Understanding Depreciating vs. Appreciating Assets
Knowing the difference between depreciating assets, appreciating assets and liabilities can help you better manage your finances.
Contributing Writer at Tally
March 31, 2022
This article is provided for informational purposes only and should not be construed as legal or investment advice. Always consult with a professional financial or investment advisor before making investment decisions.
If you're looking for ways to measure your financial health, one way to do so is by evaluating your personal assets and liabilities. However, to analyze your assets, you first should have an understanding of depreciating vs. appreciating assets. Knowing the difference between the two can help you with budgeting, saving money and retirement planning.
We'll outline everything you need to know about assets and liabilities. Specifically, we'll cover what depreciating assets, appreciating assets and liabilities are. We'll then jump into why they are important and how they can impact your net worth.
What are depreciating assets?
A depreciating asset is an asset that loses value over time. Essentially, this means that when you sell it, you will not receive as much for it as you originally paid. One of the most common examples is a new car. A new car loses value as soon as you drive it off the lot. In fact, it loses 20% of its value within the first month and 40% of its value within the first five years of ownership.
Other examples of depreciating assets include:
Electronics, including TVs, computers and smartphones
Hunting and sporting equipment
Owning depreciating assets is better than having outstanding liabilities. However, as we'll outline below, depreciating assets are likely not as advantageous as appreciating assets.
What are appreciating assets?
An appreciating asset is something that you own that gains value over time. This means that when you go to sell them, they are worth more than what you purchased them for.
An example is the money that you keep in a high-yield savings account. By keeping the money in the account, asset appreciation occurs. You earn money each month in interest without having to do anything. As time goes on, the money in the account appreciates more and more because of interest.
Below is a list of appreciating assets that you may have in your personal portfolio:
Certificates of deposit
Stocks, mutual funds and exchange-traded funds
Rental properties and other real estate assets, including real estate investment trusts (REITs)
Art, classic cars and other collectibles
There are a few things worth noting when it comes to appreciating assets. First and foremost, you often can't recognize its value until you sell the asset. Let's use real estate as an example. Say you bought a home for $300,000 using a mortgage. Over the life of the 30-year loan, your house doubles in value to $600,000. The asset has appreciated but you don’t have any of this extra money in hand.
The $600,000 value is an estimate, perhaps conducted by an appraiser. If you were to sell your house, a buyer may pay more or less for it. Additionally, factors outside of your control, like a natural disaster or a downturn in the housing market, could impact the value of your home. So until you sell, you can't recognize an asset's true value.
This brings us to our second point, which is that appreciating assets may not always remain in this asset class. Do you remember Beanie Babies? These were collectible items from the '90s that were anticipated to be worth thousands of dollars in the future — until the bubble burst.
A more modern example could be bitcoin and other cryptocurrency. It remains to be seen whether these digital assets will appreciate or depreciate in the long run. Investors should do their homework and consider diversifying with other asset classes as a way to protect themselves from the current uncertainties that crypto faces.
Furthermore, the economy tends to influence appreciation heavily. For instance, the personal housing market (think single-family homes, not office buildings) tends to increase in line with inflation. The asset's value over time, and subsequent price increases, are tied heavily to the inflation rate.
In addition, the stock market, mutual funds, exchange-traded funds (ETFs) and other assets in your investment portfolio may see drastic short-term changes in market value based on the state of the economy.
In summary, appreciating assets are the best type of assets to own. However, you need to be careful before investing in them. Work with a financial advisor to come up with a long-term investment strategy that meets your goals. Be mindful of the period of time it will take for the asset to gain value and the degree to which you are certain it will do so.
What are liabilities?
A liability is money that you owe. Examples of liabilities include:
Between depreciating assets, appreciating assets and liabilities, liabilities are the ones you least want to have. A liability is a debt obligation that you're required to pay, unless you'd like to face penalties and fees. You're also charged interest, which is essentially the cost of borrowing money. Typically, the more liabilities you have, the further you are from financial freedom.
Why is it important to understand assets and liabilities?
Knowing the difference between assets and liabilities is important for a few reasons:
You can determine your net worth: Your net worth is a measure of how much you are worth financially. It takes the value of what you own and subtracts what you owe.
You can properly budget: Knowing whether you are making money from your assets (appreciating assets) or owe money to lenders (liabilities) allows you to set an accurate budget. This in turn may allow you to stay out of further debt and reach your financial goals.
You can craft your long-term goals and plan for retirement: A general rule of thumb is that appreciating assets can put you on a better path for retirement, as they are gaining value. Understanding assets and liabilities can help you craft a long-term financial plan.
As mentioned, assets and liabilities ultimately impact your net worth. Let's take a closer look at why that's the case.
How do assets and liabilities impact your net worth?
When you have more assets than liabilities, you have a positive net worth. If you have more liabilities than assets, then you have a negative net worth. The first step in reaching financial freedom is having a positive net worth. With a positive net worth, you're less likely to have to take on debt. This in turn will prevent you from having to pay interest. The money saved on interest can go back into your savings or investments.
Much like how debt can snowball and become more difficult to pay, the same is true of a positive net worth. Meaning, once your net worth becomes positive, you will start to gain momentum.
When it comes to calculating net worth, there are two main figures that you can consider:
Your liquid net worth takes into consideration liabilities and liquid assets, which are those that can be converted to cash easily. Your total net worth accounts for all of your assets, including things like your home and car that you may not be able to convert into cash easily.
Your net worth will go up if your assets increase or if your liabilities decrease. Let’s use your home as an example.
As mentioned, your home is an asset, and your mortgage is a liability. The amount that you have paid toward the principal on your mortgage is known as equity. As your equity increases, so too does your net worth. This means as you pay down your mortgage, your net worth will go up. Your equity and net worth will also increase if your home is an appreciating asset (i.e., its value increases).
Understanding your assets can help you manage your finances
Managing your personal finances is not easy. Having an understanding of the different types of assets, along with liabilities, can help you become financially healthier. Accumulating assets – especially appreciating assets, which gain value over time – increases your chances of having a positive net worth.
One of the other steps you can take to improve your net worth is to reduce your liabilities. While you may not be able to pay off your car or home immediately, you can focus on other liabilities like your outstanding credit card debt. Credit cards often come with high interest rates that compound, making it difficult to pay off your balances and debt.
If you're looking for ways to pay off your credit card debt, consider using Tally†. Tally is a credit card payoff app that might help you pay down credit card debt quickly and efficiently with a lower-interest line of credit.
†To get the benefits of a Tally line of credit, you must qualify for and accept a Tally line of credit. The APR (which is the same as your interest rate) will be between 7.90% and 29.99% per year and will be based on your credit history. The APR will vary with the market based on the Prime Rate. Annual fees range from $0 - $300.