No blog would be complete, when it comes to money and finances, if it doesn’t talk about assets and liabilities. This is one of those topics that you either know about already, or it is a completely different look at spending for you. If I was asked the difference between these two things about 3 years ago, I would have given you that deer in the headlights look and then came up with something that sounded intelligent. But today, I understand the difference between an asset and liability and urge you to do the same. It frankly can separate the rich from the poor.
What Is An Asset???
Simply put, an asset is anything that puts money in your pocket. It is anything that can make you money. For example, if you build a business and it is profitable, that is an asset. If you own rental properties and get paid monthly, by tenants, more money than it costs you to own the property, then it is an asset. An asset is anything that brings more money in than it takes out. With the rental property example…if you pay a total of $1000 a month for the mortgage and property maintenance, but charge $1500 in rent each month, you have a positive cash flow of $500 and the rental property is considered an asset. But what if it costs you $2000 a month to maintain the property and mortgage and you can only charge $1500 a month. Then you are losing $500 a month. This is not an asset. This is a liability!!!
What Is A Liability???
A liability is anything that takes money out of your pocket. So, if you have a negative cash flow on a rental property, the property would be considered a liability. Your car is considered a liability. You may be thinking, “Not mine, I paid that thing off a year ago.” That may be true, but you still need to pay for insurance, gas, and maintenance. No one is paying you for these things, so you have to pay out of pocket, thus it is a liability. Granted, this is a necessary liability if you need your car to go to work and make a living. But if you have a car in your garage that you rarely drive, providing no real value, then it is a huge liability. Liabilities always cost you money. Now, it is possible to turn your liability into an asset. For example, if you become an Uber driver and you are making more money with your car than it cost to keep it, then the car becomes an asset. You see how that works?
The Big Debate
There tends to be a big debate on whether or not your house is an asset. Most people would say that your house is an asset, but by definition, I would have to disagree. Does your house put money in your pocket? My house doesn’t make me any money. I have to pay my mortgage, electric bill, water bill, insurance, taxes, etc…. This is a lot of money out of my pocket, therefore, it is a liability. As a matter of fact, your house is a liability up to the point you sell it for a profit. Once you can sell your house and make a profit, it can become an asset. But up to that point, it is taking money out of your pocket and is a liability.
When you understand the difference between an asset and a liability, you can begin to look at your spending differently. When you buy a new cell phone, it is going to cost you money, both in the cost of the phone itself and the monthly plan to keep it connected. True, you may need a phone for your business, but do you need the most expensive one? Can you get a cheaper phone and put the amount you save into a good investment, like the stock market, and create an asset? Stocks can pay you dividends and go up in value. These put money in your pocket, thus they are assets. Poor people tend to buy more liabilities than assets. They buy unnecessary things, sometimes using their credit card just so they can have what they want. Why not put your money into assets and put your money to work? Your money can make you more money if you are smart with it and buy assets. This is a key difference between the rich and the poor. Understand this simple difference and your financial life can drastically change!!!
[…] Net worth is pretty simple really. It’s a simple math equation where you add up all the assets that you own and then subtract from that the total amount of all of your liabilities. We’ve talked about assets and liabilities many times before. If you want a little refresher, check out my post on Assets vs. Liabilities. […]