In my previous column, I emphasized the importance of regularly investing your financial surplus. It’s crucial to remember that even holding cash is an investment decision. But what exactly constitutes an “investable asset”? Let’s explore this concept in more detail.
Defining Assets
Accountants define an “asset” as any item that can be used multiple times. For instance, a car, television, house, or computer can all be classified as assets because they serve a purpose over time. However, with the exception of a house, these items are not considered “investable assets.” This distinction arises from the fact that their value typically depreciates with use and time. When you purchase a car or a television, you are unlikely to recover your initial investment if you decide to sell them later. In economic terms, these items represent “consumption.” While they can be enjoyed multiple times (unlike say chocolates), they ultimately fall into the category of consumption rather than investment.
The Investor’s Perspective
Investors view assets differently. The primary goal of investment is to grow your capital. Investable assets typically possess one of two characteristics:
- Income Generation: These assets generate money over time through interest or rent. Examples include cash, corporate bonds, government bonds, and rental properties.
- Appreciation in Value: Some assets increase in value because their ownership becomes more desirable. Stocks represent fractional ownership in companies and benefit from the company’s growth.
Rare Assets and Scarcity
Certain assets appreciate due to their rarity. Collectibles—such as art, fine wine, first edition books, and memorabilia—can gain value over time as they become scarcer. People are willing to pay for rare items that cannot be reproduced. Other examples include gold, non-fungible tokens (NFTs), and bitcoins; their value stems from limited supply and societal acceptance of their worth. However, not all rare items are worth collecting. For instance, your childhood toys may hold sentimental value for you but are unlikely to attract attention from collectors unless you are exceptionally famous. Rarity alone doesn’t guarantee monetary value.
Investing in Popular Financial Assets
The most popular investable assets are those that are easy to buy and sell, have a large enough market to accommodate significant investments, and are accessible even to small investors. This explains the popularity of financial and digital assets like stocks, bonds, bitcoins, and NFTs. Real estate investments require larger capital outlays and physical management but can also be made more accessible through financial products that allow investors to own property without direct management responsibilities. Consequently, the most favoured investable assets include property, stocks, bonds, and precious metals like gold.
Buying the Market: Market Indices
One of the simplest ways to create a diversified portfolio is to buy everything available. This strategy helps insulate you from the price movements of individual assets; it doesn’t matter if a specific stock or bond fluctuates in price—you hold them all. This approach exposes you to “market risk,” which is the risk that all asset prices may decline simultaneously—a phenomenon known as “undiversifiable risk” or “systematic risk.” Unfortunately, there’s no way to eliminate this risk; therefore, we don’t worry about it. It’s essential to focus on what we can control. In my next column, we will delve into how you can effectively buy into the entire market through a construct known as an index. Stay tuned!