What Is an Asset?

An asset is a resource with economic value that an individual, corporation, or country owns or controls with the expectation that it will provide a future benefit.

Assets are reported on a company’s balance sheet. They’re classified as current, fixed, financial, and intangible. They are bought or created to increase a firm’s value or benefit the firm’s operations.

An asset can be thought of as something that, in the future, can generate cash flow, reduce expenses, or improve sales, regardless of whether it’s manufacturing equipment or a patent. 

Understanding Assets

An asset represents an economic resource owned or controlled by, for example, a company. An economic resource is something that may be scarce and has the ability to produce economic benefit by generating cash inflows or decreasing cash outflows.

An asset can also represent access that other individuals or firms do not have. Furthermore, a right or other type of access can be legally enforceable, which means economic resources can be used at a company’s discretion. Their use can be precluded or limited by an owner.

For something to be considered an asset, a company must possess a right to it as of the date of the company’s financial statements.

Assets can be broadly categorized into current (or short-term) assets, fixed assets, financial investments, and intangible assets.

Types of Assets

Current Assets

In accounting, some assets are referred to as current. Current assets are short-term economic resources that are expected to be converted into cash or consumed within one year. Current assets include cash and cash equivalents, accounts receivable, inventory, and various prepaid expenses.

While cash is easy to value, accountants periodically reassess the recoverability of inventory and accounts receivable. If there is evidence that a receivable might be uncollectible, it’ll be classified as impaired. Or if inventory becomes obsolete, companies may write off these assets.

Fixed Assets

Fixed assets are resources with an expected life of greater than a year, such as plants, equipment, and buildings. An accounting adjustment called depreciation is made for fixed assets as they age. It allocates the cost of the asset over time. Depreciation may or may not reflect the fixed asset’s loss of earning power.

Generally accepted accounting principles (GAAP) allow depreciation under several methods. The straight-line method assumes that a fixed asset loses its value in proportion to its useful life, while the accelerated method assumes that the asset loses its value faster in its first years of use.

Financial Assets

Financial assets represent investments in the assets and securities of other institutions. Financial assets include stocks, sovereign and corporate bonds, preferred equity, and other, hybrid securities. Financial assets are valued according to the underlying security and market supply and demand.

Intangible Assets

Intangible assets are economic resources that have no physical presence. They include patents, trademarks, copyrights, and goodwill. Accounting for intangible assets differs depending on the type of asset. They can be either amortized or tested for impairment each year.

What Is Asset Allocation?

Asset allocation is an investment strategy that aims to balance risk and reward by apportioning a portfolio’s assets according to an individual’s goals, risk tolerance, and investment horizon. The three main asset classes—equities, fixed-income, and cash and equivalents—have different levels of risk and return, so each will behave differently over time.

Why Asset Allocation Is Important

There is no simple formula that can find the right asset allocation for every individual. However, the consensus among most financial professionals is that asset allocation is one of the most important decisions that investors make. In other words, the selection of individual securities is secondary to the way that assets are allocated in stocks, bonds, and cash and equivalents, which will be the principal determinants of your investment results.

Investors may use different asset allocations for different objectives. Someone who is saving for a new car in the next year, for example, might invest their car savings fund in a very conservative mix of cash, certificates of deposit (CDs), and short-term bonds. An individual who is saving for retirement that may be decades away typically invests the majority of their individual retirement account (IRA) in stocks, since they have a lot of time to ride out the market’s short-term fluctuations. Risk tolerance plays a key factor as well. Someone who is uncomfortable investing in stocks may put their money in a more conservative allocation despite a long-term investment horizon.

Age-Based Asset Allocation

In general, stocks are recommended for holding periods of five years or longer. Cash and money market accounts are appropriate for objectives less than a year away. Bonds fall somewhere in between. In the past, financial advisors have recommended subtracting an investor’s age from 100 to determine what percentage should be invested in stocks. For example, a 40-year-old would be 60% invested in stocks. Variations of the rule recommend subtracting age from 110 or 120, given that the average life expectancy continues to grow. As individuals approach retirement age, portfolios should generally move to a more conservative asset allocation to help protect assets.

Achieving Asset Allocation Through Life-Cycle Funds

Asset-allocation mutual funds, also known as life-cycle, or target-date, funds, are an attempt to provide investors with portfolio structures that address an investor’s age, risk appetite, and investment objectives with an appropriate apportionment of asset classes. However, critics of this approach point out that arriving at a standardized solution for allocating portfolio assets is problematic because individual investors require individual solutions.

The Vanguard Target Retirement 2030 Fund would be an example of a target-date fund. These funds gradually reduce the risk in their portfolios as they near the target date, cutting riskier stocks and adding safer bonds in order to preserve the nest egg. The Vanguard 2030 fund, set up for people expecting to retire between 2028 and 2032, had a 65% stock/35% bond allocation as of Jan. 31, 2022. As 2030 approaches, the fund will gradually shift to a more conservative mix, reflecting the individual’s need for more capital preservation and less risk.

Bottom Line

Most financial professionals will tell you that asset allocation is one of the most important decisions that investors make. In other words, the selection of individual securities is secondary to the way that assets are allocated in stocks, bonds, and cash and equivalents, which will be the principal determinants of your investment results.

What Is an Automatic Stabilizer?

Automatic stabilizers are a type of fiscal policy designed to offset fluctuations in a nation’s economic activity through their normal operation without additional, timely authorization by the government or policymakers.

