Physical assets

Household wealth comes in two forms. One you can touch, the other you cannot.

Physical assets are the tangible ones: real estate, gold and other precious metals. They have an intrinsic value of their own, although the price at which they actually trade depends on demand and supply.

Financial assets are claims. A bank deposit is a promise of interest and your money back; a share is a claim on a company's profits. There is nothing to hold.

Physical assets are bought mainly for the rise in their value rather than the income they produce. Some give both — a flat can be let out. Gold gives only growth.

They are also treated as a natural hedge against inflation, because their prices tend to move up along with prices generally.

The drawbacks are real. They are hard to sell quickly, lightly regulated, need specific skills to handle, and come in large sizes. Buying one usually means savings plus a loan.

One warning from the workbook: the car in the garage is not an investment. It is something the household consumes.

Section 1.4 sets out the characteristics, and the same split is used again in the financial assets ratio of section 3.9.9.

What they are. Physical assets are tangible assets and include real estate, gold and other precious metals. They have an intrinsic value, though the actual price at which they trade is impacted by demand and supply.

Why households hold them. They are usually seen as natural hedges against inflation, since their price shows a positive correlation with inflation. They are more growth investments, bought for the appreciation in value rather than the income they generate. Some, such as real estate, provide both income and growth, while others, such as gold, are pure growth-oriented assets.

The drawbacks, in the workbook's own order:

• Illiquidity.
• Lack of regulation or limited regulation.
• The need for specific skills — to identify opportunities, assess the merits of the investment, arrange the purchase, manage the asset, and sell it when required.
• They are typically large ticket investments and require substantial savings, or a combination of savings and loan, to acquire.

The adviser's job here. When it comes to investment in physical assets, the adviser has to guide the investor not to confuse consumption assets like a car with physical investments, though the life of a particular physical asset may be relatively longer than other such assets.

Where they sit in the ratios. Section 3.9.9 divides assets into financial assets — shares, debentures, bank deposits, PPF, mutual fund investments — and physical assets — gold, other precious metals, diamonds and real estate. Its worked case, investor PQR: shares Rs 5 lakh, fixed deposits Rs 10 lakh, mutual funds Rs 12 lakh, land Rs 9 lakh and gold Rs 14 lakh. Financial assets are Rs 27 lakh, physical assets are Rs 23 lakh, total assets Rs 50 lakh, and the financial assets ratio is 54%.

Section 1.4 also carries the caution about how they are bought: loans taken to buy appreciating assets add to the long-term wealth, while assets acquired with savings and without taking on a liability add to the financial strength of the household.

Investor PQR, from the workbook's own section 3.9.9:

Physical assets are Rs 23,00,000 — 46% of everything PQR owns — and the financial assets ratio is 27 ÷ 50 = 54%.

Now an illustrative test of the drawbacks. Suppose PQR needs Rs 8,00,000 in three weeks for a medical emergency.

The Rs 14,00,000 of gold can be sold or pledged fairly quickly. The Rs 9,00,000 of land almost certainly cannot — not at fair value in three weeks. That is the illiquidity the workbook warns about, and it is why neither gold nor land counts as a liquid asset in the liquidity ratio.

And the large-ticket point. To buy another plot at Rs 30,00,000, PQR cannot invest in instalments the way a Rs 5,000 SIP into a mutual fund works. He needs the whole amount, which in practice means savings plus a loan. The workbook's verdict on that loan depends on the asset: borrowing for an appreciating plot adds to long-term wealth, while borrowing for a car — a consumption asset, not a physical investment — does not.

Chapter 1 (Introduction to Personal Financial Planning), section 1.4, on the assets and liabilities of a household, where physical assets are contrasted with financial assets; Chapter 3, section 3.9.9, uses the same split to compute the financial assets ratio. Expect a classification question — is gold, land or a car a physical asset, a financial asset or a consumption asset — or the PQR calculation itself.

• A car is a consumption asset, not a physical investment. The workbook makes this the adviser's specific duty to explain, however long the car lasts.
• Gold is pure growth; real estate gives income and growth. The workbook separates the two on exactly this point.
• Physical assets are not liquid assets. Real estate is excluded from the liquidity ratio because it takes a long time to sell at fair value.
• Limited regulation is a drawback, not a feature. Financial assets are standardised and regulated, which is what makes them easy to compare.
• The financial assets ratio has financial assets in the numerator. PQR's 54% is the financial share; the physical share is the other 46%.
• A self-occupied house is still a physical asset on the balance sheet, even though the savings to income ratio excludes it from accumulated savings.