Cash Assets (vs) Capital Assets

Assets could be classified in three ways based on their nature, returns and liquidity as cash & capital assets, appreciating & depreciating assets and movable & immovable assets. It is important to understand assets from each of these classifications so as to build a right asset mix that is unique and suitable to each investor.

Cash assets

Cash assets primarily help to meet present needs in the short and medium term, up to 3 years. Cash is regarded as “King” because it helps us buy things for our essentials, comforts and luxury. It helps to immediately satisfy one’s needs in the present, be it our food, health, education or travel. Some of the popular cash assets are bank fixed deposits, post office savings schemes, money-back insurance policies etc. Cash assets are generally regarded as safe, offers moderate returns and are taxed based on your income slab.

In your income earning years, you may not need to hold more than 2 years of expenses in cash assets. However, once retired, it is better to convert your idle physical assets such as plot of land to cash, so they could help provide you with a stable retirement income for the subsequent 20+ years.

Capital assets

All physical assets such as property, land, gold and capital market instruments such as stocks, bonds & mutual funds form capital assets. Capital assets are highly sought after due to various economic & social reasons. For example, buying a house helps save on rent and provides stability for your family. Some of us may also invest in a second property, either a house or land, hoping to sell it at a good return in the short to medium term.

Although capital assets help beat inflation, they come with certain risks & their returns are also not predictable. Under-construction property comes with risks of delays and plots of land may encounter litigation by false claimants in some cases. Either ways, we are stuck without generating any passive income from the asset. Only a resale/completed unit offers us rental yield. Even here risks of a bad tenant refusing to vacate exists, but these risks could be handled. From a tax perspective, capital assets are more tax friendly if held for long term – 2 years for house, 1 year for stocks & equity mutual funds & 3 years for debt mutual funds.

Gold

Most households buy gold as jewellery and business families buy gold bar as a contingency for meeting sudden cash requirements in their business. This asset has been part of our culture for many centuries and is believed to be the safest among all capital assets. However, jewels do not offer intermediate returns & in most families, gold is never sold, it is only passed on from one generation to the next. So, in a way, it is only an exhibit of wealth. Surprisingly, gold also does not beat inflation, so try to minimize gold to 10% of your total networth.

Stocks/Bonds/Mutual Funds

All capital market instruments fall under capital assets. As the functioning of capital markets itself is risky, these instruments are perceived to be risky and hence commands a higher return. Many regulatory and procedural hurdles over several decades have also prevented common people from investing in the market. However in the last 10-15 years several procedures were simplified to allow more retail investors to participate. Investor awareness programs are also helping diffuse the complexities around these financial products.

Capital market assets are tax friendly, hence excess cash assets could be moved to stable short term high quality debt mutual funds to minimize tax outgo. Even business people who park their excesses in 0% current accounts could make their idle money earn more by parking in liquid mutual funds & get 7% return.

Build your own asset mix

Upon understanding the various assets, the risks each one presents and the returns they offer, every investor needs to carefully choose his/her own asset mix. It does not matter whether your returns are higher or lower than someone else’s returns. What really matters is whether you are comfortable holding onto certain asset classes. After all, as much as you desire returns, you must also have peace of mind owning these assets.

In the next article, we’re about to explore what makes some of these assets a great addition to your portfolio while others a big drag down!