Investment returns come in three flavours: 1 Lump Sum
The simplest form of return is a single lump sum that you receive at some time in the future. For example, if you buy a real asset such as a painting or a bar of gold and you sell it in a few years’ time, you will receive cash in return – hopefully more than you paid for it.
Assets and markets
Some financial assets give you the right to receive a lump sum of cash at some time in the future. They are said to be redeemable, and whoever holds them at maturity (the redemption date) receives the cash on that date. You don’t have to rely on selling them to someone else unless you want to sell them before they are redeemed. But just as you can buy and sell real assets you can also buy and sell many types of financial assets. Financial assets are often referred to as securities, and are traded through securities’ markets such as the Stock Market. By selling a financial asset through a market you receive a lump sum of cash in return. However, just as the price you get for a real asset depends on how much the buyer is willing to pay, so the price you get in the market for a financial security depends on how much the buyer (usually an intermediary called a market-maker) thinks it is worth.
Market-makers frequently change prices to try to balance buyers and sellers as expectations alter regarding the asset concerned or the economy in general. The often rapid and quite large changes we see in share prices may seem crazy, but the markets make it possible for us to buy or sell many types of financial asset whenever we want, within reason. That is not always possible in the case of real assets. Property is not always easy to sell and the costs of selling can be quite high. And because real assets often have a desirability beyond their investment value, the buying and selling decisions and the prices at which they change hands may be subject to fashion and emotion.
In general, financial assets are said to be liquid, which simply means that you can convert them into cash at short notice, whilst real assets are relatively illiquid, which means that they are more difficult and often more expensive to convert into cash. Not all financial assets are liquid. Shares in private companies may be very difficult to sell and even if you can find a buyer, they will be hard to value. Shares that are traded on alternative or over-the counter markets are usually much less liquid than the shares and bonds that are traded through the London Stock Exchange. The advantage of most financial assets is their liquidity. However, liquidity means that you can put a price on them at any time (several times a day if you like) and suffer from seeing the value of your investments go up and down like a yo yo.
Financial assets that are redeemable can be held to redemption and then exchanged for a known amount of cash. The markets don’t play any part in that. But if you want cash before the redemption date, or if you have financial assets that are not redeemable (ordinary shares of publicly quoted companies for example), then you have to sell through the appropriate market.
|9 October, 2008 © 2008 K.R.Wade and Co Ltd|