What is a Financial Asset
A financial asset is a tangible liquid asset that gets its value from a contractual claim. Cash, stocks, bonds, bank deposits and the like are examples of financial assets. Unlike land, property, commodities or other tangible physical assets, financial assets do not necessarily have inherent physical worth.
Understanding a Financial Asset
Financial assets, according to the commonly cited definition from the International Financial Reporting Standards (IFRS), include cash, equity instruments of another equity (a share certificate, for example), a contractual right to receive a financial asset from another entity (receivables), a contractual right to exchange financial assets or liabilities with another entity under favorable conditions or 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, deposits and equity stakes. Many of these financial assets do not have a set monetary value until they're converted into cash, especially in the case of stocks; their values fluctuate as with other types of assets, such as real estate or commodities.
Common Types of Financial Assets
Stocks are financial assets with no set ending 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 companies or governments finance short-term projects. 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 set time with a guaranteed interest rate. A CD pays monthly interest and can typically be held for three to six months or one, three or five years.
Differences Between Financial Assets and Other Assets
Most assets are categorized as either real, financial or intangible. As mentioned, financial assets derive their value from a contractual claim on an underlying asset. This underlying asset may be either real or intangible; real assets are physical assets that draw their value from substance and properties, such as precious metals, real estate and commodities. Meanwhile, intangible assets stand in contrast to tangible assets and include patents, trademarks and intellectual property — valuable property that's not physical in nature.
Commodities, for example, are the real, underlying assets that are pinned to such financial assets as commodity futures or some exchange-traded funds (ETFs). Likewise, real estate is the real asset associated with shares of real estate investment trusts (REITs), which are financial assets.
Pros and Cons of Financial Assets
Financial assets such as checking accounts, savings accounts and money market accounts are easily turned into cash for paying bills and covering financial emergencies, such as car repairs. Keeping too much money in illiquid investments may result in using a high-interest credit card to cover bills, increasing debt and negatively affecting retirement and other investment goals. In the case of stocks, an investor has to sell stock and wait for the settlement date to receive the cash; an investor must have other financial assets available for when emergencies arise.
Keeping money in more conservative accounts results in greater preservation of capital. Money in bank accounts is typically covered by the Federal Deposit Insurance Corporation (FDIC) and is insured against loss. When enough money is set aside in more liquid accounts, an investor is better able to purchase more aggressive assets such as real estate or Forex (FX) with greater peace of mind.
However, liquid assets such as checking accounts and savings accounts have a more limited return on investment (ROI). In addition, CDs and money market accounts restrict withdrawals for months or years. When interest rates fall, callable CDs are often called, and investors face moving their money to potentially lower-income investments. Since FDIC insurance covers each financial institution individually, an investor with brokered CDs totaling over $250,000 in one bank faces losses if the bank becomes insolvent. Also, cashing out assets before their maturity dates typically results in lower returns and other financial penalties.