Understanding Depreciating Assets

A key to health and happiness is having a balanced and comprehensive understanding of personal finance. This post by Jeffrey Strain discusses the concept of depreciating assets.
***
Not all assets are created equally. When you purchase something, it's usually an appreciating asset or a depreciating asset. During your financial life, you want to purchase as many appreciating assets as possible as these are purchases which will gain in value over time. On the other hand, you also want to purchase depreciating assets only when it's necessary since these items will lose value over time. Understanding the difference between appreciating assets and depreciating assets is important to improve your overall finances.

The purchase of a home is considered an appreciating asset. While it's certainly true that the value of homes can fall over short periods of time, the general assumption is that a home will increase in value over long periods. Since a home will general increase in value over time, it often makes sense to purchase one as you can actually make money by purchasing and holding onto it. On the other hand, there are a lot of purchases that we want to make, but they are depreciating assets. Timeshares, boats and recreational vehicles are all good examples of depreciating assets. These are usually "wants" and not "needs" of the person buying them, but they lose a huge portion of their value the instant that they are purchased. Boats and recreational vehicles can lose 20% or more the instant that they are purchased. Timeshares are so bad that you can lose 90% or more. Except in very rare occasions, you are going to lose a lot of money on these purchases if you ever decide to sell them at a later date.



It would be easy to make financial decisions if it were possible to only purchase appreciating assets and avoid buying depreciating assets. The problem is that there are many purchases that we need to make in our life that are depreciating assets. A perfect example of this is your car.

The moment that you purchase a new car from a car dealership and you drive it off the car lot, it depreciates by 10% or more. Even though we know that a car is a depreciating asset, most people will need to buy a car sometime during their lifetime, and usually several. So how do you keep your finances in order when you know that you will need to purchase depreciating assets during your lifetime?

To get the most out of a depreciating asset, you need to focus on what is needed rather than what you may want. When you go to purchase a car, there are a huge range of models and prices. You can spend a little or a lot depending on what you decide to buy. Learning to purchase only what you really need when buying a depreciating asset rather than what you might want will help you not waste money on these depreciating assets. In the example of the car, getting a good quality car with all the basics makes sense while avoiding all the fancy extras that may look good, but don't make the car function any better. In fact, it probably makes financial sense to consider buying a used car in good condition which is several years old. Doing this will mean that much of the initial depreciation (which is the largest portion) of the car has already been priced out.

Another good way to look at the difference between needs and wants when purchasing a depreciating asset is to consider what you would buy if the depreciating asset were an investment. For example, think of a car purchase as if you were buying gold to invest it. If you wanted to invest in gold, would you purchase gold bullion or jewelry? Most people would say gold bullion because you would end up paying a lot more than the value of the gold if you purchased jewelry. When you purchase a car with a lot of extras that aren't needed to make it run, you are basically doing the same as purchasing jewelry. It may look flashier and turn people's eyes around you, but it does so at the expense of your investment.

It's important to remember to first ask yourself "do I really need this?" when considering making any large depreciating asset purchase. If you determine that you do need to make the purchase, think of it as an investment and opt for purchasing what fulfils your needs rather than your wants at the best possible value. When you understand that depreciating assets will also hurt your finances to some degree, you can learn to avoid them when possible while making financially solid purchases when you do need them. When you do this, you have put yourself in a position where depreciating assets will have the least effect on your finances as possible.
 ***
Jeffrey Strain is a personal finance writer and digital nomad. His main website is Saving Advice.

2 comments:

  1. Very enlightening read. Somehow we are always more attracted to 'wants' rather than 'needs' and that can really hurt in the long run, both financially and otherwise. Many thanks for sharing the article.

    ReplyDelete
  2. Very useful perspective that we dont often think about. In addition to the depreciating asset most purchases are made using credit card which also adds increasing interest component with the passing of time to the price of the asset itself. Thanks for posting.

    ReplyDelete

Dialog is the path to peace, and this blog is all about dialog, peace and love. Go ahead and join in.

Related Posts Plugin for WordPress, Blogger...