Appreciating Assets (vs) Depreciating Assets

In the previous article, we saw the classification of assets into cash & capital assets. In this issue, we’re going to classify assets based on the returns they generate, into appreciating assets and depreciating assets. All of you would like your money to work harder for you to provide financial security for you and your family in the future years. Hence, it is important to understand the difference, so that your hard earned money does not disappear in depreciating assets.

Appreciating assets

Appreciating means growing in value over time. And from experience, we understand property and even certain cash assets like recurring deposit & PPF are appreciating assets. Just as how land & property appreciates over time, mutual fund units too appreciate in value. Not only have their returns beaten inflation, in certain categories such as equity funds, they have offered the best returns among all asset classes over the last 10-20 years.

Lets take the case of John, who had bought a plot of land in 2006 for Rs.5Lacs. In 2013, he received some offers to sell it for Rs.25L – that is 5 times appreciation in 7 years, one of the fastest growth attained in the real estate sector. It translated to 26% return p.a, but, he decided to sell it later. However, between 2013 to 2018, real estate price actually corrected & he sold it in 2018 for Rs.20L, at 12% p.a return. The plot still gave him a positive return, but at a lower rate.

At the same time, in 2006, John had also invested Rs.5 Lacs in equity mutual funds. In 2013, his mutual fund units had grown to Rs.12Lacs at 13% p.a compared to his plot at Rs.25L. However, come 2018, John’s funds were worth Rs.30 Lacs, as they had appreciated by 16% year over year.

Actual returns in both cases differed at different times primarily due to demand-supply dynamics in the respective asset classes. Overall, John’s Rs.10Lacs investments in 2006 had grown to Rs.50Lacs in 2018, giving him a combined return of 14% p.a year on year. Hence depending on your knowledge & risk appetite, it is good to have a mix of these appreciating assets in your portfolio as returns from different assets vary & are not predictable.

Depreciating assets

Depreciating means losing value or worth over time. Although we like to consider buying a car, laptop, mobile or doing expensive decors/renovation as owning an asset, these investments are technically depreciating assets. They start losing value the moment you pay for them, so try to optimize your purchases – instead of paying your hard earned money for a brand, look for value in your purchases. Good things do not always have to be expensive. Most of the technically superior products are no.2 or no.3 in the market and would be available at a very good discount to the price of the no.1 branded products.

And however compelling it may be, it is important to never buy a depreciating asset on loan. Your rate of depreciation just accelerates by the interest you pay on your loan. If your vehicle or gadget depreciates by 15% each year and your loan interest is 10%, you are rapidly losing 25% of its value each year.

Devil is in the details

At the same time, not all appreciating assets actually appreciate. For example, if you wrongly invest in a dividend or dividend-reinvestment scheme of a debt mutual fund, you deprive yourself of the opportunity to let it grow over time, due to the periodic dividend payouts and the high 28% dividend distribution tax (DDT) that gets deducted prior to the dividend payout to you – for equity dividend schemes, the DDT is 10%. There is no such tax on a growth scheme since returns grow cumulatively in a growth scheme. Hence only growth schemes of mutual funds are truly appreciating assets.

Similarly, if you are saving gold for your daughter’s marriage, buying the sovereign gold bond or gold ETFs might be a better alternative to the physical gold because you lose money twice, when buying (wastage, making charge, GST) & when exchanging it later (again wastage). During the year of your daughter’s marriage, you could sell your ETFs and buy the latest design rather than losing 25% value in old gold jewel exchange programs.

Choose your asset right

It is very important to invest in appreciating assets in the early income earning years of your career/business. This goes a long way in making your money work harder for you & giving you the wealth multiplier effect. On the other hand, if you spend a good portion of your hard earned money in depreciating assets, you would be depriving yourself of the multiplier effect.

In the next article, we’re going to look at movable & immovable assets..