How to Choose the Perfect Asset
I know, leave it to an accountant to write a blog post about assets. Well, this is the stuff that keeps us up at night. What is the perfect asset from a personal financial planning perspective? I cannot tell you the number of times I have had this debate with clients, peers, and even family members. Is it a bold investment in Bitcoin, a position in a hot stock, gold, real estate, luxury autos, cash, or some other asset that promises impressive returns into the future?
I don’t think you could ever get a room full of personal finance experts to ever agree on the perfect asset. In fact, such a group would probably end up with more questions than answers. Well, maybe sometimes to get to the answer, you just have to come up with the right questions. So, let’s try to do just that. Let’s make a list of questions to consider to determine what is the perfect asset for you.
What is an Asset?
The textbook definition that I teach in class is that an asset is a resource with economic value that is expected to provide a future benefit. In the context of personal finances, the provision of a future benefit is very significant. In accounting, we often use the word “utility” when describing the benefit or the perceived value of an asset.
Consider Bitcoin, for example. Does it provide its utility or value as a currency to buy stuff with, or is its best use as an asset in the form of an investment? The answer is somewhat relative. When Bitcoin arrived on the scene, its value was as a virtual currency. It was used to buy gaming tokens and even pizza in very limited circles. It had utility, but not much.
Today, one Bitcoin is worth $50,000 plus (depending on the market) and is considered a hot investment with a significant future benefit.
What About Depreciation vs. Appreciation?
Ok, so here is a good question in our journey to decide on the perfect asset. These are polar opposite terms, but they each are unique in relation to most of the physical assets that we can purchase today. Appreciation is the easy one. You buy a house today for $150,000 and it grows in value to $1,000,000 in the next twenty years. That definitely fits the definition of an asset in terms of economic value that will provide a future benefit. It’s also a resource, as we can live in it and use it for our enjoyment. Real estate is often touted as the perfect investment asset due to this concept of appreciation.
Depreciation, on the other hand, is the measurement of an asset’s economic value that has been used up. This loss of value generally happens over a period of time. It occurs because of physical factors (wear and tear) or functional factors (obsolescence). Examples of assets that depreciate are autos, boats, planes, etc. While these assets do have a good measure of utility to the owner, their economic value decrease greatly impacts their future benefit. Can these depreciating assets be considered the perfect asset? It really comes down to quality of life (utilizing the asset) vs. the future economic benefit desired. That new car smell may be nice, but it will not pay me a dividend check when I retire (OK, enough implied about cars and depreciation. I will leave that topic for another day!)
What About Inflation?
We are all guilty of holding on to cash. Like gold, cash is a “security blanket” to many of us. It’s one of the most liquid assets you can own. In fact, I still have the $50 my father gave to me when we went to the bank to set up my first savings account when I was 10! So what’s the problem here? Well, Inflation is the hidden thief that robs value out of certain assets like cash. Over time, what we can buy goes up in cost (inflates) and therefore it takes more and more cash to purchase it. So holding onto an asset that is not keeping up with inflation is actually decreasing the future benefit that it will provide.
What About Cost?
There is an old personal finance proverb that states “stuff costs”. So when you buy an asset, are you really counting the costs? That perfect real estate investment has to be insured and maintained, and property taxes paid. There are broker’s fees, attorney’s fees, title company fees, etc. that add to the real cost of the property. Don’t forget that there are intangible costs here to be considered as well. Will you have to take your time repairing that rent house, painting it, plunging the toilets (not a happy thought to an accountant who only knows how to work with numbers)! Just remember to count the cost before you take the plunge (pun intended).
What about Debt?
The question here is can you really afford the asset. In the finance world we use more inviting terms for debt such as leverage or margin. The concept of buying an appreciating asset with debt is not necessarily bad, but remember who really owns the asset – the lender! Too many times I have seen people invest in what they consider to be the million-dollar stock using margin because they don’t have the funds, only to have the stock price go in the wrong direction leaving them with a lot of debt and no asset.
What About Diversification?
So when I find my perfect asset, should I put all of my money into it? The logical answer is no, but you would be surprised at how many people invest in only one or two assets (or asset classes). A simple example is real estate. I have seen people leverage every dollar they have into buying rent houses. Not a bad investment on its face, but also not a very liquid asset either. During COVID, when tenants lost their jobs and could not pay their rent, some landlords could not afford to pay their own bills including the debt on their properties.
The principle of diversification teaches that in order to reduce risk, you should invest in a variety of asset classes such as stocks, bonds, real estate, cash, and even gold or bitcoin. The basic idea here is that when one asset goes down in value, the other will go up. It also helps in liquidity, where you hold some of your assets where they are available (liquid enough) to pay your bills without having to sell at the wrong time in the market cycle. Although you certainly could buy a lot of pizza with Bitcoin today!
So What is the Perfect Asset?
Well as my college students so eloquently reply in class when I ask a question, “it depends”! Selecting the perfect asset is a very relative decision. It is, as they say, “in the eye of the beholder”. Making a list of questions like these and many more should at least help in refining the decision-making process. Asking some good questions will also help you to filter out some of the hype you see in the promotion of the next hot asset out there. Ultimately, your answers should help to be your guide in the selection of what asset(s) is perfect for you.
To learn more about the various business degrees offered at the West Texas A & M University Paul and Virginia Engler College of Business, click here.
David W Clark, MPA, CPA
Instructor of Accounting & Healthcare Management