Types of Financial Assets
You can summarise your wealth in the same way that businesses do – by detailing your financial worth in a balance sheet. Just as businesses have assets and liabilities, so do people.
On one side of the balance sheet, businesses list tangible physical assets – things like premises, plant and machinery, vehicles and office furniture and equipment, and financial assets, most of which are not physical.
Financial assets are categorised under four headings:
- HTM – Held to maturity
- LAR – Loans and receivables
- FVTPL – Fair value relating to profit and loss
- AFS – Available for sale.
A company’s balance sheet can be quite a complex thing, but on a personal level, your balance sheet is a lot simpler, although it works on the same principles.
In this blog, we are focussing on financial assets. We’ll start out looking at financial assets from the business point of view, then compare them to what you would consider from your personal wealth situation.
Financial assets explained
Before I explain what financial assets are, I should start with what does an asset mean, and to find out, we need to go back to basic accounting.
A company balance sheet is divided into two categories – assets and liabilities. The assets are the items that your company owns that provides some sort of future economic benefit. On the other hand, liabilities are what you owe to third parties. In the simplest of terms, assets can put money into your pocket, whereas liabilities can take out money.
Under types of assets on your balance sheet, you could list all the production machinery your business owns, with the value of each machine denoted in monetary terms. The future economic benefit these machines provide is the products they make, which are then sold.
But remember that this blog is about financial assets and when the word “financial” is introduced, the asset referred to is not real or tangible, so machinery, for example, is out of the equation. Financial assets are in a field of their own, but they can and do play a key role in deciding a business or your net worth.
The definition and examples of financial assets
What are financial assets? – Well, according to Investopedia, their financial assets definition is a liquid asset that represents or gets its value from the ownership of an entity or legal rights to future payment generated by a said entity – such as bank deposits, bonds, cash, certificates of deposit, insurance, stocks, etc.
Financial assets and liquidity and illiquidity
When talking about financial assets, you will often come across the term “liquidity.” Liquidity refers to how quickly an asset can be turned into cash. So, for example, the most liquid asset on any balance sheet is cash because it can be used with immediate effect to pay a liability.
At the other end of the scale, you have an illiquid asset that cannot be turned quickly into cash. A good example of this would be a factory because generating cash by selling the factory can be a lengthy process.
Most liquid assets tend to be current assets – assets that can be turned into cash in less than a year. Examples of these would be accounts receivable, cash, stock or inventory, and saleable securities.
Then you have non-liquid assets, usually referred to as fixed assets. And they include things like property, machinery, and vehicles. Fixed assets usually require a significant investment of cash and are long-lasting.
When it comes to financial asset examples as mentioned above, the ones that are considered to be the safest are cash and bonds – more specifically, government-backed bonds. But as these bonds are the safest, it means that the interest rates they offer are low.
The advantages and disadvantages of highly liquid financial assets
We now know that liquid assets are those that can be quickly turned into cash, with highly liquid financial assets being the ones that can be turned into cash pretty much immediately. The advantages with these types of assets are:
- Immediate cash convertibility
- The possibility of earning interest which increases their value
But as well as advantages, highly liquid financial assets also have disadvantages, including:
- Low returns due to their high liquidity
- Subject to volatility. It’s all very well when markets are stable and confident, but these types of assets are also vulnerable to market downturns
- It may not be suitable for keeping up with inflation
Financial asset management
In the business world, financial asset management usually falls under the remit of the CFO. But it is also relevant in the private investment world; particularly liquid financial assets like bonds, stocks, and shares which also need to be carefully managed, especially given the volatility of the stock markets and circumstances like the unforeseen COV-19 pandemic.
If you are knowledgeable in this field, you will do your financial asset management. But if you are less well informed or experienced, it is best to turn to outside financial asset management companies, which employ the services of specialist portfolio managers or financial advisers who will manage your financial assets for you.
The various types of liquid financial assets open to investors
Most investors know about the value of bricks and mortar, and purchasing your home is at the top of most people’s lists. But liquid financial assets don’t include real estate. Property is considered a safe long-term investment and therefore comes under the illiquid category
The most popular types of liquid financial assets include the like of:
- Bank products
- Commodity Futures
- Mutual Funds and ETFs
- Pensions and Retirement
If you are not satisfied with the interest rates offered on ordinary savings accounts, especially given the latest news that inflation has reached 5.4%, investing your money in financial assets could be the answer. The interest or returns that a financial asset makes, in theory, can easily outstrip inflation and give you more money in real terms.
Minimising risk of your financial assets
There is always a certain amount of risk involved with any investment, particularly when those investments are highly liquid. That’s why one of the key recommendations when investing is diversification. While illiquid investments may not be very exciting in terms of high returns, they are often a much more stable bet and can help to offset the risks of things like stocks and shares.
After delving into asset finance meaning, we hope that you now understand the term and have a better idea of how you can take advantage of it to shore up your own personal wealth position. But, at the end of the day, personal financial asset management is a tough, continuous task that can challenge even the most economically savvy individual and easily lead to confusion and short-sightedness.
The world in which we live today, where financial assets and investments move and change so quickly, is a tough one. Dealing over the internet with instant access to financial markets and stock exchanges around the world can lead to some resounding successes if you know what you’re doing, and if you don’t, can also lead to some spectacular disasters.
Always remember that you can lose money buying and selling financial assets almost in the blink of an eye. It all depends on how risk-averse you are. For the safest stance and a good starting point, it’s always a good idea to never invest more than you can afford to lose. The final piece of advice is to avail yourself of the best professional advice available.