An asset is widely known as something of value that you can own. What is less well-known is that “asset” is a broad term, referring to several asset types. One such type is financial assets.
In this article, we will explain what a financial asset is, how they work, and compare them against other types of assets. Let’s get started.
What are financial assets?
We’ll start with a financial assets definition. Put simply, financial assets are an asset that is valuable because of a contract, or a similar documented claim. Financial assets are not always physical objects.
A prime example of a financial asset is stock equity. Stock equity gains its value from a different asset, like a commodity, for example. This is known as an underlying asset. Despite not being a physical asset itself, stock equity gains its value from this underlying, physical asset. As the value of these underlying assets change, it will impact the value of the connected financial asset.
While stock equity might be a good example, it isn’t one that everyone can relate to. Bank deposits are far more common, with an overwhelming majority of people having one in some form. In fact, checking accounts are the most used form of financial asset, though savings accounts, money marketing accounts, and retirement accounts are also widely used.
Financial assets for businesses
Though financial assets are held most commonly by private individuals, in the capacity outlined above, many businesses also hold some kind of financial asset. This is often in the form of accounts receivable, which details the amount of money owed to a business for products or services it has provided, but has not yet been paid for. In addition to accounts receivable, cash and cash equivalents are possessed by businesses. While this may seem like complicated at first glance, these kinds of financial assets are no different from the savings account you likely have. With your savings account, you effectively loan your money to the bank, turning it into a financial asset. Businesses engage in similar practices, though typically with a bit more complexity than a private individual. Despite the added complexity, the results are the same, resulting in the creation of financial assets.
Examples of financial assets
Financial assets refer to a wide range of assets that fall under the umbrella term. Naturally, some kinds of financial assets are better suited to some goals than others. Let’s take a look at a few types of financial assets.
Stocks
Stocks are a widely known form of financial asset. When purchased, they grant ownership over a small portion of a publicly-traded company, allowing the owner to benefit from the growth of said company. This growth can be pretty explosive, given the dynamic nature of the stock market. However, while stock ownership can expose you to noteworthy financial gains, you are equally exposed to drastic losses. As such, stocks are viewed as a double-edged sword; simultaneously the financial asset with the highest potential for great returns and the riskiest.
Bonds
Bonds are of a similar stripe to stocks, being a type of financial asset that requires investment. When purchasing bonds, you agree to lend your money to the bond issuer, on the condition that it is returned, with interest, at the end of an agreed-upon term. Bonds are often used by both governments and companies alike, as a means to raise capital for short to medium-term projects. This makes bonds a low-risk, reliable investment, though one with limited returns when compared to stocks.
Cash and cash equivalents
Cash and cash equivalents are the broadest category of financial asset. Including a range of assets used mostly by private individuals, and others by businesses. Bank deposits are the most common type of cash equivalent, with many people opening a checking or savings account with their local bank. The popularity of bank deposits is easy to understand. They are an almost risk-free means of earning a fixed interest rate on the account owner’s money.
The minimal risk is due to a guarantee made by an official body. Depending on the particular cash equivalent in question, the value of an account is guaranteed up to a certain point. This guarantee can be made directly by the government, as is the case with the NS&I, or by an official body charged with ensuring account owners don’t unfairly lose their money.
One potential downside to some cash equivalents is withdrawal terms. How you get your money out varies from bank to bank, and is further determined by the type of account you have open. Some allow the instant withdrawal of any amount of money, while others have considerable restrictions.
How do financial assets work?
Though they might not seem so at first, financial assets are, thankfully, quite simple to understand. As we mentioned earlier, financial assets get their value from an underlying, usually physical, asset. As detailed in a contract or other form of agreement. There are many types of agreements that result in the creation of a financial asset, with some examples given above, there isn’t any one way they work. Instead, they work differently depending on their type.
Although financial assets have their differences, the main mechanism is the same. Each financial asset is tied to a contract, or similar claim, entitling the owner to some of the value of the underlying asset. How much and when it is received is usually the main difference.
Conclusion
In summary, financial assets are intangible assets that gain value from a contract, with an underlying asset justifying that value. As they are intangible, they are quite different from other assets, such as property, that are physical.
Despite not being physical, financial assets can provide an excellent means to grow your wealth, while often being much more accessible than many physical assets. Savings accounts are easy to open, hence why they are so popular, and stocks can be traded from the comfort of your desk. As such, financial assets are likely to become more prevalent amongst businesses and private individuals alike.