In simple terms, appreciation means something gets more valuable as time goes on. This can happen because more people want it, there’s less of it available, or because inflation and interest rates change. Appreciation is the opposite of depreciation, which is when something loses value over time.
How Appreciation Works
Appreciation means when something like a stock, bond, money, or property becomes more valuable. For instance, if the value of stocks goes up, it’s called capital appreciation. This happens when companies do well financially.
But just because something becomes more valuable doesn’t mean the owner makes money from it right away. If the owner updates the value of their asset on their financial records to show the increase, that’s when they realize the gain.
Another kind of appreciation is currency appreciation. It’s when a country’s money becomes worth more compared to other countries’ money over time.
How to Calculate the Appreciation Rate
The appreciation rate is almost the same as the compound annual growth rate (CAGR). To calculate it, you take the ending value, divide it by the beginning value, and then raise that result to the power of one divided by the number of holding periods (like years). Finally, you subtract one from the result.
To calculate the appreciation rate, you need to know the initial value of the investment, the future value, and how long the asset will appreciate.
For instance, Rachel bought a home for $100,000 in 2016. By 2021, the value went up to $125,000. That means the home appreciated by 25% [($125,000 – $100,000) / $100,000] over those five years. The appreciation rate (or CAGR) is 4.6% [($125,000 / $100,000)^(1/5) – 1].
Appreciation vs. Depreciation
In accounting, appreciation means increasing the value of an asset recorded in a company’s books. Most adjustments for assets in accounting go down, which is called depreciation.
Some assets gain value, while others lose it over time. Usually, assets with a limited useful life lose value instead of gaining it.
Depreciation happens as the asset becomes less valuable with use, like a machine being used over time. Appreciation in accounting is less common but can occur for assets like trademarks when their brand recognition increases.
Real estate, stocks, and precious metals are bought with the hope they’ll be worth more in the future. On the other hand, cars, computers, and equipment lose value as they’re used over their useful lives.
Example of Capital Appreciation
An investor buys a stock for $10. Each year, the stock pays $1 as a dividend, which means the investor gets 10% of their money back each year. After a year, the stock price goes up to $15, and the investor also gets the $1 dividend.
So, the investor gains $5 because the stock price increased from $10 to $15. That’s a 50% increase in the stock price. The $1 dividend is a 10% return as expected. Together, the increase in stock price and the dividend give the investor a total of $6, which is a 60% return on their investment.
Example of Currency Appreciation
China became a big economic player in the world. This change affected the value of its money, called the yuan. From 1981 to 1996, the yuan became stronger compared to the dollar. This made it cheaper for American companies to manufacture goods in China because labor and production costs were low. Many American companies moved their operations to China because of this.
During this time, American products became more competitive globally because they were cheaper to make. But in 2005, the yuan started to get stronger compared to the dollar. It went up by 33%. Even today, in May 2021, the yuan is still pretty strong, trading at 6.4 yuan for 1 dollar.
FAQs
An appreciating asset is something that becomes more valuable over time. Like, when you buy it, it becomes worth more as time goes by. Some examples of appreciating assets are real estate (like houses or land), stocks (pieces of ownership in companies), bonds (which are like loans you give to companies or governments), and currency (money).
Appreciation rate means how fast something, like a thing you own, the value increases. It’s like saying how much more your stuff is worth over time.
Capital appreciation means when something you own becomes worth more money over time. This could be things like stocks, real estate, or other investments.