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Appreciation

The increase in an asset's value over time. The increase may be brought on by a variety of factors, such as a rise in demand, a decline in supply, increases in inflation or interest rates, or all of the above. Depreciation, which is a decline in value over time, is the opposite of appreciation.


The Mechanisms of Appreciation

The term "appreciation" can be used to describe the rise in value of any item, whether it be a stock, bond, currency, or piece of real estate. Capital appreciation, for instance, is the rise in the value of a financial asset like a stock due to factors like the company's improved financial performance.

Having an asset appreciate in value is no guarantee that the owner will benefit monetarily from that rise. Realization of the rise occurs when the owner reports the asset's new, higher value on their financial statements.

Appreciation of a currency is another form of appreciation. Over time, the value of one currency relative to another might increase or decrease.



Methods for Estimating Growth

The rate of appreciation is quite similar to the compound annual growth rate (CAGR). In this case, you'd take the final value, divide it by the initial value, then multiply the resulting value (by 1 for each holding period) to get the dividend (e.g. years). The last step is to take away one from the total.

The rate of appreciation can be determined, however, by knowing both the purchase price and the expected return. It's also important to have an idea of the asset's appreciation rate and time horizon.

For example Mr and Mrs Smith spent $200,000 to purchase a house. Five years later, the price value of their house is $300,000, up  $100,000 over the initial price. [($300,000 / $200,000)(1/5) - 1] is the compound annual growth rate (CAGR) of 8.4%.


Value Growth vs. Value Decline

The term "appreciation" can also be used in the context of accounting to mean an increase in the book value of an asset. In accounting, depreciation refers to the practice of writing down the value of an item over time.

There are some assets that appreciate with time, whereas others often degrade. Finite-life assets typically deteriorate rather than appreciate.

When an item, like a piece of machinery, is used up over its useful life, its value decreases economically, and this is where depreciation comes in. Value increases for some assets, such trademarks, due to greater brand awareness are more common than for other types of assets in the accounting system.

Assets such as real estate, equities, and precious metals are bought with the hope that they will increase in value over time. Vehicles, computers, and other pieces of hardware, on the other hand, depreciate over time as their useful lives come to an end.


The Appreciation of Capital: A Example

If a share of stock costs $20 and pays a dividend of $1 each year, the dividend yield is 5%. A year later, after the owner has received the $1 dividend, the stock is selling for $25.

Since the stock's market value has increased by $5 from the investor's original investment of $20 (the cost basis), the investor obtains a return of $5 through capital appreciation. 

The return on investment due to capital appreciation was 25% as a result of the rise in stock price. There will be a return of $1 in dividend income, or 5% of the initial dividend yield. When dividends are added to the capital gains, the total return on the stock is $6, or 30%.


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