In finance, relative value has to do with the desirability or attractiveness of one asset in comparison to another asset. Determining the relative value often requires considering such aspects as the ease of converting each asset into cash if necessary, the potential for appreciation in the value of the assets, and the degree of risk that is assumed by choosing to purchase and hold the asset. In some cases, this outcome of this comparison may also be influenced by factors such as sentimental value.
The idea behind assessing the relative value of two or more assets is to determine which one offers the most benefit to the investor for whatever time frame the investor intends to hold onto the asset. Here, the personal goals of the investor will often play a significant role in the comparison process. Should the reason for acquiring the asset be to fund a short-term project, it is very possible that going with an asset that is expected to experience an unusually high upswing in value over the next few months may be the better option than one that is anticipated to earn decent but less spectacular returns over a longer period of time. In like manner, if the goal is to secure an asset that will earn a consistent return over a number of years, avoiding the purchase of assets that are expected to peak soon and then drop significantly would not be a good idea.
Another factor that is often important to the process of assessing relative value is how quickly an asset can be converted into cash should an emergency arise. Stock options that are holding their value over the long-term can often be sold with very little effort. In contrast, real estate holdings may or may not sell quickly, depending on current demand in the local market. If the idea is to secure an asset that serves as backup funding for emergencies, a stable stock option would likely be the better approach in this scenario.
Understanding the degree of risk associated with a given asset is also very important to determining the relative value of two or more investment options. While the returns may be high with one investment, the volatility associated with the option may be outside the comfort zone of the investor. When that is the case, the investor would do well to go with an option that exhibits a level of volatility that is considered acceptable, given the potential return. While the earnings from the venture will be less spectacular, the relative peace of mind enjoyed by the investor, along with the greater assurance of adding to the worth of the portfolio, may be enough to sway the results of the relative value comparison in favor of the more stable stock option.
