(This post is a part of the series on Basics of Finance and Investing.)

Your education and bank balance - both are your assets, and more of the first can help you get more of the second. Which one of them helps the economy? Both, actually, but in very different ways.

In finance, an asset is classified as a real asset and a financial asset. Real assets are utilized to produce goods and services, and they represent the material wealth of the society. Examples are land, buildings, machines, and knowledge and skill of the workforce - the “physical” and “human” assets together determine the productive capacity of an economy.

By contrast, financial assets do not directly contribute to production, and so they are not part of the society’s wealth per se. For example, stocks, bonds, money in bank - they are merely pieces of paper, or more appropriately for today, binary digits stored on computer discs. Instead, a financial asset specifies the claim of its owner on income generated by real assets. Owning shares of a company stock entitles you to the earnings of the company in proportion to the value of your shares.

Financial assets indirectly contribute to the productive capacity of the economy, by funneling funds from stock owners to businesses (they use these funds to finance real assets for production purposes). Firms also borrow funds from banks, where you deposit your money. In both cases, you as an investor are entitled to a portion of the earnings of these businesses via dividends and interests.

Thus, real assets produce goods and services and contribute to the society’s wealth, whereas financial assets determine the allocation of income (generated by real assets) and contribute to the wealth of investors.

See related posts:

1. Banks, Investment companies and Investment banks
2. Players in an investing environment
3. "Real" and "nominal" interest rates
4. What determines the "real" interest rate?