Appreciation (Finance)

Appreciation is an increase in the value of an asset over time. In investing it most often means a rise in the market price of a stock, bond, fund, property or other holding; in foreign exchange it means a rise in one currency's value against another. The opposite movement is depreciation. Appreciation matters because it is one of the two sources of investment return, the other being income such as dividends, rent or interest.

Appreciation is a change in value, not a cash payment. Until the asset is sold the gain is unrealized, and it can disappear if prices fall. Once the asset is sold for more than it cost, the appreciation becomes a realized capital gain, which many countries tax. Fund documents often name "capital appreciation" as an investment objective, as distinct from current income.

Picture a painting bought at a small gallery. Years later, the artist becomes well known and similar paintings sell for far more. The painting on your wall has not changed, but what someone would pay for it has. That rise is appreciation. You have not received any money yet; you would only collect it by selling.

The same idea applies to a house in a neighbourhood that becomes popular, a share in a company whose profits grow, or a currency that buys more foreign goods than before. Appreciation is simply "it is now worth more", and it lasts only as long as buyers keep valuing it that way.

• Growth in earnings or cash flows. A company whose profits rise is worth more to owners, which is the basis of growth investing and the appeal of a growth stock.
• Changes in interest rates. When interest rates fall, the value of existing bonds and of most long-lived assets tends to rise, because their future payments are discounted less heavily.
• Inflation. General inflation lifts the money price of real assets such as property and commodities, though part of that rise is not a gain in real purchasing power.
• Scarcity and demand. Land in a growing city, collectibles and limited-supply assets appreciate when demand outpaces supply.
• Market sentiment. Prices also move on expectations, and in a bull market appreciation can run ahead of fundamentals.

Appreciation over a period is usually expressed as a percentage of the starting value:

Here $V_0$ is the value at the start and $V_1$ the value at the end. A house bought for $300,000 and valued at $360,000 five years later has appreciated by $60{,}000 \div 300{,}000 = 20\%$ in total. Spread over five years with compounding, that is about 3.7% a year, the same calculation used for the compound annual growth rate (CAGR) and for an annualized return. Adding any income received turns the figure into total return, which is the fairer measure of how an investment performed.

A currency appreciates when its exchange rate rises, so each unit buys more of another currency. Under a floating exchange rate this happens through the market, driven by interest-rate differences, trade flows and capital movements; under a peg, the authorities can revalue the currency deliberately, the mirror image of a currency devaluation. A stronger currency makes imports cheaper and exports dearer, and it changes the value of foreign holdings for investors: a US investor who owns European shares gains from euro appreciation even if the share price in euros is unchanged.

Financial reporting handles appreciation differently by asset. Traded securities held at fair value are revalued through mark-to-market accounting, so appreciation shows up in reported results before any sale. For property, plant and equipment, IFRS (IAS 16) lets a company choose a revaluation model and record upward revaluations in equity, while US GAAP generally keeps such assets at historical cost and does not allow them to be written up. Falls in value are the mirror image; for banks they appear as unrealized losses on securities portfolios.

For tax, most systems tax appreciation only when it is realized. In the United States the gain on sale is a capital gain, taxed at lower rates if it qualifies as a long-term capital gain. Deferring a sale defers the tax, which is one reason long-held assets accumulate large untaxed gains.

Appreciation is not guaranteed and can reverse quickly, as the fall from a peak into a bear market shows. Nominal appreciation can mask a real loss when inflation is higher. Appraised values, such as for property or private holdings, may differ from what a buyer will actually pay, and illiquid assets can be hard to sell at their paper value. A rising net worth built on unrealized appreciation is therefore less certain than one built on cash.

• Investor.gov: Capital gain