I promise to not use much technical jargon on this blog. But there are a couple terms that are useful. Today those terms are “asset” and “liability”. In this post, I talked about how you use your assets and liabilities to determine your net worth.
However, I want to slightly change the definition of an asset and a liability.
An Asset is anything that puts money in your pocket.
A Liability is anything that takes money out of your pocket.
When I understood this new definition of assets and liabilities, my view on wealth completely changed.
The goal to build wealth is to gain assets and minimze liabilites.
It’s really that simple! Find and acquire things that gain you money, and minimize any of your losses.
– Wealthy people acquire assets and minimize liabilities
– Middle class people buy liabilities thinking they’re assets
– Poor people buy liabilities
Let me give some examples of assets and liabilities. This may be a bit revolutionary and I suspect a lot of people won’t necessarily agree. But under the above definitions, these are exactly right.
– Owning a business. A successful business that is… This one should be pretty obvious – your business makes a profit, you gain money at the back end. Yes there are expenses, but they are balanced out by the profits.
– Rental property. If your rent income exceeds your expenses, you get a positive cash flow. By definition, asset.
– Books or ebooks. The profits from the sale of these books brings in money.
– Investments. The higher the return and lower the risk, the better.
– Your brain. Ok, not exactly the squishy grey matter, but the knowledge, experience, and education you have inside. This is always a good place to invest in. This may be a little bit of a stretch to call it an asset in terms of it bringing you money, but it’s pretty close.
– Lots more. That’s part of this journey – finding and acquiring assets. This is a very limited list, but my goal is to continue to find an buy assets.
This is where it gets surprising…
– House. Do what?? I thought a house was supposed to be an asset? Well according to the definition above, my house is costing you hundres or even thousands of dollars a year. Taxes, utilities, mortgage, repairs – they all take money out of your pocket. By definition, this is a liability. But what about appreciation? Yes it’s true your house may be going up in value, but unless the appreciation of your house is greater than the expenses (which would be very unusual), it’s still losing you money. Also, prices of houses aren’t going up significantly; if anything they’re stagnate or even going down a little, depending on the economy. Rental property is different – you’re able to gain money from renting it out. Unless you take on boarders in the house you’re living in, it’s still a liability.
– Rent. Rent takes a chunk of change out of your pocket every month, so it should be pretty easy to see that it’s a liability too. So if both renting and owning a home are liabilities, what are you supposed to do? Find the one that loses you the least amount of money every month. Minimize your liabilities. Rent vs own is a completely different topic that I can get into another time if there’s any interest.
– Car . As much grief as I might get for this, a car again takes money OUT of your pocket, and doesn’t put money IN your pocket. Car payments, fuel, repairs, insurance, depreciation – none of these are earning you money. “But without a car, I wouldn’t be able to work? See, it does earn me money!” Unless you’re a cab or bus driver, your car is not earning you money. Your car takes you TO the place where you earn money. Big difference! In order to minimize liabilities, it’s good to have a cheaper (lower car payment if you have those still, lower insurance costs), economical (lower fuel costs), older (minize depreciation), yet still a quality (minimizes repairs and depreciation) car.
– Debt. Pretty easy here, debts cost you money. Sometimes a LOT of money such as credits cards, and sometimes less, such as mortgages. But they still take money out of your pocket. Minimize any debt you have!
So if you haven’t gotten it subliminally, here it is again:
A very easy litmus test for whether something is an asset or a liability is to realistically see if it puts money IN your pocket or takes it OUT.
If it puts it in, it’s an asset.
If it takes money out, it’s a liability.
Easy as that!