Picture your most prized material possessions. Some of them may help you build wealth over time as they become more valuable, like real estate or stock investments.
Others, like your smartphone or a car, might lose value or even need to be replaced after a while. This change in value is what sets appreciating and depreciating assets apart.
How can you tell the difference between the two types, and why are they important to know? Learn more below.
Identifying appreciating vs. depreciating assets
Simply put, an appreciating asset has the following qualities:
- Grows in value over time mainly due to an increase in demand, a limited supply, or both.
- Includes items like stocks, bonds, investment funds, real estate, precious metals, collectibles, and more.
- May generate passive income like rental income, dividends from stocks, and interest from bonds.
Investments aren’t always guaranteed to rise in value or provide regular income. For example, stocks can go up and down in price due to different market-moving factors.
That’s why you should understand the risks before investing in anything. It’s also ideal to assess the performance of your investments periodically to know if they’re still performing well.
Meanwhile, here are the characteristics of a depreciating asset:
- Drops in value over time as it become less useful due to age and wear and tear.
- May become obsolete as newer technologies pop up, or as consumer or market trends change.
- Includes items like vehicles, electronics, furniture, and clothing.
- May require maintenance, repairs or upgrades that can add to its overall cost.
While it’s ideal to avoid spending too much on things that lose value quickly, depreciating assets aren’t always bad for your money. Some of these items can make life easier, bring joy, and help with your productivity and earning capacity.
Why it’s important to know the difference
Understanding how an asset might grow or drop in value can help you make better financial decisions. Here’s why:
1. You can make wiser investing choices
Some people justify purchases as “investments” when they are in fact losing money because of depreciation.
If you don’t realize something is a depreciating asset, you might overestimate its value over time.
For example, buying a luxury item might leave you disappointed if you expected to resell it at a high price but end up letting go of it at a huge loss.
If you seek long-term growth, you may want to consider assets whose growth potential is backed by a solid reason, like a company with strong earnings or a real estate property in a good location.
2. You’ll avoid unnecessary spending
It’s best to avoid spending a lot on something that can end up costing you more than the value it brings. You can practice mindful spending when you know the true cost and worth of the things you want to buy.
To tell if it’s ok to splurge on something, you can factor in how much and how quickly it might deteriorate in value and usefulness.
Understanding depreciation can also keep you from overspending and getting into bad debt. There’s a lower chance you’ll borrow money for an item only to owe a lot more than what it’s worth or make payments even when it’s no longer useful.
