What Is Appreciation?
Appreciation, in general terms, is an increase in the value of an asset over time. The increase can occur for a number of reasons, including increased demand or weakening supply, or as a result of changes in inflation or interest rates. This is the opposite of depreciation, which is a decrease over time.
The term is also used in accounting when referring to an upward adjustment of the value of an asset held on a company's accounting books. The most common adjustment on the value of an asset in accounting is usually a downward one, known as depreciation, which is typically done as the asset loses economic value through use, such as a piece of machinery being used over its useful life. While appreciation of assets in accounting is less frequent, assets such as trademarks may see an upward value revision due to increased brand recognition.
[Important: Assets that appreciate in value are considered "paper gains" until they are sold, at which point they become "realized gains," which may be taxable.]
How Appreciation Works
Appreciation can be used to refer to an increase in any type of asset, such as a stock, bond, currency or real estate. For example, the term capital appreciation refers to an increase in the value of financial assets such as stocks, which can occur for reasons such as improved financial performance of the company. Just because the value of an asset appreciates does not necessarily mean its owner realizes the increase.
If the owner revalues the asset at its higher price on his financial statements, this represents a realization of the increase. Similarly, capital gain is a term used to denote the profit achieved by selling an asset that has appreciated in value.
Another type of appreciation is currency appreciation. The value of a country's currency can appreciate or depreciate over time in relation to other currencies. For example, when the euro was established in 1999, it was worth approximately $1.17 in U.S. dollars. Over time, the euro has risen and fallen versus the dollar based on global economic conditions. When the U.S. economy began to fall apart in 2008, the euro appreciated against the dollar, to $1.60.
Beginning in 2009, however, the U.S. economy started to recover, while economic malaise set in across Europe. Consequently, the dollar appreciated versus the euro, with the euro depreciating in relation to the dollar. As of July 2016, the euro exchanges for $1.10 in U.S. dollars.
- Appreciation, in general terms, is an increase in the value of an asset over time.
- Capital appreciation refers to an increase in the value of financial assets such as stocks, which can occur for reasons such as improved financial performance of the company.
- Currency appreciation refers to the increase in value of one currency relative to another in the forex markets.
Appreciation Versus Depreciation
Certain assets are given to appreciation, while other assets tend to depreciate over time. As a general rule, assets that have a finite useful life depreciate rather than appreciate.
Real estate, stocks, and precious metals represent assets purchased with the expectation that they will be worth more in the future than at the time of purchase. By contrast, automobiles, computers, and physical equipment gradually decline in value as they progress through their useful lives.
An Example of Capital Appreciation
An investor purchases a stock for $10 and the stock pays an annual dividend of $1, equating to a dividend yield of 10%. A year later, the stock is trading at $15 per share and the investor has received the dividend of $1.
The investor has a return of $5 from capital appreciation as the price of the stock went from the purchase price or cost basis of $10 to a current market value of $15; in percentage terms, the stock price increase led to a return from capital appreciation of 50%. The dividend income return is $1, equating to a return of 10% in line with the original dividend yield. The return from capital appreciation combined with the return from the dividend leads to a total return on the stock of $6 or 60%.
An Example of Currency Appreciation
China's ascension onto the world stage as a major economic power has corresponded with price swings in the exchange rate for the yuan, its currency. Beginning in 1981, the currency rose steadily against the dollar until 1996, when it plateaued at a value of 1 dollar equaling 8.28 yuan until 2005. The dollar remained relatively strong during this period. It meant cheaper manufacturing costs and labor for American companies, who migrated to the country in droves.
It also meant that American goods were competitive on the world stage as well as the United States due to their cheap labor and manufacturing costs. In 2005, however, China's yuan reversed course and appreciated 33% in value against the dollar until last year.