Are you investing? Take a minute to ponder

It is important to understand the distinction between investment and consumption assets when it comes to taking financial decisions

Like many individuals, you may be living in your own mortgage-free house. Do you consider your self-occupied house as an investment? In this article, we discuss what defines an investment and why many consider consumption assets as investments.

Investment versus wealth

Your self-occupied house is not an investment but can be considered as part of your wealth. So is the case with your priceless gold jewellery. We will call these consumption assets — assets that last for a long time and provide emotional satisfaction.

So, what is the difference between investment and wealth? The objective of an investment is to derive a monetary benefit from the transaction. Investments typically carry two sources of returns viz. capital appreciation and income return. If you buy a real estate, you can earn rental income (income return) and later sell the property for a higher price (capital appreciation). You can apply the same argument for your equity investments (dividend income and capital appreciation) and bonds (interest income and capital appreciation). Wealth, on the other hand, includes all your assets (consumption and investment assets).

Why is it important to distinguish between investment and wealth? Your decision to buy an asset is based on your intent — are you buying the asset to generate monetary returns or for emotional satisfaction? If your objective is to accumulate wealth to achieve a life goal, then you should consider investing for monetary gains.

In such cases, allocating more money to assets that provide emotional satisfaction can reduce your chances of achieving your goals.

Passion assets

There are some assets where your intent can change from emotional satisfaction to investment returns. Example of such assets are art and paintings, rare artefacts and antiques. Such assets are collectively called as passion assets. Your intent while acquiring these assets could be for emotional satisfaction. Your excitement of owning these assets could diminish with time but their value could increase as they age and become rare.

That is when your intent could change from deriving emotional satisfaction to selling them for monetary gains.

Note that luxury products may not qualify as passion assets because such products typically lose value with age.

You should consider ‘investing’ in passion assets, if you are confident that you are buying an original asset (and not a reproduction) for a good price. Even though you are unlikely to part with these assets immediately, they could form part of your investment portfolio if your intention is to eventually sell them. Note that passion assets can offer only capital appreciation and not income returns. This is important because any asset that offers a single source of return can be riskier than the ones that offer both sources of return.

Conclusion

There is a behavioural reason why we blur the distinction between investment and wealth. We expose ourselves to pain and regret whenever we take a decision. The pain comes from parting with money when we buy an asset. The regret comes when the asset falls short of providing the satisfaction (or utility) we hope to get from owning it. For instance, when we buy a high-value consumption asset, we do not think in terms of the amount spent, but of the ‘investment’ we are making. This is a simple way to cheat our brain into reducing the pain when we part with our money to pay for the asset. Thinking of the asset in terms of ‘investment’ helps us spread the benefit over a period.

This helps us moderate regret if the asset does not offer instant gratification.

You need both assets. Investment assets can help you achieve your life goals. Consumption assets can provide emotional satisfaction. But it is important that you do not treat your consumption assets as investment assets; for, consumption assets can be best used as collateral to raise emergency cash, not to help you achieve your goals.

(The writer offers training programmes for individuals to manage their personal investments)

Source: Read Full Article