Reassess Assets

In my opinion having a realistic perspective of what exactly an asset is will go a long way toward keeping you out of financial trouble. It’s a word we through around a lot (particularly if we’re sophisticated), yet too often it’s attached to the wrong thing. I’m not sure when it happens, but somewhere along the road of life we’re programmed with a somewhat misleading representation of what assets are.

In the strictest sense of the word assets are things you own, and liabilities are things you owe. So your net worth would be your assets minus your liabilities (what you own minus what you owe). For example if you took out a $15,000 loan to buy a $20,000 car then you have a $20,000 asset and a $15,000 liability. Same thing for a house – a $100,000 loan for a $120,000 house means you have a $120,000 asset and a $100,000 liability.

We’re in the black in these two examples right? Yes. If we’re sticking to accounting rules then both the car (you owe money on) and the house (with a mortgage) would go on the left side of the balance sheet – assets.

This kind of reasoning from academia can get you in a lot of trouble in my opinion. Real life isn’t as simple as which side of the balance sheet something goes on and this simplistic (not sophisticated) view isn’t painting a complete picture.

When dealing with personal finance I think Robert Kiyosaki has more accurate definitions:

An asset is something that makes you money. A liability is something that costs you money.

Let’s go back to that $20,000 car. Anyone have a car that makes them money? Unless you’re running a escort chaffeur service your car is costing you every month in repair, maintenance, and operational costs. And what about your home, isn’t that the biggest investment most people will ever make (according to real estate commercials)? I hope not. Your home has huge maintenance and tax bills accompanying it monthly as well.

I’m not disagreeing that you can sell either of those and get more then you owe, but I am arguing that these are costing you money to possess. When you think about assets from this perspective you’ll be much more likely to avoid biting off too much. Want to trade up to a $500,000 house? Maybe, but that’s quite a liability (even if it’s paid for).

So don’t just look at the left side of your balance sheet without taking into account what kind of cash-flow those things are generating. Your income (not your assets) is your most powerful wealth building tool. That’s why we pay off debt fast, and that’s why we take a good hard look at what is really an asset.

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Related posts:

1. Balance Sheets Explained