Financial Asset Definition and Liquid vs.

Illiquid Types

What Is a Financial Asset?

A financial asset is a liquid asset that gets its value from a contractual right or
ownership claim. Cash, stocks, bonds, mutual funds, and bank deposits are all
are examples of financial assets. Unlike land, property, commodities, or other
tangible physical assets, financial assets do not necessarily have inherent
physical worth or even a physical form. Rather, their value reflects factors of
supply and demand in the marketplace in which they trade, as well as the
degree of risk they carry.

Understanding a Financial Asset

Most assets are categorized as either real, financial, or intangible. Real assets are
physical assets that draw their value from substances or properties, such as
precious metals, land, real estate, and commodities like soybeans, wheat, oil,
and iron. Intangible assets are the valuable property that is not physical in nature.
They include patents, trademarks, and intellectual property. Financial assets are
in-between the other two assets. Financial assets may seem intangible—non-
physical—with only the stated value on a piece of paper such as a dollar bill or
a listing on a computer screen. What that paper or listing represents, though, is a
claim of ownership of an entity, like a public company, or contractual rights to
payments—say, the interest income from a bond. Financial assets derive their
value from a contractual claim on an underlying asset.

This underlying asset may be either real or intangible. Commodities, for example,
are the real, underlying assets that are pinned to such financial assets as
commodity futures, contracts, or some exchange-traded funds (ETFs). Likewise,
real estate is the real asset associated with shares of real estate investment trusts
(REITs). REITs are financial assets and are publicly traded entities that own a
portfolio of properties. The Internal Revenue Service (IRS) requires businesses to
report financial and real assets together as tangible assets for tax purposes. The
grouping of tangible assets is separate from intangible assets.1 2

Key Takeaways

 A financial asset is a liquid asset that represents—and derives value from—

a claim of ownership of an entity or contractual rights to future payments
from an entity.
 A financial asset's worth may be based on an underlying tangible or real
asset, but market supply and demand influence its value as well.
 Stocks, bonds, cash, CDs, and bank deposits are examples of financial
assets.

Common Types of Financial Assets

According to the commonly cited definition from the International Financial

Reporting Standards (IFRS), financial assets include:

 Cash
 Equity instruments of an entity—for example a share certificate
 A contractual right to receive a financial asset from another entity—known
as a receivable
 The contractual right to exchange financial assets or liabilities with another
entity under favorable conditions
 A contract that will settle in an entity's own equity instruments3

In addition to stocks and receivables, the above definition comprises financial

derivatives, bonds, money market or other account holdings, and equity stakes.
Many of these financial assets do not have a set monetary value until they are
converted into cash, especially in the case of stocks where their value and price
fluctuate.

Aside from cash, the more common types of financial assets that investors
encounter are:

 Stocks are financial assets with no set ending or expiration 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 that companies or governments finance short-term
projects. The bondholder is the lender, and 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 specified period with a guaranteed interest rate. A
CD pays monthly interest and can typically be held between three months
to five years depending on the contract.

Pros and Cons of Highly Liquid Financial Assets

The purest form of financial assets is cash and cash equivalents—checking

accounts, savings accounts, and money market accounts. Liquid accounts are
easily turned into funds for paying bills and covering financial emergencies or
pressing demands.

Other varieties of financial assets might not be as liquid. Liquidity is the ability to
change a financial asset into cash quickly. For stocks, it is the ability of an investor
to buy or sell holdings from a ready market. Liquid markets are those where there
are plenty of buyers and plenty of sellers and no extended lag-time in trying to
execute a trade.
In the case of equities like stocks and bonds, an investor has to sell and wait for
the settlement date to receive their money—usually two business days. Other
financial assets have varying lengths of settlement.

Maintaining funds in liquid financial assets can result in greater preservation of

capital. Money in bank checking, savings, and CD accounts are insured against
loss of up to $250,000 by the Federal Deposit Insurance Corporation (FDIC) for
credit union accounts. If for some reason the bank fails, your account has dollar-
for-dollar coverage up to $250,000. However, since FDIC covers each financial
institution individually, an investor with brokered CDs totaling over $250,000 in one
bank faces losses if the bank becomes insolvent.4

Liquid assets like checking and savings accounts have a limited return on
investment (ROI) capability. ROI is the profit you receive from an asset divided by
the cost of owning that asset. In checking and savings accounts the ROI is
minimal. They may provide modest interest income but, unlike equities, they offer
little appreciation. Also, CDs and money market accounts restrict withdrawals for
months or years. When interest rates fall, callable CDs are often called, and
investors end up moving their money to potentially lower-income investments.

Pros
 Liquid financial assets convert into cash easily.
 Some financial assets have the ability to appreciate in value.
 The FDIC and NCUA insure accounts up to $250,000.

Cons
 Highly liquid financial assets have little appreciation
 Illiquid financial assets may be hard to convert to cash.
 The value of a financial asset is only as strong as the underlying entity.
Illiquid Assets Pros and Cons

The opposite of a liquid asset is an illiquid asset. Real estate and fine antiques are
examples of illiquid financial assets. These items have value but cannot convert
into cash quickly.

Another example of an illiquid financial asset are stocks that do not have a high
volume of trading on the markets. Often these are investments like penny stocks
or high-yield, speculative investments where there may not be a ready buyer
when you are ready to sell.

Keeping too much money tied up in illiquid investments has drawbacks—even in

ordinary situations. Doing so may result in an individual using a high-interest credit
card to cover bills, increasing debt and negatively affecting retirement and
other investment goals.