Financial Assets vs Physical Assets - Striking right balance

Financial Assets vs Physical  Assets - Striking right balance
Assets that one can feel, see, touch or hold are called physical assets for example, real estate, precious metals, jewellery, plant and machinery, vehicles, tools etc. Physical assets require maintenance, repairs and upgrades which involve expenses.

The financial assets are intangible assets that cannot be seen or felt except for the documents, if any, that represent ownership interest in the said asset, for example, shares, bonds, corpus held in bank deposits, account receivables, goodwill, copyrights, patents etc. Financial assets do not incur any depreciation or loss of value due to wear and tear. However, the financial asset may appreciate or depreciate in value terms depending upon the market conditions.

Now let us limit ourselves to an individual investor’s portfolio for discussing the physical and financial assets and its share in his portfolio. Let us exclude the assets like living house, vehicles and jewellery from the portfolio as these are purchased for consumption.

We, Indians, love physical assets, be it real estate or gold. Among the two, gold offers no income other than value appreciation in case of uncertainty. Physical gold involves substantial making charges and involves storage cost. Warren Buffett had derided gold as an asset class: “Gold gets dug out of the ground in Africa or someplace. Then we melt it down, dig another pit, bury it again and pay people to stand around guarding it. It has no utility.” Hence, one should buy gold or other precious metals only to the extent needed for consumption.

Being a growing economy, real estate — both commercial and residential — has latent demand. Real estate is an income generating asset, but the yield differs from location to location unlike financial instruments. The demand drives the value appreciation in real estate, and since the demand differs from pocket to pocket, the appreciation and rentals vary in different cities and different locations in the same city or town. Real estate also requires periodical maintenance or uplift and involves legal hassles including expenses at the time of letting it out. Investing in real estate requires huge sums of money at the time of investing. 

Physical assets markets are illiquid; these assets are relatively difficult to be monetised at the time of need. The market for both bullion and real estate is opaque and thus lacks transparency. These asset classes are not regulated; there are no market-makers for these asset classes and hence, the counter party risk always persists at the time of transaction.

Financial investments are of two types — Fixed income giving predictable returns like FD, bond etc. or equity and equity-linked products like ETFs and mutual funds that can potentially give you superior returns but with concomitant risks. Fixed income securities offer periodic interest and principal on maturity. The risk of losing money or not getting your interest is rather limited. The risk is limited and so are the rewards. Equities have historically beaten the inflation by a wide margin, it has helped in wealth creation over long time period, despite the volatility due to different factors. Equities offer, what is called the magic of compounding which enables the invested corpus multiply over long period of investment.

Another advantage for financial asset is that one can create a portfolio by investing small amount say Rs 500 on a monthly basis in SIP. One can shop for even one share of the company irrespective of denomination and endeavour to build a portfolio over a long time using small investments on a regular basis.

The storage of financial assets and instruments is far easy, safe and cheaper than bullion and requires no maintenance like real estate. The transactions in financial assets is completely transparent and quick given that the exchanges act as market-makers and no counter party risk exists at the time of liquidation. The markets are regulated by the apex body which has designed the rules and regulations to ensure smooth functioning and transparency in operations. Hence, the financial assets score over the physical assets as an investment avenue.

Now how should your portfolio look like? The basic aim of investment is wealth creation. Equities, by far, have consistently created wealth over a long period of time. Thus, financial assets and equities, in particular, should share highest share in your portfolio.

Having identified your target goals at a pretty early age of your work life, one should create portfolios tailored to meet those specific goals. Define your risk profile for every portfolio based on the goal and the time period given to meet the goal and accordingly design the constituents giving an overweight to equities.

(The writer is Managing Director and Chief Executive Officer at Axis Securities)

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