assets refer to physical assets that get value from properties or substances, like real estate, land, precious metals, oil, iron, soybeans, and anything of the sort.

Meanwhile, you can think of financial assets as being in-between the other two types. Financial assets usually seem non-physical and intangible, while their only stated value is on a dollar bill or a computer screen listing. That listing or paper represents a claim of ownership of an entity though, as well as contractual rights to payments.

Because people can sell them very easily, financial assets are classified as liquid. However, over time, they can also lose their value. This may happen when the company’s share price goes down. Also, while some consider real estate a financial asset, others consider it a physical asset instead.

Types of Financial Assets

There are different types of financial assets out there. The International Financial Reporting Standards gave a definition that includes the different financial asset types. They include:

  • the contractual right to exchange financial liabilities or assets with a different entity under favorable conditions
  • cash
  • a contract that settles in the own equity instruments of an entity
  • a contractual right to get a financial asset from a different entity
  • equity instruments of an entity, like a share certificate, for instance

Apart from receivables and stocks, the definition also comprises money market holdings, bonds, derivatives, or just other account holdings. There is usually no set monetary value for any of these markets until they get converted into cash. This mostly applies to stocks, as they have a fluctuating price.

There are also different types of financial assets that you may come across aside from cash – these are bonds, stocks, and certificates of deposit.

Highly Liquid Financial Assets

Cash and its equivalents represent the purest financial asset form. Cash equivalents include money market accounts, savings accounts, and checking accounts. It is possible to turn liquid accounts into funds when you cover pressing demands, financial emergencies or when you pay bills.

Then, there are financial assets that are not as liquid, which means that they cannot be turned into cash that quickly. Liquidity represents the capability of turning a financial asset into cash, and when it comes to stocks, it represents an investor’s ability to either sell or buy holdings from a ready market. In liquid markets, there are a lot of sellers and buyers, and barely any lag-time extensions when trying to make trades.

When it comes to equities such as bonds and stocks, investors will have to sell, after which they have to wait until the date of the settlement to get their money. Most of the time, this is after two business days. Meanwhile, other financial assets will have settlement lengths that vary.

When you keep funds in financial assets, there may be more capital preservation resulting from them. Money invested in things like CD accounts, savings, and bank checking will be insured against loss of up to $250,000. This insurance was added by the Federal Deposit Insurance Corporation for credit union accounts.

In case the bank fails for any reason, you will at least have coverage. But FDIC offers coverage individually for every financial institution, so an investor that has any brokered financial assets over $250,000 in a single bank will deal with losses in case of insolvency.

Then, liquid assets like savings and checking accounts have limited ROI abilities. ROI, or return on investment, represents how much you get in profit from an asset divided by the ownership cost of the asset. The ROI is pretty small in savings and checking accounts, and while they may offer some decent interest income, they don’t offer a lot of appreciation.

What’s more, withdrawals are restricted for months or years for CDs and money market accounts. As a result of the falling rates, investors decide to move their money to investments with potentially lower income.

Pros

  • The NCUA and FDIC can insure accounts up to $250,000
  • There are several financial assets that can appreciate in value
  • It is easy to convert financial assets into cash

Cons

  • It may be harder to convert illiquid financial assets to cash
  • Highly liquid financial assets don’t have a lot of appreciation
  • A financial asset’s value is only as strong as the underlying entity

Illiquid Assets

Illiquid assets are the opposite of liquid assets. Some examples of illiquid assets are fine antiques, real estate, and some stocks. While illiquid stocks have high value and you may want to have as many as possible, having too much money invested in them can have bad consequences on your life and even on your funds.

Pros

  • They have a high value

Cons

  • Having too much money in illiquid investments can make someone use high-interest debit cards for bill coverage, resulting in more debt
  • Using high-interest cards to cover bills can affect retirement goals and other investment goals
  • You cannot easily convert illiquid assets into cash
  • When you are ready to sell stocks, there may not be a buyer ready to get them

How to Calculate Your Net Worth with Assets

If you have to calculate your net worth or you are just curious about it, you can use the assets to do so. Include all your funds from the bank, as well as the investments’ value, and then include the value of your property and car worth if you were to sell them to someone. The payments you receive every month from a retirement plan, or a pension should be added as well.

Once you have all of them, you will have to subtract all your liabilities. Liabilities represent your debt. It may include the balances on your car loans, student loans, or credit cards, as well as the mortgage you still have left. Then, the amount you get represents your net worth.

The Bottom Line

Financial assets can be liquid or illiquid, and they also come in multiple types and with their own pros and cons. If you are interested in financial assets or own any, you need to know as many details about them as possible. This way, you can make informed decisions. Hopefully, this article was helpful in this respect.