Real Assets versus Financial Assets

Real assets are auto plants, knowledge, and machine that are used to produce goods and services. Whereas financial assets are claims such as securities to the income generated by real assets.

We begin by examining the differences between financial assets and real assets. Then we proceed to the three broad sectors of the financial environment: households, businesses, and government.

The material wealth of a society is determined ultimately by the productive capacity of its economy - the goods and services that can be provided to its members. This productive capacity is a function of the real assets of the economy: the land, buildings, knowledge, and machines that are used to produce goods and the workers whose skills are necessary to use those resources. Together, physical and "human" assets generate the entire spectrum of output produced and consumed by the society.

In contrast to such real assets are financial assets such as stocks or bonds. These assets, per se, do not represent a society's wealth. Shares of stock are no more than sheets of paper; they do not directly contribute to the productive capacity of the economy. Instead, financial assets contribute to the productive capacity of the economy indirectly, because they allow for separation of the ownership and management of the firm and facilitate the transfer of funds to enterprises with attractive investment opportunities. Financial assets certainly contribute to the wealth of the individuals or firms holding them. This is because financial assets are claims to the income generated by real assets or claims on income from the government.

Real assets are income-generating assets, whereas financial assets define the allocation of income or wealth among investors.

An operational distinction between real and financial assets involves the balance sheets of individuals and firms in the economy. Real assets appear only on the asset side of the balance sheet. In contrast, financial assets always appear on both sides of balance sheets. Your financial claim on a firm is an asset, but the firm's issuance of that claim is the firm's liability. When we aggregate over all balance sheets, financial assets will cancel out, leaving only the sum of real assets as the net wealth of the aggregate economy.

Another way of distinguishing between financial and real assets is to note that financial assets are created and destroyed in the ordinary course of doing business. For example, when a loan is paid off, both the creditor's claim (a financial asset) and the debtor's obligation (a financial liability) cease to exist. In contrast, real assets are destroyed only be accident or by wearing out over time.