The best-known automatic stabilizers are progressively graduated corporate and personal income taxes, and transfer systems such as unemployment insurance and welfare. Automatic stabilizers are called this because they act to stabilize economic cycles and are automatically triggered without additional government action.

Understanding Automatic Stabilizers

Automatic stabilizers are primarily designed to counter negative economic shocks or recessions, though they can also be intended to “cool off” an expanding economy or to combat inflation. By their normal operation, these policies take more money out of the economy as taxes during periods of rapid growth and higher incomes. They put more money back into the economy in the form of government spending or tax refunds when economic activity slows or incomes fall. This has the intended purpose of cushioning the economy from changes in the business cycle. 

Automatic stabilizers can include the use of a progressive taxation structure under which the share of income that is taken in taxes is higher when incomes are high. The amount then falls when incomes fall due to a recession, job losses, or failing investments. For example, as an individual taxpayer earns higher wages, their additional income may be subjected to higher tax rates based on the current tiered structure. If wages fall, the individual will remain in the lower tax tiers as dictated by their earned income.

Similarly, unemployment insurance transfer payments decline when the economy is in an expansionary phase since there are fewer unemployed people filing claims. Unemployment payments rise when the economy is mired in recession and unemployment is high. When a person becomes unemployed in a manner that makes them eligible for unemployment insurance, they need only file to claim the benefit. The amount of benefit offered is governed by various state and national regulations and standards, requiring no intervention by larger government entities beyond application processing.

Automatic Stabilizers and Fiscal Policy

When an economy is in a recession, automatic stabilizers may by design result in higher budget deficits. This aspect of fiscal policy is a tool of Keynesian economics that uses government spending and taxes to support aggregate demand in the economy during economic downturns.

By taking less money out of private businesses and households in taxes and giving them more in the form of payments and tax refunds, fiscal policy is supposed to encourage them to increase, or at least not decrease, their consumption and investment spending. In this case, the goal of fiscal policy is to help prevent an economic setback from deepening.

Real-World Examples of Automatic Stabilizers

Automatic stabilizers can also be used in conjunction with other forms of fiscal policy that may require specific legislative authorization. Examples of this include one-time tax cuts or refunds, government investment spending, or direct government subsidy payments to businesses or households.

Some examples of these in the United States were the 2008 one-time tax rebates under the Economic Stimulus Act and the $831 billion in federal direct subsidies, tax breaks, and infrastructure spending under the 2009 American Reinvestment and Recovery Act.

In 2020, the Coronavirus Aid, Relief, and Economic Security (CARES) Act became the largest stimulus package in U.S. history. It provided over $2 trillion in government relief in the form of expanded unemployment benefits, direct payments to families and adults, loans and grants to small businesses, loans to corporate America, and billions of dollars to state and local governments.

Special Considerations

Since they almost immediately respond to changes in income and unemployment, automatic stabilizers are intended to be the first line of defense to turn mild negative economic trends around. However, governments often turn to other types of larger fiscal policy programs to address more severe or lasting recessions or to target specific regions, industries, or politically favored groups in society for extra-economic relief.  

What Is an Autoregressive Model?

A statistical model is autoregressive if it predicts future values based on past values. For example, an autoregressive model might seek to predict a stock’s future prices based on its past performance.

Understanding Autoregressive Models

Autoregressive models operate under the premise that past values have an effect on current values, which makes the statistical technique popular for analyzing nature, economics, and other processes that vary over time. Multiple regression models forecast a variable using a linear combination of predictors, whereas autoregressive models use a combination of past values of the variable.

An AR(1) autoregressive process is one in which the current value is based on the immediately preceding value, while an AR(2) process is one in which the current value is based on the previous two values. An AR(0) process is used for white noise and has no dependence between the terms. In addition to these variations, there are also many different ways to calculate the coefficients used in these calculations, such as the least squares method.

These concepts and techniques are used by technical analysts to forecast security prices. However, since autoregressive models base their predictions only on past information, they implicitly assume that the fundamental forces that influenced the past prices will not change over time. This can lead to surprising and inaccurate predictions if the underlying forces in question are in fact changing, such as if an industry is undergoing rapid and unprecedented technological transformation.

Nevertheless, traders continue to refine the use of autoregressive models for forecasting purposes. A great example is the Autoregressive Integrated Moving Average (ARIMA), a sophisticated autoregressive model that can take into account trends, cycles, seasonality, errors, and other non-static types of data when making forecasts.

Example of an Autoregressive Model

Autoregressive models are based on the assumption that past values have an effect on current values. For example, an investor using an autoregressive model to forecast stock prices would need to assume that new buyers and sellers of that stock are influenced by recent market transactions when deciding how much to offer or accept for the security.

Although this assumption will hold under most circumstances, this is not always the case. For example, in the years prior to the 2008 Financial Crisis, most investors were not aware of the risks posed by the large portfolios of mortgage-backed securities held by many financial firms. During those times, an investor using an autoregressive model to predict the performance of U.S. financial stocks would have had good reason to predict an ongoing trend of stable or rising stock prices in that sector. 

However, once it became public knowledge that many financial institutions were at risk of imminent collapse, investors suddenly became less concerned with these stocks’ recent prices and far more concerned with their underlying risk exposure. Therefore, the market rapidly revalued financial stocks to a much lower level, a move which would have utterly confounded an autoregressive model.

It is important to note that, in an autoregressive model, a one-time shock will affect the values of the calculated variables infinitely into the future. Therefore, the legacy of the financial crisis lives on in today’s autoregressive models.

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