These two words rarely come up in conversations. Even with my friends and colleagues, unless initiated by me, I have seldom noticed anyone popping them up into a regular chat. I guess there are good reasons for that. They sound complicated. They sound very “financial”. They just don’t fit in the “what are you planning for the weekend” talk. They also don’t really fit in the “what do you do after work” conversation. And yet, when it comes to financial knowledge, these two words are the most crucial terms and in my humble opinion, everyone should learn their meaning as early on as possible.
What is an asset?
Obviously, if one is about to learn something, one should always try to learn from the best. The book titled “Rich Dad Poor Dad” by Robert Kiyosaki was my personal eye-opener. It takes the most simple and accurate approach to define assets and liabilities with one-line definitions:
“Assets constantly generate money and put it in your pocket”.
“Liabilities constantly take money out of your pocket”.
That’s it. It doesn’t get simpler than that. And yet many have trouble getting the concept. Especially the traditional souls out there who dream about buying a house or condo might have some challenges with this definition.
I as house an asset?
The definition is clear in terms of what to do with your money in general. A car is not an asset. It uses energy, depreciates in value, you need to pay taxes, insurance and chances are that even if you use it to earn money with Uber, your net-balance will remain negative.
Stocks and bonds are assets IF they generate cash-flows and add on value. So personally, I consider dividend-paying stocks, REITs, and index-ETFs to be assets. Other stocks that are highly speculative and don’t pay dividends I consider to be just that: Speculations.
But how about a house? Is a house an asset? The answer to this question is: It depends. Unless purchased for a commercial purpose, they don’t generate cash per se and if purchased with a mortgage or with any other form of a loan, they actually take money out of our pockets, month-in, month-out.
Now you can argue, that you won’t need to pay rent and the money saved is equivalent to a handsome return on investment. It is a valid comment and one could definitely have debates about it. The reason why I would still hesitate to count it is due to the structure of mortgage payments. Especially during the first years of a mortgage, almost every penny you pay to the bank is actually only covering bank fees and interest. Very little is going into the actual payback of the loan. You are therefore actively spending money on it.
Furthermore, a house is good for a couple of years, but you do have additional costs associated with it which will grow even larger as the house gets older. Repairs, refurbishments, taxes, insurance. These factors play a big role and can massively diminish your return on your investment.
Buy assets, avoid liabilities
Once you have the understanding of assets and liabilities, all you need to do is to focus. Keep buying assets. Try to avoid liabilities. Following this simple rule will lead you straight to financial independence and out of the rat race.