What is appreciation?
Investors buy different types of assets with the expectation that their value will increase over time. Appreciation shows that the price of a specific asset has grown during a particular time period. Depending on the industry, there could be capital appreciation, currency appreciation or real estate appreciation.
Capital appreciation is used when the value of financial investments has increased.
Currency appreciation takes into account the increase in the exchange rate of one currency in relation to another currency. Currency appreciation can occur under a floating exchange rate regime.
Real estate appreciation occurs when a home’s value or the value of other types of real estate has increased.
Reasons for the appreciation of asset value
Different types of assets can appreciate over time for different reasons. Appreciation can occur when there is an increase in the demand for an asset. Higher demand puts upward pressure on the asset’s price, meaning the value of the asset appreciates. Limited supply could also cause an appreciation of asset value. If there is high interest for a specific asset, but the supply is limited, this will put upward pressure on the asset’s price and its value will appreciate. Changes in interest rates could also be a reason for the appreciation of an asset. For instance, when market interest rates decrease, the price of bonds on the secondary market increases. This is because the new bonds issued in time of lower interest rates will offer a lower yield for investors.
Appreciation vs. depreciation
While appreciation is the increase in assets value, depreciation refers to the reverse movement. In accounting, depreciation considers the decrease in asset value due to the utilization of the assets in day to day activities. Depreciation can also occur in the value of financial instruments, real estate, and currencies.
Appreciation vs. capital gain
Both appreciation and capital gains are related to an increase in the value of an asset. But the difference is that although a stock can appreciate, it will not provide capital gain until it is sold. It could be said that appreciation is unrealized capital gain. After the sale of an asset, the appreciated value is recorded as a realized capital gain. Let’s say that a stock is bought for $16. After a couple of months, the stock price has appreciated, and it is worth $19. It can be noted that the portfolio has a higher value because the price has appreciated by $3. If the owners decide to sell the stock, then they will realize a capital gain of $3. However, if the owners decide to hold the stock, then the appreciated value is referred to as a “paper profit” of $3.