Understanding Different Kinds of Assets and Asset Allocation
When I’m writing about personal finance issues, I often use a subset of terms that, to me, feel like common sense. Stocks. Bonds. Savings. Frugality. These things all seem commonplace.
One word that’s nearly in that group for me is “asset.” It’s a simple term to describe a simple thing.
Which brings me to this email from “Jodie”:
You have mentioned assets in a few emails recently. What are assets? I’ve looked them up in Google but none of the definitions completely make sense.
In simplest terms, an asset is any item owned by you that has value. Your car is an asset. Your DVDs sitting on your shelf are assets. Your home is an asset. The money in your savings account is an asset. They’re all assets.
Usually, items that have a very direct and clear value are known as tangible assets. All of the items listed above are tangible assets. With a tangible asset, you can get a very realistic estimate of the value of the item and how much you can sell that item for to directly convert it into cash.
When people figure their net worth, they usually include their tangible assets on the positive side. Many people don’t count small tangible assets, such as individual DVDs or the used value of their refrigerator, when they do such calculations.
Most of the time, personal finance deals with tangible assets. However, there are also intangible assets, something I often touch on. Things like friendships, reputation, time, personal relationships, skills, talents, and other such attributes are intangible, but they clearly have value. You can’t put a precise dollar sign on any of these things, but they’re clearly assets.
Quite often, when investors discuss assets, they’re talking about things purchased for the primary purpose of generating a positive return, not necessarily for using them. They hope that when they buy this item, they can someday sell it for more than they purchased it for or earn enough income from the item that the total earnings and the sale price add up to a positive return.
Essentially, that’s how a savings account works. You put in $1,000 into an account that earns 1%. At the end of the year, the account has $1,010 in it. That $1,000 asset earned a $10 return over the course of a year.
Naturally, there are a lot of ways to put assets to work to earn a return. You can own some stock in a company that earns dividends, then sell that stock later on (earning a return on the dividends and a return on the sale). You can buy a house and the land it sits on, rent it out to people, then sell it later.
When people talk about asset allocation, they’re talking about owning a lot of different kinds of assets at once so that no matter what happens to the economy, they won’t go bankrupt. A person might own some U.S. stocks, some international stocks, some cash, some Euros, some gold, and some land as investment assets.
Good asset allocation means that if something bad happens in one area, like an economic downturn in the United States, you don’t significantly lose out with regard to the overall value of your assets. Obviously, asset allocation can be a very deep subject, indeed.
The idea of an asset is simple. It’s what people do with those assets that tends to sometimes get complicated.