Let’s get down to some foundational stuff. Let’s talk about assets and liabilities and how they will determine your wealth and, ultimately, financial freedom.
The other day I saw a post online with a bunch of formulas and algebraic equations related to finance. The person who posted it asserted that anyone with a high school education should be able to understand and apply these concepts. In the poster’s mind, this would lead you to wealth.
I have to be honest. I would not have been able to solve one of those equations without assistance. And true, I am not yet wealthy. My net worth remains in the red. But…I am well on my way and making some big progress in a short time.
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My response to this was that this was way too complex and unnecessary.
In life, there are people who complexify and people who simplify
I am a simplifier. It works better.
Break things down to their component parts. Sift out the necessary and important parts. Discard the parts that add little and only confuse the picture.
In most areas of life, I find that this works well.
Finance is certainly no different. In fact, I think finance should be the poster child for simplifying.
People, myself included, get so confused by the whirlwind of information and misinformation surrounding the stock market, real estate, insurance, and personal finance in general. Often, it’s so confusing that she just figure it is too difficult and risky and avoid it out of intimidation and fear. Kinda like I did before last year.
Turns out, the best and most efficient strategy is just to invest in low cost, broadly diversified index funds and let it chill for a long time.
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Assets and liabilities
Now, onto the topic at hand.
You wealth is defined by two variables: assets and liabilities.
This is how your net worth is defined. Your net worth is your assets minus your liabilities.
So, we’ve now broken down our wealth into just two simple factors and one simple strategy.
That’s one simply strategy is this: increase your assets and decrease your liabilities to increase your wealth.
But what are assets? What are liabilities?
Now that we know the players in the game, we need to understand what they are.
And let me tell you, there are a lot of complex definition for these two terms out there.
But let’s keep it simple. That’s the whole point, right?
Assets are anything that makes you money, it puts money in your pocket.
Liabilities are anything that takes money out of your pocket.
(These definitions are courtesy of Robert Kiyosaki)
Let’s have some examples
I’m going to list some things. Decide if you think they are an asset or a liability. I’ll list my classification for each below.
- Your personal house
- Your retirement account
- A whole life insurance policy
- The car you are leasing
- Your cash-flowing rental property with a mortgage
- Your student loans
- A taxable brokerage account
Ok…here’s my answer key (argue about it if you must in the comments below!)
- Liability
- Asset
- Liability (in just about all cases but a few)
- Liability
- Asset
- Liability
- Asset
How’d you do? Did any answers surprise you? If they did, thing about it in a very simple way…does that item take money out of your pocket or put it in your pocket?
The home you live in, likely with a mortgage…definitely takes money out of your pocket. Also, if you lost your job and couldn’t pay the mortgage, what would happen? The real owner of the home, the bank, would come knocking and take the home. Same goes for a car loan or lease.
Compare that with a cash-flowing rental property like this one of ours. If you lose your job, your tenants keep paying rent. Money keeps going into your pocket. That, my friends, is an asset.
Same for retirement accounts, taxable brokerage accounts, and the like.
Maximize assets. Minimize liabilities. That’s it. That’s the game.
You know how net worth is calculated with assets and liabilities. You have a simple definition of what assets and liabilities are and are not.
So, what’s next?
Well, if you want to grow your wealth, achieve financial well-being, and reach financial freedom, just maximize your assets and minimize your liabilities.
That’s the name of the game.
Notice that the absolute numerical value of your income does not matter at all in this equation.
Your income, however high or low, is simply the seed money with which to maximize your assets or pay down your liabilities. That’s how I look at it and that’s how I recommend you look at it.
What changed for me
Once this flip switched for me, it just made so much sense and if I can do that for just one person, this whole blog is beyond worth it.
I made a plan to maximize my retirement accounts to receive the match, to aggressively pay off my massive student loans in 5 years, to invest in cash flowing rental properties, and to grow a business.
Nothing is special about me (ask anyone). There’s no requisite degree or IQ or time commitment to do this. All it takes is a “why,” a plan, and continued action.
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You can do it!!!
What do you think? How do you define assets and liabilities? Do you calculate your net worth regularly? What helps you keep on the right path to financial well-being? Let us know in the comments below!
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Great post, i definitely had an epiphany in reading it! wouldnt a house without a mortgage though be an asset in number one?
Hey Tom, thanks for reading! A house without a mortgage in my mind is kind of in some grey area. It still has liability traits in that it will take cash out of your pocket (repairs etc). Also, if you tap the equity in the house with a heloc for instance, then you just turned it into a big liability again. Also, if you sell it to get the equity out, well now you donāt have a house.
So I donāt really look at it as an asset, but once itās paid off it stops being a liability for sure!
Great point about cash flows on homes. Iām a recent first time home owner and my first few mortgage payments have been exceeded my repair and furnishing costs!
TPPS,
Rich Dad Poor Dad seems to be a common theme among all financial bloggers. The simple definition of assets put money in your pocket and liabilities take money out of your pocket is so clean.
Great post. The home debate is very tricky. I agree that it is a liability because it takes money out of your pocket but at the same time a home can help build wealth. If your property appreciates then your net wealth increases. You can also tap your equity with a HELOC which I also consider a liability…. but a heloc could be a useful tool in real estate if you use it as a temporary loan to perform the BRRRR method. So a liability with some upside… ?
Lastly, I think paying off the student loan liability is a priority for high interest loans but for low interest loans you might be better off paying over time and using your capital for investments. Your hybrid plan seems like a great balance. You skipped living like a resident but still budgeted to pay down your loans while owning a home and investing in real estate. I think your strategy will advance your cause more quickly then only paying down debt for your first three post grad years š
That Kiyosaki framing of assets and liabilities may be attractively simple but think about how profoundly it breaks down in the business world. For instance, in my world of Pharma a drug in development is going to cost the company an enormous sum for years but might be sold right now, before finishing development for hundreds of millions of dollars. The same is true for a new factory, establishing a new foreign affiliate or maintaining international patent rights. By the simple Kiyosaki formulation those are liabilities but they are among the best assets in my world. I think the problem comes with confusing the cash flow characteristics of an asset with whether it is an asset or liability. Lots of assets require cash but they are still assets and these assets have some of the best characteristics for tax treatment on an ongoing basis as well.
I partly agree with you but still think these items fall into the āputting money in your pocketā asset category because there is not necessarily a time frame on the definition. For comparison, all my real estate investments have thus far still lost me money. Even at 20% CoC return it will take each property 5 years to regain my initial investment. But they are still assets!
I like to think of my rental properties as
Assets (the Houses) paired with Liabilities (the Mortgages)
I agree with this. I like to think of it as debt that pays me to take it on – aka good debt!