In my last post, I focused on what I believe to be considered THE definition of an Asset as it relates to building wealth. As a quick recap, in my opinion an asset is only considered an asset if it generates income and has a high probability of increasing in value for a reasonable return on investment. Beyond that, we have to learn how to avoid financial liabilities at all cost.
Now of course there are nuances. In order to hone in on these nuances I want to explain how I look at a financial liability. To fully understand what a liability is, it might be beneficial to review what an asset actually is https://thefinancialstoic.com/?p=223
Not every expensive item is an asset
Most Americans, in particular, like to justify every purchase they make that was expensive as being an asset. It’s understandable when you consider the fact that they had to part with a large amount of hard earned money in order to acquire these items.
However, I would argue that the exchange of money to acquire an item, regardless of how expensive that item was, is hardly a justification for it being an asset. In fact, most of these items that are purchased depreciate in value and by their very nature of being consumable items will not only continue to depreciate in value from when they were purchased but also don’t have any potential of creating income.
A car is a liability unless it makes you money
Let’s look at one of the most prolific examples of a liability that’s continually confused as being an asset. The automobile.
Most people who purchase an automobile will immediately classify that purchase as an asset because they parted with a LOT of their hard earned money to get it. However, even if it is a luxury car or a limited production vehicle, it is truly a liability.
They’ll continue to argue the point further that it’s an asset due to the fact that their outstanding loan might at some point in time be less than the market valuation of the vehicle. However, what it might be is ‘less’ of a liability. More specifically, that there is a little bit of residual value left over after the outstanding loan against the vehicle is paid off.
Unfortunately, in my humble opinion a vehicle is still a liability no matter how you slice it. The only exception is that rare occasion where a vehicle is generating income for you (this does not include vehicles you depreciate in a business) such as a particular YouTuber who is able to show that his Lamborghini IS the reason he generates income.
Although genius on his part, for the rest of us the purchase of a vehicle in our personal lives is purely a lifestyle purchase and is rung up in the L, for Liability, column.
If it doesn’t make you money it’s a liability
I would argue that outside of a business that just about everything that is purchased, including your single-family dwelling, is a liability. Let’s go deeper on this. Take for example the other favorite ‘faux asset’ class of jewelry and in particular, watches. I’m going to freely admit that I personally understand the allure of the beauty and fine craftsmanship of an expensive watch.
In fact, I’m a big fan of the Tag Huer brand and would love to own one one day. That said, however, I in no way can fool myself into thinking that it could somehow be confused for being an asset. It CLEARLY is a pure liability.
What about a more substantial purchase such as furniture? Part of the ‘big three’, housing, a vehicle and furniture, it is among the most expensive of all the purchases and even though it will have a substantial life it too is considered a straight line liability.
It needs to appreciate AND generate income to not be a liability
What about specialty items such as firearms? I heard someone tell me just the other day that he had never sold a firearm for less than he paid for it.
Now although one could argue that due to the possibility that it might appreciate in value it isn’t a liability, I would have to interject that it doesn’t normally have the profile of generating income AND appreciating in value and therefore IS a liability.
Let’s talk briefly about housing. It IS the ‘big one’ of the ‘big three’ when it comes to purchases. I can remember when Robert Kiyosaki the author of Rich Dad, Poor Dad came out and called a single-family house a liability. All the critics went ballistic.
A single-family house IS a liability
They argued that a single-family house always appreciates in value and therefore when the mortgage is paid off will leave the owner with significant equity or residual value. However, Kiyosaki argued that you ‘pay for it’, ‘it doesn’t pay you’ and maintained his position that a single-family house from a pure wealth building perspective should actually be seen as a liability.
Low and behold, 2008 rolled around in the United States and after the melt down of the economy and the housing industry a large amount of people saw the mortgages they held on single-family homes were significantly larger than the sale value of their homes.
Now these individuals found themselves having to pay each month for the home, along with all the expenses to maintain it AND had the privilege of having it be worth less than what they owed on it. Due to the possibility of this happening again when someone needs to sell a single-family house, for wealth building purposes I classify your own single-family home a liability.
Now what about collectibles? I have to be honest and admit that at least one time along my journey of building wealth (roughly between 2008 – 2010) the only things that I owned that seemed to be appreciating in value were two older American muscle cars that I had in my possession.
As much as that was interesting to me at the time it still didn’t overcome the issue that they still didn’t generate income even though they might have been enjoying a sharp increase in value.
The difficulty of dealing with collectibles, no matter what they are, is that even though they might be highly sought after and enjoy an increase in value over time due to market forces here’s the issue; they don’t offer the potential to generate income like a real asset.
In addition, the probability that they will act like a real asset from the standpoint of an increase in value is also speculative in nature versus that of a true asset because the ‘market’ that they trade on is purely trend and consumer emotion driven. Unfortunately, collectibles don’t ‘trade’ on the same basis as a true asset.
Conclusion
It’s not enough for something just to be expensive or significant, like your single-family house or a luxury car, to be an asset. It needs to add wealth to the net worth column. In order to do that it should generate income AND appreciate in value.
A wealth builder who is not easily swayed by popular opinion or the latest trend in the consumer market has a distinct advantage over the average person when it comes to building wealth. All a wealth builder needs to know is that if something doesn’t generate income AND have the potential to appreciate in value, it’s a Liability. Plain and simple!
