What are Financial Assets and Securities?

What are Financial Assets and Securities?

For the purposes of SimplePassiveInvesting.com, we focus on investing in financial assets and securities, not real estate or businesses. So, it is useful to define certain terms that you will commonly see in investment articles. Such as, what are financial assets and securities?


What is an Asset?

As defined by Investopedia, an asset is “a resource with economic value that an individual, corporation or country owns or controls with the expectation that it will provide future benefit.”

What is a Financial Asset?

In investing, a financial asset refers specifically to an asset that has been securitized. Securitization is the process of taking an illiquid asset, or group of assets, and through financial engineering, transforming them into a security.”

A financial asset is a non-physical or intangible asset.

The value of a financial asset is not inherent. Its value is represented by a real or virtual (online) document that states the agreed value of the asset.

The most basic financial assets include cash, stocks and bonds.

You might be thinking, isn’t cash (money) a tangible asset since you can feel, hold and touch it? It is not considered a tangible asset because money, unlike gold or land, does not derive its value from the paper it is printed on. Its value is derived from the value assigned by the government or central bank that issues that money.

A $50 dollar note and a $2 note are printed on the same type of paper and would incur practically the same cost to print but the value attached to it note is different. Hence, money is a financial asset because its value is derived from a representative document – the printed piece of paper.

In investing terms, a financial asset can also be referred to as a security or paper asset* and financial assets are traded on financial markets.

Your goal is to build a portfolio of financial assets that is basically your collection of invested holdings.

*Note, in accounting terms, the definition of these terms can be slightly different. For example, a paper asset is one that is recognized on the balance sheet, but it is of no use to the company, nor can it be sold for financial gain. It is considered illiquid as it cannot be converted to cash easily. This is very different when we talk about paper assets in investing which are considered very liquid; i.e. can be sold for cash easily.

What is a financial instrument?

Sometimes you will also see the word financial instrument. This essentially refers to a financial asset. In investing terms, both terms are interchangeable.

However, it is useful to define financial instrument a bit more as it will conceptually help you to understand the different types of financial assets that you will ultimately invest in.

First of all, all financial instruments are financial assets. But different financial instruments are more complex than others. Complex financial instruments can be thought of as packages of individual financial assets.

For example, cash is a straightforward financial instrument as the value is represented by a printed piece of paper. The same goes for a stock or bond where the value is guaranteed by a printed or virtual (online) document.

A mutual fund or unit trust is an example of a more complicated financial instrument. A mutual fund is a financial instrument comprising of a basket of financial assets. It is made up of different individual stocks and bonds. But, as a collective whole, the mutual fund itself is considered a separate financial asset.

Think of it this way. Imagine you own a fruit store and sell apples, oranges and bananas. While you have only these three types of fruit, you can package them in such a way that you can sell multiple products.

For example, Product #1 is an apple, Product #2 is an orange and Product #3 is a banana. However, you create more products such as:

Product #4 – A package consisting of an apple and an orange.

Product #5 – A package consisting of an apple and a banana.

Product #6 – A package consisting of an orange and a banana.

Product #7 – A package consisting of an apple, an orange and a banana.

Each product is an asset by itself because you sell each product individually at a different price. However, Product #4, #5, #6 and #7 consists of the individual assets that make up Product #1, #2 and #3. This is what is known as underlying assets.

So, a mutual fund is a financial instrument with underlying assets that can comprise of other individual assets such as stocks and bonds. But, the mutual fund itself, as a collective, is considered a financial asset.

apple orange banana

This probably this sounds confusing now but it will become clearer when you learn about financial assets such as stocks, bonds and mutual funds (unit trusts).

So, don’t worry if you do not know what are stocks, bonds and mutual funds at present. For now, just know that, as an investor:

You will be investing in financial assets also known as securities or paper assets.

All financial assets are financial instruments in some form.

Some financial instruments are more complex than others.


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