Things you need to know about Assets and Liabilities

Back in 1998 there was not that much out there as it related to wealth building or the practice thereof.  In fact, this was at the very early stage of the Internet as we presently know it and was even before most of the popular bloggers and influencers that are currently in the wealth building space got started. There were very few people talking about things you need to know about assets and liabilities.  

To that end, the only resources that were out there would have been in old-school written and published books.  Remember those?

Why this is so important is because Robert Kiyosaki’s book ‘Rich Dad, Poor Dad’ was an absolutely seminal book in personal finance and certainly in the wealth building space at this time.  In fact, other than books that were indirectly about wealth building systems such as ‘The Richest Man in Babylon’ and the works available at that time by Napoleon Hill and Wallace D. Wattles, there were very few items of work focused on wealth building. 

Knowing what an asset and liability is sets the framework for wealth building

However, I would argue that ‘Rich Dad, Poor Dad’…whether one agrees or disagrees with most of the premise around the approach set forth in the book…is hard to argue against it being one of the more influential and directed book about the methodology of wealth building. 

In fact, it set forth some extremely important principles that should make up anybody’s wealth building framework.  One of the most important principles that the book set forth was its detailed explanation between the difference of an asset and a liability.  I believe that has become legendary in the wealth building community.

Of all of the wealth building principles, the distinction of what is an asset and what is a liability is a critical one.  More specifically, as a basic concept an asset is something that provides a financial value to you and has inherent value in the marketplace. 

Traditionally many individuals in the financial space had a much broader perspective of what was classified as an asset.  As a result, items such as gold, real estate, stocks, bonds, debt instruments all were traditional mainstays of the asset class and still are. 

Just because it costs a lot doesn’t make it an asset

In addition, items that had more variable and depreciable value such as jewelry, furniture, automobiles and collectibles were also considered assets.  However, what is an interesting distinction that I like to make is that the ideal asset is one that generates income for the holder of the asset and doesn’t depreciate in value. 

This becomes a very discriminating litmus test as the true assets then become ones that grow someone’s wealth appreciably through the ownership of items such as stocks, bonds, rental real estate, debt instruments, mutual funds and businesses.  Under this definition jewelry, automobiles, furniture and other such depreciable items wouldn’t be considered assets as they do not generate income for the owner. (However, in the following blog post I show you how to turn liabilities into assets https://thefinancialstoic.com/?p=226

Liability defined

As a basic definition, a liability is any item that costs you money or is something that reduces your wealth.  Traditional liabilities would be consumable items such as clothes, home goods, electronics, recreational equipment and just about any physical item that you have to purchase and in exchange only has its depreciable value which decreases over time.

Now what made this concept controversial?  To be honest, I never found it controversial at all and in fact, I found it to be at the time quite profound. 

It was pretty clear to me.  If it doesn’t generate income it’s not an asset. 

To me if someone is truly interested in generating wealth as quickly as possible this is the purest strategy available, as there is no question that an item being purchased is going to yield the best probability of generating income and or appreciating in value.

Although this concept doesn’t seem to be controversial at all Kiyosaki added an additional clarification when it came to single family housing. 

Single-family houses are great to have but really not an asset from a wealth building perspective

In his declaration, he indicated that he thought that single family housing was actually a liability because in his opinion single family owner-occupied housing actually costs you money on a monthly basis (mortgage, taxes, maintenance, etc.) with the promise that it MIGHT be worth more in the future. 

Although people could take exception to Kiyosaki’s assertion, and many, many people did, it isn’t much of a debate that your single-family house that you live in really doesn’t generate income.  In fact, it costs you a substantial amount of money each month to own and operate. 

For the most part, the only opportunity to receive a return on your investment is when you sell it and that’s dependent on timing the market to sell it at the top of a good market. In the worse case scenario, you may not have the choice as to when you sell it due to life’s circumstances.

Based on Kiyosaki’s interpretation, the purchase of a rental unit that generates a positive cash flow would undoubtedly be a better wealth building decision.  Not only does the bank allow you to control 100% of the asset for 20% down but if the property cash flows (and those are the only ones you buy!) then someone else gets to pay your mortgage.

Conclusion

There are several wealth building principles that are pretty significant but being able to identify an asset that builds wealth is perhaps one of the most important. 

Of course the reason for this is that in order to build wealth over time, and passively where applicable, it can really only be done by owning assets. 

More specifically, it can only be done by owning income generating assets.  In contrast to this, individuals who trick themselves by owning items such as automobiles, boats, furniture, jewelry, etc. because they have value in the marketplace are kidding themselves and more concerning, are denying themselves of wealth building opportunities. 

Knowing what a true asset is truly is the first step in building a solid foundation for a wealth building strategy.  In fact, simply focusing on income generating assets will put you on the right track and if combined with consistency and commitment over time will make you wealthy.