Equilibrating Financial Assets and Physical Assets

The views and opinions expressed are of Mr. Arun Thukral, MD & CEO, Axis Securities.

Assets are anything with a value that embodies economic resources or ownership that can be converted into something of value such as cash. Financial assets and physical assets, both represent such ownerships of value, albeit they are very different from each other based on their features and characteristics. 

Financial assets are elusive, meaning that they cannot be seen or felt and may not have a physical existence except for the presence of a document that represents the ownership interest held in the asset. Financial assets do not earn any depreciation or loss of value due to wear and tear. But, the financial asset may appreciate or depreciate depending upon the market circumstances. 

Physical assets are tangible assets and can be seen, touched and held, with a very identifiable physical existence. Physical assets include land, machinery, buildings, tools, equipment, vehicles, gold, silver, or any other form of material economic resource. Physical assets require preservation, upkeep and upgrades which entails expenditure. 

The main resemblance between financial and physical assets is that they both signify an economic resource that can be converted into cash. The difference is that physical assets generally lose value due to wear and tear, whereas financial assets do not undergo such reduction in value due to downgrading. However, financial assets may depreciate owing to changes in the market interest rates, a drop in investment returns, or a collapse in the stock market prices. 

Now, let us oversee an individual investor’s portfolio to understand the physical and financial assets and its share in his/her asset portfolio.  

Indians have an affinity towards physical assets - be it real estate in the form of plots, farming land, and developed real estate or gold. The attraction of Indians to these physical assets can be attributed to the lack of alternative instruments in the financial asset area. Over the last few decades, the financial markets have grown from level to level and now have become an asset class that can be reckoned with. With the arrival of information technology, telecommunication and internet, the interactions have made deep infiltration. The mindset of an average Indian is now varying with an inclination towards financial assets.

Know that the physical assets markets lack liquidity. It means these assets are comparatively complex to be monetised at the time of need. The market for both gold and real estate is dense and thus lack transparency. This asset category is non-regulated and hence, the counter-party risk is always there at the time of transaction. 

Alternatively, the financial assets offer cash flow in the form of dividends or interest payments for fixed income securities. If diligently invested, the shares offer capital appreciation over a period of time and the fixed income securities return the principal on maturity. Since equities have previously beaten the inflation by a wide margin, it has helped in wealth creation over time despite the unpredictability due to different factors. Equities enable the invested corpus multiply over a long period of investment through what is known as the magic of compounding. Therefore, if one wants to build wealth, he/she should turn to equity investment for the long term. 

The dealings in financial assets are completely translucent. The markets are controlled by a regulating body which has designed the rules and regulations to guarantee smooth execution and transparency in operations. Hence, the financial assets get the upper hand over the physical assets as an investment opportunity. 

All said the financial markets are enormously unpredictable in nature. The market evaluations of the instruments have control of domestic as well as global developments daily. Unless one is long term or has access to an experienced consultant, it would not be advised to invest in financial instruments. 

So, how should one’s asset portfolio look like? 

The basic aim of investment in assets is wealth creation. Thus, financial assets should get the highest share in the portfolio. After identifying one’s goals, one should build portfolios bespoke to meet those specific goals.  One should define the risk profile for every portfolio based on the goal and the time given to meet the goal and accordingly invest. As real asset and gold are hedges against inflation, the wealth created by these assets comparatively falls behind the wealth created by the financial instruments. 

Hence, it is advisable to start investments using the financial assets to build wealth by degrees so that after it grows into a significantly large corpus, one can invest in the physical asset like real estate or gold instead of doing the vice-versa.