Financial Instruments - Basic Defenitions and Descriptions

A financial instrument is anything that carries an implied or actual value and can be converted to cash. While cash is considered the most fundamental financial instrument, there are many other examples such as stocks, bonds, gold (or other precious metals), savings accounts, real estate, vehicles, and collectibles. Just about anything that can be sold for cash can be considered a financial instrument.

One important factor to bear in mind when assessing your financial instruments, and decisions on what to invest in is liquidity. Liquidity refers to the speed at which you can convert your financial investments into cash. Your savings account is a more liquid asset than your house is. Your house would take some time to sell and it would likely be a matter of months before you could turn your house into cash in your hand. The savings account is virtually the same as cash since you could venture to the bank and withdraw the money very quickly, therefore your savings account is considered to be a more liquid asset than your house.

Knowing what financial instruments are can help you in assessing your net worth, which is defined as the amount of assets you have, less the liabilities (debt). If you have a house worth $100,000 with a $75,000 mortgage, a checking account containing $500, and a savings account with $1,000, your net worth is $26,500 ($100,000 - $75,000 + $500 +$1,000 = $26,500).

Knowing what your net worth and financial instruments are is very important to help you when considering applying for a credit card and when purchasing a home, car, or other large item requiring a loan. Keeping a close account of your investments is also vital to help you asses your household budget, savings, and retirement planning needs.